Valuation of Intangible Assets

As a follow-up to our posts “Profit from Intangible Assets in a Business Sale” and “Understanding the Value of Intangible Assets”, this post offers answers to the question, “How do you value intangible assets?”

In one of these posts, we looked at a simple example for valuing the Bayer tradename associated with its sale of aspirin using a simple capitalized earnings approach to a likely royalty stream. While the valuation of intangible assets is the subject of a dedicated course of study and professional certification, I will try to simplify these methodologies and offer other approaches to give you a general idea on how these assets are valued.


The same approaches to estimate the value of a business are applied to intangible assets. These are: i) the income approach; ii) the market approach; and ii) the cost approach. Selection of an approach depends on the situation and the characteristics of the intangible asset. The most common approach when valuing intangible assets is the income approach, while the less common applied is the market approach.

The income approach is a general way of determining a value indication of a business, business ownership interest, security, or intangible asset by using one or more methods through which anticipated benefits are converted into value. A method within the income approach is the discounted cash flows (DCF) method, based on the present value of the forecasted cash flows during the expected life of the asset.

The market approach determines a value indication of a business, business ownership interest, security or intangible asset by using one or more methods that compare the subject to similar businesses, business ownership interests, securities or intangible assets that have been sold.

The cost approach estimates a value indication of an individual asset by quantifying the amount of money required to replace the future service capability of that asset. [1]

[1] American Society of Appraisers – ASA Business Valuation Standards.


There is one technique that it is especially useful within the income approach. It is called the “with” and “without” method, since the objective is to extract the value of the intangible asset that it is in the company by determining the value of the business with and without the intangible asset. The difference between the two values is the value of the intangible assets.

Let me illustrate this technique with a simple example. Assume that you own a business and the buyer wants you to sign a non-compete agreement that says that you can’t compete within the industry (or geographic area) for three years. You agree. Therefore the value of the business is the value “with” the non-compete. The “without” scenario has you not sign the agreement with the expectation of competing day one after the deal closes. This competition will impact the buyer in many ways from a decline in revenues, the possibility of losing other staff, and the need to go out and replace you with someone else, likely through a recruiter. All of these costs add up and the buyer, in the “without” scenario suggests that the impact to the value of the business is $500,000 in lost profits and increased costs over the three year period they hoped to have you not competing. Therefore, the value of the non-compete intangible asset is the difference in value between the “with” and “without” scenarios. That is exactly how it works when dealing with an intangible asset.

Other applications of this technique are applied to estimate the value of employment agreements, franchise agreements, and key knowhow (formulas and other intellectual property) and processes and technologies developed internally.

In many ways, this approach highlights the overall theory of intangible asset value as a subset of the enterprise value. This concept is true in identifying specific income streams associated with certain intangible assets like technology and customer relationships. In thinking of your business as a portfolio of these tangible and intangible assets, some have low risk (real estate or fixed assets) while others have significant risk (technology, drug development; i.e intangible assets).

Other methodologies using the income approach include the Relief from Royalty (see our Bayer tradename example in our prior post), and the Excess Earnings (see above in terms of carving off income streams to an asset). Understanding these methodologies and the fact that every intangible asset has a “charge” that you need to apply to the other intangible assets, including the estimation of a discount rate that considers additional risk are fundamental when valuing intangibles. These concepts may be the subject of another blog.

Exit Strategies values intangible assets as well as control and minority ownership interests of private businesses for tax, financial reporting, strategic purposes. If you’d like help in this regard or have any related questions, you can reach Victor Vazquez, ASA, MRICS at

Selling Your Business in the Covid-19 Era

Business owners contemplating a sale may be asking the question: Is this a good time to sell my business or do I need to wait until the Covid-19 economic disruption is over?

Let’s explore three interrelated factors to help an owner answer that question for their situation.

Market Conditions

  • Are their buyers for my business during this pandemic?  Yes, there is no shortage of buyers for well-run companies.

That statement was true before Covid-19 and it is true during the era of Covid-19. As a M&A professional, I get inquiries almost daily from buyers who are interested in acquiring a well-run business that fits within their industry and financial parameters. In addition, buyers have access to capital at historically low interest rates, and deals are getting done.

Business Value

  • Will I be able to get the price I want in this market?  Yes, is the short answer.

