Lessons Learned After Connelly Reflections from the October 2025 BVResources Webinar

/in , /by Joe Orlando

In January 2025, our firm published a blog on the impact of the Connelly v. United States case and how the court’s ruling has influenced business valuations. In October 2025, I had the opportunity to present at a Business Valuation Resources (BVR) webinar titled “Lessons Learned After Connelly: Valuation, Insurance, and Planning in Practice.” The session brought together valuation analysts, estate planners, attorneys, and advisors to examine how the Supreme Court’s 2024 decision in this case is reshaping the valuation and planning landscape. Although the ruling appears straightforward at first glance, its implications for buy-sell agreement design, estate tax exposure, and valuation methodology are significant.

As our prior blog detailed, the Supreme Court unanimously held that corporate-owned life insurance must be included in the value of a business for estate tax purposes. This sounds simple, but as we discussed during the webinar, the decision created new urgency around understanding how life insurance appears on the balance sheet, how redemption arrangements function, and how valuation professionals approach buy-sell structures. Many practitioners are now discovering issues that had gone unnoticed for years.

Clarity Around a Complex Decision

During the webinar, we reviewed the facts of the Connelly case, which involved two brothers who owned all shares of their company. Their buy-sell agreement (BSA) was funded with $3.5 million of corporate-owned life insurance. Although the agreement required regular updates to a Certificate of Agreed Value, none were ever executed, and no appraisal was performed during either brother’s lifetime.

When Michael passed away, the corporation received $3.5 million of insurance and was required to redeem his interest. The estate’s valuation excluded the insurance proceeds and relied on the position taken in Estate of Blount (11th Cir.). The IRS disagreed, asserting that the insurance proceeds were corporate assets and must be included in the company’s value. The Supreme Court ultimately affirmed the IRS position, noting that the redemption obligation was not a liability that reduced corporate value.

The decision surprised many. However, as we noted in the webinar, Connelly did not create new law. It simply reaffirmed existing valuation principles that require non-operating assets, including life insurance, to be included in corporate equity value unless already accounted for elsewhere. This is consistent with the valuation concepts outlined in Rev. Rul. 59-60 and Treasury regulations.

Valuation Takeaways for Practitioners

My portion of the webinar focused on valuation implications that closely mirror the guidance we share with clients when reviewing or valuing buy-sell agreements. Several themes stood out:

  1. Life insurance is a non-operating asset that must be included in value. Whether the proceeds are allocated for redemption does not change their status as corporate assets. Practitioners should treat entity-owned life insurance consistently with other non-operating assets.
  2. Many buy-sell agreements no longer reflect their intended purpose. We regularly encounter agreements that contain outdated formulas, vague valuation requirements, unclear pricing language, or poorly designed redemption arrangements. Connelly did not create these problems, but it magnified them.
  3. Benchmark valuations are an effective planning tool. As in our previous discussions with clients, establishing an initial valuation and periodically updating it can reduce disputes and increase certainty. This approach is consistent with the guidance we provide in our broader writing on valuation and buy-sell planning.
  4. Use secondary-market indications to benchmark fair value. Policy’s fair value often differs from cash surrender value (CSV) or Form 712. Health status and market demand, in most cases, make CSV an unreliable proxy.  Obtain life-settlement bids or an opinion supported by longevity analytics.
  5. Collaboration among advisors is essential. Because buy-sell agreements involve legal, tax, insurance, and valuation considerations, coordinated review is necessary. Connelly demonstrated what can happen when these areas are addressed independently.

Why This Matters for Private Companies and Advisors

For closely held businesses, the Connelly decision serves as a reminder that buy-sell agreements require regular maintenance. They are not static documents. If an agreement is not reviewed periodically, it can lose its relevance and fail to hold up under scrutiny. For valuation professionals, the decision reinforces the importance of understanding how insurance-funded redemption structures affect equity value, estate tax exposure, and appraisal methodology.

As noted in our earlier writing, effective buy-sell agreements provide an orderly transfer mechanism, restrict ownership appropriately, create liquidity for departing shareholders, and include a clear and supportable valuation process. These principles remain unchanged, but the need for careful drafting and regular review has increased.

Looking Ahead

The strong engagement during the webinar reinforced that advisors are actively adjusting their planning approaches in a post-Connelly environment. As clients revisit their agreements or consider new valuation benchmarks, it is important to ensure that insurance structures, valuation methods, and legal provisions are aligned.

Built on our firm’s many years of institutional experience and knowledge in helping clients structure and update BSAs, we utilize a proprietary database of the terms associated with BSAs to present the topic of “Avoiding Landmines in Buy-Sell Agreements: A Business Valuation Expert’s Perspective” to attorneys and CPAs for CPE credit.

