Creative deal structures and deal terms move to lower middle market

When selling your business, price is not the only important factor you’ll negotiate with a buyer. The deal structure includes a wide range of considerations from transaction type, ownership and payment structures, working capital, assurances, timelines, and more.

What we’re seeing in the market right now is a rise in creative deal structures. These are non-typical solutions that help dealmakers bridge some sort of gap between the buyer and seller. If properly negotiated, these structures can make a lot of sense for both sides, but it’s critical for a seller to have an experienced M&A advisor and transaction attorney on their side to ensure they understand these more complex provisions.

An earnout is, perhaps, the classic example of a creative deal structure. Under these agreements, the seller receives additional payments provided the business hits certain targets down the road. Earnouts can be a great way to bridge valuation gaps, such as when the business is expecting a big performance boost in the near future – and the seller wants to be paid for those as-yet-unrealized gains.

Some creative deal structures are more common in the middle market M&A (transactions with values over $50 million). But as private equity buyers continue to shift into the lower middle market (business values of $2 million to $50 million), they’re bringing deal structures like these with them:

Reps and warranties insurance. When selling your business, typically you’re going to “represent and warrant” certain things about the business (e.g., you’ve provided accurate info, no known legal or customer issues pending). If something turns out to be not wholly accurate, the buyer can come back to you for a certain percentage of the purchase price.

In smaller deals, the seller will simply agree to a guarantee. But as transactions get larger, buyers may ask sellers to put that money in escrow. That money is then tied up for a certain period of time, not earning any returns.

As an alternative to escrow, the deal can include reps and warranties insurance. In this case, the insurance company does their own due diligence and agrees to take on that risk. The advantage for sellers is that they don’t have to hold that money in escrow anymore and shed the risk of covering a reps and warranty claim during the warranty period.

Premiums for reps and warranties insurance often start at around $250,000. Because of the cost and additional diligence required by the insurer, it was only common in larger transactions over $50 million. Now we’re seeing that move down into deals as small as $10 million in enterprise value.

In some cases, buyers are using reps and warranties insurance as a tool to win the deal. If competition is strong (and these days it often is), buyers may offer to pay for reps and warranties insurance. As sellers evaluate multiple offers, they might consider the opportunity to bypass escrow as a factor that tips them in a buyer’s favor.

338(h)(10). In these transactions, the deal is treated as a stock sale from a legal standpoint but as an asset sale from a tax standpoint. From a legal standpoint, this structure can eliminate the need to comply with time consuming and sometimes challenging customer contract “change in control provisions.” For the buyer, that means they can get a step-up in basis and re-depreciate the assets they just acquired.

F reorganization. An F-reorg is a tax efficient method to allow the seller to rollover equity into the new business (i.e. retain a small portion of the business ownership) without paying taxes on the rollover amount.

Without using an F-reorg, for example, the seller might sell 100% of the company and get taxed on that full amount before reinvesting some of their proceeds in the buyer’s new entity.

Deal makers predict an increase in these and other creative deal structures in the year ahead. The pandemic is one factor behind that. Businesses saw their operations disrupted, and that has created some business opportunities and some risks. Alternative deal structures are one way for buyers to mitigate valuation gaps, reduce seller’s taxes, and create win-win agreements between buyers and sellers.

Deal competition and private equity activity are also driving creative structures. According to a Mergermarket survey, private equity respondents indicated they were more likely to consider creative deal structures than corporate dealmakers (75% to 37%).

That may be because private equity firms simply have more experience with these structures. Or it could be that they have a stronger imperative to win deals, and creative structures provide more flexibility to do that. Regardless of the reason, by utilizing an experienced M&A advisor sellers have an opportunity to embrace these more complex deal terms leading to increased enhanced upside.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at Exit Strategies Group is a partner in the Cornerstone International Alliance.

How 100 minus 90 equals 20

Here’s a story of how 100 – 90 = 20. We recently represented some owners who had lots of options when it came to selling their business. They had a high demand manufacturing operation, and buyers wanted in – offering everything from minority or majority investments to full exit options.

At first, the sellers thought they wanted a full exit, all cash at close. If they were going to give up control, they figured it was best to cash out. But as they continued to talk with potential buyers and partners, they began to consider a majority recapitalization.

In a majority recap, the owners sell a majority interest to investors who provide a cash infusion. The sellers maintain a meaningful minority stake in the business and, typically, continue to manage the “recapitalized” operation.

In this transaction, the sellers got 90% of company value as cash at close, rolling over just 10% of their proceeds into the new company. But because of the debt structure on the new entity, that 10% actually translated into a 20% ownership stake.

A typical model for investment buyers like private equity firms or family offices is to put roughly 50% debt on the new company. This allows them to leverage their equity and generate a better return. Through that debt arrangement, the value of the sellers’ rollover essentially doubled to 20%.

Majority recaps are a way for an owner to diversify their net worth while also getting a strong financial partner who will help grow the business. Typically, these transactions are structured so that the seller (aka the new minority owner) holds no personal guarantees on the debt.

So worst case scenario, if the company goes totally south, they’d only lose that 10%. No one could go after the 90% they already took out of the business. It’s like the seller gets to take their chips off the table and play with the “casino’s money”.

Value today

Business valuations are strong today. Market conditions are such that there are a lot of well-funded buyers out there looking for opportunities. We’re in a seller’s market and people are seeing values trending at or above previous benchmarks in their industry.

What that means is that the 90% cash at close our sellers took in this deal was probably worth as much or more than a 100% sale would have been worth a few years ago.

Value tomorrow

As we say in M&A, majority recaps provide the seller with a “second bite of the apple.” That second bite typically occurs four to seven years after the initial recap.