The longer answer: Yes, if the seller has reasonable expectations based on past, present and future earnings, growth and risk. Yes, because buyers are competing. Yes, price is one component of value when selling, terms are the other component. The best offer is really a combination of the best price and terms available in the market.

Personal Needs

  • What is the best timing for me personally? The answers stem from asking yourself these questions: Are you ready? What will you do if you exit? How long do you WANT to work? Is your family taken care of? Are you slowing down?

Some people think – My business is always for sale, if the price is right. Right? No. Telling people you’re not for sale is no way to sell, at least not on your terms and preferred timeframe. Selling should be proactive, planned and deliberate. Selling a business is a process that takes time, on average, from start to finish 9 months.


The three factors discussed above don’t align perfectly in most business sales. The best outcome for a seller is a proactive and planned exit strategy. If you are thinking of selling within the next 2 years, now is the time to start the process.  Obtaining a professional assessment of value and sale readiness is normally one of the best first steps an owner can take in the sale process.

For more information on exit planning or the business sale process, Email Louis Cionci at or call him at 707-781-8582.


“Closing of the Books” to Allocate Income on S-Corp Ownership Change

As brokers and appraisers of closely-held and family-owned businesses, we work with a lot of S-Corporations. When S-Corp shares transfer subject to a buy-sell agreement, the valuation date, trigger date and transaction date rarely fall conveniently at the end of a year.  That’s no problem for valuation experts. We can determine value as of any date. But what’s the fairest way to allocate taxable income among S-Corporation shareholders in a year in which ownership changes?

The answer, according to Santa Rosa California-based CPA Dan Prince, is to allocate income among the S-Corporation’s shareholders on a per-share basis in the pre-change period and in the post-change period as if the  books were closed on the date of the ownership change. The shareholders agree to make what’s called a “Closing of the Books” election.

Let’s look at a simple example.

Greg and Matt each own 50% of an S-Corp’s shares at the beginning of the year, and on September 30 they both sell 1/3 of their shares to Bud, at which point they each own 1/3 of the shares outstanding. As part of their purchase and sale agreement, they agree to make a closing-of-the-books election.  Assume the Corp has pre-change income of $200,000 and post change income of $100,000, for a total of $300,000 for the year.

Under the Closing of the Books method, the allocation of the year’s income is calculated as follows:

  1. Greg: 50% x $200,000 + 33.333% x $100,000 = $133,333.
  2. Matt: 50% x $200,000 + 33.333% x $100,000 = $133,333.
  3. Bud: 33.333% x $100,000 = $33,333.

The Closing of the Books method is in contrast to the general rule where annual income is simply prorated on a per share per day owned in the change year.  Under this general “proration method”, here’s the income allocation calculation:

  1. Greg: $300,000 x (50% x 3/4 + 33.333% x 1/4) = $137,500.
  2. Matt: $300,000 x (50% x 3/4 + 33.333% x 1/4) = $137,500.
  3. Bud: $300,000 x 33.333% x 1/4 = $25,000.

In practice there’s more to this, but you get the idea.

Business valuation plays an important role in a buy-in, buy-out, buy-sell, redemption, MBO, ESOP or other equity transactions in privately-held businesses.  When you  transfer stock or LLC interests during a tax year, Exit Strategies Group can provide a business valuation but we are not CPA’s. Be sure to consult with your CPA and business attorney for tax and legal advice.

Al Statz is founder and President of Exit Strategies Group, Inc., a business valuation and M&A brokerage firm with offices in California and Portland, Oregon. For further information on this subject or to discuss a valuation or M&A question or need, confidentially, contact Al at 707-781-8580 or

One Business Appraiser that All Parties Know and Trust

Jointly retaining a single trusted business valuation expert in disputes over value is becoming increasingly common as owners seek ways to streamline the valuation process, protect their companies and control costs. Naming one appraiser in buy-sell agreements is also becoming more popular. In this slightly long-winded rant, I will discuss the pros and cons of using one appraiser that all parties know and trust, and explain why you should give serious consideration to this option.

Where My Thought Process Started

Exit Strategies has provided valuation services for many California companies going through involuntary dissolution processes.  Involuntary dissolution proceedings, per California Corporations Code § 1800 and § 2000, give minority shareholders who feel they have been victimized by those in control to force a liquidation or sale of the company, unless the corporation or its majority owners agree to buy them out at fair value.  CCC § 2000 stipulates that, “The court shall appoint three disinterested appraisers to appraise the fair value of the shares …”. Often, the judge in these cases requires that the appraisers work together to develop a conclusion of value.

What’s interesting to me is that in every CCC § 2000 case where I worked collaboratively with other competent appraisers from start to finish, we were able to reach agreement on a conclusion of value.  I’ve talked to several other BV experts who have similar experiences on such panels.

So, why do appraisers, working separately, reach different values?

I see three main reasons why Qualified (experienced and professionally accredited) valuation experts selected by opposing parties and working in isolation from each other are more likely to conclude different values for the same business:

  1. They have different facts. They ask different questions about the company, often of different people with different agendas, Then, using different information they arrive at different conclusions. Makes sense, right? Conversely, when appraisers receive the exact same inputs on a company, they are far more likely to produce similar values. If you hire multiple appraisers, be sure that they all get the exact same information.
  2. They head off in different directions.  Subtle differences in scope of work can have substantial effect on reported values.  Appraisers using different standards or levels of value are guaranteed to report different values.  It’s also common to see different valuation dates used.  Or, one appraiser reports a value of equity and another reports an undefined asset sale value. Often, the clients don’t even know this is happening.  And the appraisers don’t know because they are working in isolation. Such differences in direction are best identified and resolved in advance.
  3. Bias. Even though appraisers are supposed to be impartial, some succumb to pressure to deliver a result that favors the party that selected them or satisfies the attorney that hired or referred them. Exit Strategies’ professionals assiduously avoid letting bias creep into our valuations. (M&A advisory is a different story. There we absolutely advocate for our client.)

Now, CCC § 2000 cases are fairly infrequent, and usually the parties decide how many appraisers to hire. As this point you may be thinking, “wait a minute, doesn’t each shareholder need to have their own appraiser?” Let me turn that question around…

If a panel of appraisers working together generally see eye-to-eye, why have more than one?

The main argument for having multiple appraisers (besides putting more appraisers to work!) is that it can guard against an outlier opinion or one appraiser making an honest mistake. If you are careful in selecting the appraiser, however, you can mitigate these risks.

Cost is an obvious disadvantage to having multiple appraisers. Not only do the parties have to pay for 2 or 3 valuations, but appraisers generally charge more when they know they’ll be working in an antagonistic and uncooperative environment or when they know their report is likely to be challenged in litigation. The reason; more hours of work.

One very important disadvantage of hiring multiple appraisers is the deleterious effect it can have on shareholder relationships and the company itself. The perception of having an appraiser in their corner promotes divisiveness between owners. They become suspicious of the other expert(s). And doubling or tripling the number of information requests, interviews and follow up questions increases management’s workload, distracts them from running the business, and prolongs the valuation process. As the rift between owners grows and the company drifts, value erodes for all shareholders.

This seems to be a good point to summarize the advantages of a using single, jointly-retained business valuator — lower cost, less work and distraction for management, better shareholder cooperation, reduced likelihood that information will be withheld or biased, less danger of advocacy, and scope of work clarity. Next, let’s discuss how you go about selecting and working with a joint BV expert.

Keys to Success with a Jointly Retained Business Valuation Expert

  1. Get to know the expert. Establish trust between all parties and the appraiser at the outset. Start by requiring professional valuation credentials, several years of relevant BV experience and real-world business transaction expertise (not just financial theory). Ask around for recommendations. Jointly interview appraisers until you find one that you are all comfortable with.
  2. Correctly define the engagement, i.e. standard of value, subject interest, level of value, scope of analysis, type of report, valuation date, etc. Many buy-sell agreements and jurisdictions do not have well-defined valuation criteria. A trusted and Qualified BV expert can point out the various interpretations and work with the parties and their legal advisors to reach a consensus. Or the parties can have the appraiser produce multiple values using different interpretations, often for little extra cost.
  3. Require open communication. Set ground rules to involve all shareholders, and advisors (attorney, CPA, etc.) in some cases, in all communications with the valuation expert throughout the process. Shareholders should have access to all information requests and documents provided, be copied them on emails, be invited to fill-out and review questionnaire responses, be invited to all live interviews, presentations and meetings, and be given the opportunity to review and give feedback on a draft valuation report.