After a period of investment and growth, the majority and minority owners agree to liquidate value (i.e., “re-sell” the business). If performance has been good, the owner’s minority shares could be worth similar and sometimes more than they received in the original transaction, depending on how much equity they roll over.

Gain or give

For some sellers, that extra minority stake in the business is really bonus money. We sometimes see sellers use deals like this as a way to transition ownership to their children or their management team. (Note: Roll over equity could be 10%–49%).

It’s a way to provide people with a meaningful ownership stake and opportunity for growth – without risking their own financial future in the process.

Control issues

When considering a majority recap, understand the role your new partners will want you to play in the business. Sellers think, “I’ll be a minority owner and I won’t have control anymore.” While technically true, it’s not the reality of most relationships.

Financial buyers (i.e., investors) are not looking to come in and take over your business – not if they can help it. These buyers prefer companies with strong management teams who have a vision for the future. They want to support the team that will grow the business – not control them.

The takeaway here is that you have options when selling your business – lots of options. Sell and exit right away, sell and stay, minority stake, majority stake, control, consult, gift, succession plan. It’s all on the table in today’s M&A market.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.comExit Strategies Group is a partner in the Cornerstone International Alliance.

M&A Advisor Tip – Know Your Priorities

The market is still strong, and sellers are receiving multiple offers, but the buyers they choose aren’t always the ones with the biggest checks.

Would you take a lower price to ensure that the buyer’s culture fits yours? How about a million-dollar price cut if it meant getting all cash at close and avoiding years of seller financing? Or trading $100,000 in salary to for an extra $1 million in sale price?

Sellers face these kinds of choices all the time. Potential deal structures should be carefully considered and explored, long before you reach the negotiating table. Whether or not you realize it, you’re positioning and negotiating from day one of a sale process. If you don’t have your priorities figured out, you might give a buyer the wrong impression … and that can spoil a deal.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.comExit Strategies Group is a partner in the Cornerstone International Alliance.

M&A’s dirty playbook

If you work in M&A, you can take a class on how to take advantage of people. It’s true! Buyers can go through mergers and acquisitions training, at some of the most prestigious universities, learning how to pay as little as possible for a family-owned business or privately held company.

M&A transactions are complex, and it’s natural that buyers and sellers will have some competing interests. When both parties come to the table in good faith, with a commitment to finding a workable agreement, these negotiations don’t have to be overly contentious.

But when buyers are out to do their worst, negotiations can devolve into a hostile power play. Worse yet, some sellers don’t know enough to push back. They get steamrolled and taken advantage of by specialists who wake up every morning intent on getting the best possible deal for their investors, at all costs.

These buyers know what they’re doing and they’re willing to play dirty to get what they want. Here are some of the tactics they might use:

Tie you up in exclusivity

Many M&A negotiations include a no-shop clause. This is a period of exclusivity when the seller cannot solicit offers from other parties. The due diligence process is expensive for buyers, so sellers sign these agreements as an act of good faith, giving buyers some security that their investment will be worthwhile.

Typically, a no-shop clause has a near-term expiration date and are only in effect for a couple of months (45—90 days). Buyers with a lot of leverage, and those working with inexperienced sellers trying to represent themselves, will work hard to tie you up in exclusivity for as long as possible.

If they can get away with it, the no-shop clause won’t have any expiration date at all, allowing the buyer to drag their feet indefinitely. Which brings us to the next strategy…

Drag it out

The goal here is to wear the seller down. They’ll request more and more documents. They’ll find “surprise concerns” they need to discuss with their team.

They’ll tell you, “We like your company, but we’re finding some issues we need to look into more. We need you to get us X, Y, Z.” They want to amplify tension, use up your mental energy, and distract you from the real work of running your business.

Re-trading the deal

At the end of the day, the whole play is about getting you to accept a lower value. You will have entered into exclusive negotiations based on certain expectations, but they’ll “uncover” issues to rationalize a price adjustment – an adjustment they were planning on from day one.

Play on your emotions

In the book of dirty plays, this one is a doozy. Buyers will find out key occasions in your life: your spouse’s birthday, your kid’s graduation date, your anniversary. And right before the big day, they’ll find something in due diligence and call an emergency meeting.

They’ll make you think the whole deal is going to blow up if you can’t make that meeting. Again, they’re looking to get you to wave the white flag of surrender.

In every industry, there are good and bad actors. Unfortunately, the bad ones are perfectly willing to engage in psychological warfare.

The less interaction the buyer and seller will have after a sale – i.e., the less future success hinges on the seller’s continued cooperation – the less incentive a buyer has to treat the seller fairly. Unsuspecting sellers can find themselves at the losing end of a winner-take-all kind of game.

It’s like a boxing match. You’re going into the ring at 0-0 and they’re at 40-2. They’ve been playing the game for two decades. I don’t care how strong you are, you’re not going to win that fight. That’s why it’s important to have professional, specialized advisors by your side before you enter the game.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at Exit Strategies Group is a partner in the Cornerstone International Alliance.

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 a 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. At 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.

Three Keys to Success Using a Jointly Retained Business Valuation Expert

  1. Find, select and get to know the expert. Ask around for recommendations. Require professional valuation credentials, several years of relevant valuation experience and real-world business transaction expertise (not just financial theory). Be sure they are unbiased and have no conflict of interest.  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 all communications with the valuation expert throughout the process. Shareholders should have access to all information requests and documents provided, be copied 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 high 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? 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 greater trust is built.

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 a trigger event. Select an appraiser now and go through the valuation process together while there is 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 even recommend strategies to enhance the value of your company, which benefits all shareholders and more than pays for the extra valuation work.

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 valuation 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.