Getting to Trust an Appraiser

Successful jointly-retained experts have integrity and strong interpersonal skills. Get a sense of who they are by looking at their website and LinkedIn profile. Are they transparent and forthcoming with information? Can they write? Are they involved in their community and do they give back to their profession? Etc. Someone from a pure litigation support firm with little or no digital footprint probably isn’t right for this job.

In our experience, when we are jointly-retained, the parties are naturally more open and honest about company strengths/weaknesses, risks and future prospects. Separate experts rarely get the full access 360-degree view that a single expert with the support of all parties gets. In turn, they do better work and trust in them grows.

There is perhaps no better way to decide if you can trust someone than to work on a project together. If you know you’ll need an appraiser to set a share price for an imminent buy-sell transaction, don’t wait for the trigger event. Select an appraiser now and go through the valuation process together while there’s less at stake. You and your stakeholders will get to know the appraiser and the quality of their work. Further, the appraiser’s knowledge of the company and its industry will grow and they can probably recommend strategies to enhance the value of your company, which benefits all shareholders and more than pays for the extra appraisal.

What Business Owners Can Do

The next time you need an accurate unbiased business valuation or are preparing shareholder agreements, think about using a single Qualified BV expert that all parties know and trust.  Feel free to call us to discuss your needs and circumstances, or ask your attorney to contact us, in total confidence. We will let you know if we think this is a good option for you.

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Valuations play a part in all strategic transactions, tax, and many litigation matters.  Al Statz is President and founder of Exit Strategies Group, Inc. which has four California offices and has been selling and appraising businesses since 2002. Al is an accredited business appraiser (ASA and CBA) and a Merger & Acquisition Master Intermediary (M&AMI).  For additional information or advice on a current situation, please do not hesitate to call Al at 707-781-8580 or Email.

Four Questions Your Buy-Sell Agreement Should Answer

A buy-sell agreement is a common contract between shareholders that both restricts ownership and facilitates the transfer of shares in a closely-held company. The other shareholders or the company become the buyers (marketplace) for what would otherwise be highly illiquid stock. Every buy-sell agreement should answer four fundamental questions:

1. Who is the purchaser?

Generally, buy-sell agreements take one of three approaches to determining who the purchaser will be: Redemption, Cross-Purchase or Hybrid.

In a redemption agreement, the company buys back an owner’s shares. When there are several owners of the company, this may be the best method. In a cross-purchase agreement, the remaining owners purchase a departing shareholder’s interest. This type of agreement is often considered best when there are only two or three shareholders. The cross-purchase method becomes unwieldy when there are several owners and the agreement is funded by life insurance. Insurance policies will have to be purchased by each owner to cover every other owner, which quickly multiplies the number of policies needed. A hybrid agreement is a combination of the above two methods. Upon an owner’s withdrawal, the stock may be first offered to the other shareholders of the company. If they do not wish to buy some or all of the stock, the corporation then buys the shares.

2. What are the buy-sell trigger events?

A buy-sell agreement should be tailored so that a buy-sell is triggered if a company owner dies, becomes disabled, retires, gets divorced, becomes insolvent, has a falling out with the other shareholders or disassociates with the company for any reason. You, your partners and your attorney decide what triggers are appropriate and how shares will be valued and bought out in each case.

3. How will shares be valued?

One of three approaches is generally used to value a departing shareholder’s interest:
(a) Agreed Upon Price – Since the agreement is usually executed years before it is triggered, an agreed upon price is rarely used. The owners must make extraordinary efforts to update the value on a regular basis. In practice, the price is rarely updated.
(b) Valuation Formula – Somewhat common with very small businesses, as an attempted cost-savings measure. Can work when a business has stable management, sales, profitability and operations, and industry and economic conditions are static.
(c) Independent Valuation – This is the most accurate, robust and fair approach. An appraiser can deal with dynamic economic conditions, an emerging industry, complex capital structures, and changed business circumstances.

4. How will the buyout be financed and paid?

Often installment payments are made from the business’s operating cash flows over time, and sometimes life insurance proceeds upon an owner’s death are used. The approach taken should ensure that the business won’t be crippled with a large payout, and that heirs will have money when they need it. A lump-sum payment is available if life insurance is involved. However, if the corporation is to buy out owners during their lifetime, scheduled note payments may be necessary. If an owner retirement triggers a buy-sell, life insurance cash values can serve as a down payment. There is no assurance that a company or purchasing shareholders will have sufficient funds in the future to satisfy note payments. Getting this right requires thoughtful and early planning.

A buy-sell agreement is an important part of a closely-held business owner’s succession plan. There are many more questions to be carefully considered and answered. Exit Strategies provides business valuation and consulting services to owners and attorneys when creating and carrying out buy-sell agreements. We do not provide legal services but can connect clients with attorneys who have deep buy-sell knowledge and experience. Contact Al Statz at 707-781-8580 with any questions or to discuss a current need.

Does My Buy-Sell Agreement Establish Value for Estate Purposes?

Al StatzBuy-sell agreements that contain a clause that values stock at less than fair market value can be disregarded for tax purposes. It is important to consider the requirements of Internal Revenue Code (IRC) Section 2703 when developing an estate plan involving business interests in which 50% or more of the stock is family owned.

Section 2703(a) states that a shareholder agreement (entered into after October 8, 1990) that allows for the acquisition or transfer of property at a price that is less than fair market value will be ignored for estate and gift tax purposes. With respect to buy-sell agreements, Section 2703 provides that such agreements will set the value of shares for estate tax purposes if the agreement is binding in life as well as at death and results in the shares being transferred at fair market value.

Also, the buy-sell agreement must meet these requirements:

  1. It is a bona fide business arrangement.
  2. It is not a device to transfer property to members of the decedent’s family for less than full and adequate consideration.
  3. Its terms are comparable to similar arrangements entered into by persons in an arms­-length transaction.

A buy-sell agreement is deemed to meet the three requirements if more than 50% of the business enterprise is owned by individuals who are not members of the transferor’s family.

 A business owner’s estate plan and succession plan can be interrelated in other ways as well.  Exit Strategies does not provide tax counsel, but we connect owners with competent tax professionals.  Our accredited business valuation experts appraise privately held businesses and fractional interests for buy-sell, tax, exit planning and many other purposes.  Contact Al Statz at 707-781-8580 with any questions or to discuss a current need. 

Hidden Problems with the Price Formula in Your Buy-Sell Agreement, and Solutions

It is tempting to select a formula approach to pricing shares when business partners come and go. After all, a formula is easy for everyone to understand, and in theory at least, inexpensive to apply. If you’re satisfied with getting to a price, any price, then congratulations – job done. But the goal is to arrive at a price that is fair to all concerned. This article discusses some of the unforeseen problems with buy-sell pricing formulas that we as valuation experts encounter frequently.

As a quick introduction, buy-sell agreements usually employ one of three basic approaches to pricing shares upon buy-sell trigger events (when a shareholder retires, dies, becomes disabled, etc.):

  1. Fixed Price: Shareholders agree on a price per share and agree to periodically revisit that price.
  2. Formula: Shareholders agree on a formula to calculate share price. Examples include: book value; adjusted book value; 4 times trailing 3 years average EBITDA, etc.
  3. Independent Valuation: Shareholders agree on a professional business appraiser to determine fair market value (or another appropriate standard of value).

The pricing method prescribed in your company’s operating agreement, by-laws, or shareholder, buy-sell or stock restriction agreement, as the case may be, is important to the success of your next buy-sell transaction. So, what are these hidden problems with the formula method?

Businesses evolve, and formulas are static

No single formula will consistently produce a fair market value result year in and year out. It is common, for example, for companies to move from a project-based model to a recurring revenue model over time. The latter sell for higher multiples, yet the multiple stated in the buy-sell agreement still reflects the old business model. In this scenario, the buyer wins and the seller loses. Formulas don’t capture changes in the business, and eventually become irrelevant. Shareholders usually have every intention of updating pricing formulas, but in practice buy-sell agreements get filed away and forgotten about, and their formulas become stale. As years go by and shareholders’ interests diverge (some become buyers and some become sellers), renegotiating a formula to bring it in line with market value becomes increasingly difficult.

Value is forward looking, and formulas aren’t

One of the central tenets of valuation is that the value of an operating business is based on expected future financial returns, considering risk and market conditions at a point in time. Valuation is therefore a forward-looking concept. Past performance may be a strong indicator of what to expect going forward, or it may not. Let’s say a manufacturing company has invested heavily in new product development for the past three years or has just added significant equipment to increase production capacity. A multiple of earnings formula would grossly under-value the shares in this case. In our work testing buy-sell formulas and providing benchmark valuations, we find that prices determined by formulas often bear little resemblance to fair market value.

Formulas are seldom 100% replicable

I’ve seen three reasonable financial experts apply the same price formula to a company and arrive at three different answers because there were at least three ways to interpret the formula. Rarely do we see pricing formulas that are totally unambiguous. When the formula was created, no one was sweating the details. Years later, when buyers and sellers emerge, a formula that leaves room for interpretation will almost certainly result in a dispute. While seemingly straightforward, a pricing formula that is not designed by a seasoned valuation professional is very likely not 100% replicable.

Formulas can create the wrong incentives

An earnings formula creates a disincentive for a managing shareholder to invest in operations toward the end of his or her reign. If he or she expects to be paid a multiple of EBIT, they might hold back from making investments that fuel growth or allow the company to remain competitive. The exiting shareholder receive more per share, while reducing future cash flows, which reduces actual value. Conversely, an unscrupulous controlling shareholder who knows that other shareholders are nearing retirement, could overspend for a few years to reduce EBITDA and therefore the buyout price. It does happen.

Bottom line; pricing formulas often yield results that are not true economic values. They produce winners and losers, which leads to hard feelings, disputes, and sometimes litigation, which becomes shockingly expensive, time-consuming and disruptive; and destroys shareholder value for all concerned.

All of the above shortcomings can be overcome by having a valuation-based buy-sell agreement and appointing a qualified and experienced business appraiser. However, if you insist on using a formula, I recommend that you at least hire a valuation expert to do a benchmark valuation of your company and design a formula that is more accurate, more replicable, and more robust. Then have that appraiser update the valuation and test and revisit the formula every three years or so.

If you would like to have your buy-sell agreement objectively reviewed from valuation, economic, fairness and practical business perspectives, please give us a call. Al Statz, ASA, CBA, can be reached at 707-781-8580 or

Twenty Reasons to Know the Value of Your Company

Private company owners and shareholders seek independent business valuations at various times for various reasons. Here are twenty situations in which you may want to obtain a business valuation:

  1. An owner has passed away and a valuation is required to settle the estate per IRS regulations
  2. An owner is getting divorced and needs to have the company or their fractional interest valued to settle the marital estate
  3. An owner wants to gift shares to his or her heirs
  4. Business acquisition financing
  5. Owners need an independent opinion of value to comply with provisions of the company’s shareholder or buy-sell agreement
  6. A management buyout (MBO): the business can be valued on behalf of the current owners, or management or both
  7. When considering selling, merging with another company, or acquiring a company – an objective opinion of value can play an important role in setting expectations and having a successful negotiation
  8. One or more owners are developing a retirement plan and need to establish a preliminary value of their shares
  9. The business is often the largest asset in an entrepreneur’s investment portfolio – understanding its value is essential to any good personal financial plan
  10. Owner(s) wants to enhance business value – a current valuation establishes a baseline and identifies opportunities for value enhancement
  11. Owners are creating a buy-sell agreement or purchasing life insurance
  12. Owners want to part ways and need an independent valuation to determine the share price, because they can’t agree on price or their buy-sell agreement requires it
  13. The company is recapitalizing
  14. The company is converting from a C corporation to an S corporation
  15. The company (public or private) has acquired another company and needs to allocate the purchase price to all the tangible and intangible assets for financial reporting purposes in accordance with ASC 805
  16. The company has an employee stock ownership plan (ESOP) or incentive stock options
  17. The company has goodwill on its balance sheet and needs to test it for impairment in accordance with Generally Accepted Accounting Principles (GAAP)
  18. The company has stock-based compensation and needs to comply with IRC 409A and ASC 718
  19. The court, or one or more owners needs an independent valuation in support of litigation, or to avoid litigation
  20. The owners decide a capital call is required and one of the owners has become insolvent, triggering a buy-sell

Click here for more information on the different uses of business valuations.

Contact one of Exit Strategies Group’s business valuation experts to discuss a potential business valuation need, confidentially and at no cost.

Buried in the Corporate Archives – a Valuation Case Study

A lot of our valuation work is done for the purpose of internal share transfers of private businesses, or buy-sell transactions. In doing this work, we often see that owners have overlooked or neglected to keep important documents up to date. One such document is the buy-sell agreement, which articulates important legal, tax, valuation and financing issues that are important to ensuring smooth share transfers and business continuity.

We recently evaluated a holding company with a fair market value of approximately $40 million dollars. Two shareholders each owned a 50% interest in the company, a C Corporation, and one wanted to sell their stake to the other. The client said during our initial conversations that there was no buy-sell agreement in place, so we proceeded with developing a Fair Market Value opinion of a 50% interest. Just to be safe we requested a copy of “any agreements governing  or restricting the sale of shares”.

Guess what? Just as we were wrapping up the valuation, the client came across a type-written copy of the corporate buy-sell agreement executed in 1982. The owners and officers had been unaware of its existence. Hence, it hadn’t been updated and they certainly weren’t aware of its terms and provisions. As we reviewed the agreement, we found that it prescribed that any transfer of company shares would be at book value. In this case, book value was less than $1 million dollars.

A buy-sell agreement is a legally enforceable contract.

In the 2011 New Jersey Appellate Court case of Estate of Cohen v. Booth Computers, the partnership (buy-sell) agreement stated that value would be “net book value, plus $50,000, on the most recent financial statement.” When Cohen passed away this formula generated a value of $178k. Cohen’s heirs had the business appraised for $11.5 million. The Court upheld the $178k value based on the terms of the partnership agreement!

For our client, this was a nightmare waiting to happen. Imagine what would have happened had our clients not had a great relationship — the seller could have received less than $1 million for a $40-million-dollar asset! Fortunately, the owners were committed to a fair deal and they agreed to set aside the buy-sell agreement.

To assure that your company shares will transfer for an appropriate price when your buy-sell agreement is triggered or to put a buy-sell agreement in place, contact a business appraiser who is experienced in valuing company shares for buy-sell transactions. When you bring in a seasoned business valuation expert early on to interpret the pricing mechanism and other terms of your existing buy-sell agreement, they can recommend changes that will ensure that the agreement will operate the way the shareholders intend. And the sooner the better. It’s an easy discussion while all shareholders interests are aligned. Later on, as shareholders becomes buyers and sellers, their interests diverge and in most cases making changes to these agreements become far more difficult.

For further information on buy-sell agreement business valuation or to discuss a potential need, confidentially, please one of our senior business appraisers.

Pricing Methodologies in Buy-Sell Agreements

When it comes to valuing a business for tax filings, M&A transactions, ESOP’s and most other purposes, business appraisers are usually free to use all of the methodologies in their arsenal.  But, when it comes to Buy-Sell Agreements that govern the sale or exchange of interests among closely-held business owners, many of these agreements specify a fixed amount or formula to price equity interests. Recently our firm analyzed the valuation and funding-related provisions used in thirteen buy-sell agreements that we encountered over the past several months.

Here’s a summary of the pricing approach taken in those agreements:

• 6 called for one or more independent valuations to determine share price (46%)
• 6 contained a predetermined price formula (46%)
• 1 used a fixed price (8%)

Despite the small sample, our findings were remarkably similar to a survey by forensics and valuation services firm Dixon Hughes Goodman LLP, which asked attorney’s what their preferred method was for valuations in BSA’s:

• 43% prefer a valuation
• 39% prefer to prescribe a formula
• 17% default to using a fixed price

Using a valuation process in a buy-sell agreement normally produces a value that is most fair to all parties, that stands up to scrutiny, is less likely to result in a dispute, and is less likely to be challenged by tax authorities.  On the other hand, the use of formulas and fixed prices introduces potential landmines that should be avoided under most circumstances.
Proper business valuation is one of the keys to making buy-sell transactions occur smoothly and cost-effectively. Jim Leonhard works out of Exit Strategies’ Roseville, California office. For more information feel free to Email Jim or call him at 916-800-2716.