If you are interested in having us present this topic to your professional staff for CPE credit, please get in touch with Joe Orlando at 503-925-5510 or jorlando@exitstrategiesgroup.com for more information.

THE IMPORTANCE OF BUY-SELL AGREEMENTS IN BUSINESS CONTINUITY

/in , /by Joe Orlando

For business owners, a well-structured buy-sell agreement is essential for ensuring a seamless transition of ownership in the event of death, disability, or retirement. These agreements define who has the right to purchase ownership interests and at what price, mitigating potential disputes among partners, heirs, and buyers.

Valuation: A Critical Component

A properly structured buy-sell agreement includes a clear valuation method to determine the fair market value of a departing owner’s shares. Common valuation approaches include:

  • Business appraisal – An independent assessment by a business valuation expert(s) based on fundamental business valuation methodologies and the prevailing market conditions.
  • Formula-based calculations – Methods such as EBITDA multipliers, revenue multiples, or asset-based valuations.

To maintain fairness and accuracy, business owners should:

  1. Select an appropriate expert to determine the appropriate valuation methodologies that reflect the company’s fair market value.
  2. Review and update valuation methodologies regularly to align with market conditions.
  3. Avoid outdated valuation metrics, which can lead to financial disputes.

Lessons from Pappas v. B & G Holding Co.

A failure to update valuation terms led to a four-year legal battle in Pappas v. B & G Holding Co.:

  • William Egan, a 50% owner of B & G Holding Co., passed away, leaving his interest to a beneficiary, Dean George Pappas.
  • A pre-existing buy-sell agreement required the surviving partner, Eugene Leogrande, to purchase the shares at a predetermined price.
  • Pappas contested the valuation, seeking a fair market assessment instead of the agreement’s preset formula.
  • The court upheld the buy-sell terms, requiring Pappas to sell the shares for $318,348—likely based on an outdated rent-multiple valuation method.

Key Takeaways for Business Owners

  1. Review Buy-Sell Agreements Regularly – Ensure valuation methods reflect current market conditions. Outdated figures can significantly undervalue or overvalue a business.
  2. Update Your Valuation Annually – Some agreements require annual updates. These updates allow business partners the opportunity to assess value within their strategic planning process to identify ways in which to grow value.
  3. Prioritize Fair Market Value – Formula-based calculations become stale with new market data. Failing to update them may force reliance on outdated formulas. Market-driven valuations promote transparency and fairness.

Exit Strategies values control and minority ownership interests of private businesses for tax, financial reporting, and strategic purposes. If you’d like help in this regard or have any related questions, you can reach  Joe Orlando, ASA, at 503-925-5510 or jorlando@exitstrategiesgroup.com.

Will your business survive losing you?

/in , /by Al Statz

Most entrepreneurs are a rare breed — full of optimism and confidence. But that faith and certainty can also make them feel invincible. Every business downturn will be the last, every new year will be another record, and every good leader retires happily with their family.

Unfortunately, none of us are invincible. And if you’re like many business owners, a significant portion of your wealth — and your family’s income — is derived from your business.

Consider taking these practical steps to minimize the effects of your death or incapacity on your family, employees and business:

Partnerships

If you have partners, update your buy-sell agreement to be sure it reflects your current business situation. I’ve seen many business owners set these agreements up when they start or purchase their company, only to let them sit for 15 years, unchanged as partners come and go and as business and market conditions change.

Many business partners fund their buy-sell agreements with life insurance. Insurance proceeds can be used to purchase your ownership interest from your estate. Your family is made whole and the business isn’t burdened with debt.

Get an updated estimate of value every 2 to 3 years, then adjust your buy-sell agreement and  amount of life insurance accordingly. If you don’t, both your family and your business could be mired in litigation and/or face financial difficulty. As valuation experts, we’re often involved in settling disputes over value.

Consider this scenario.  The fair market value of a company is $10 million, but it is insured for just $4 million. Two 50/50 partners have $2 million of life insurance on the other partner.  If a partner dies, there will only be $2 million to pay the departed partner’s estate, leaving a $3 million gap.  That’s a significant liability for the company to bear, and paying down that debt could mean forgoing growth investments for years to come, negatively affect the company’s ability to compete and reducing the chances of the departing partner’s estate getting paid.

Sole Owners

If you can, build up a management team that can carry on without you. Hire and groom your eventual successor. The better key employees are able to operate the business without you do, the better off your company (and family and partners) will be in the event of your death, illness (or even a business sale).

Even if you don’t have a partner, life insurance can still be a good tool. Proceeds can sustain your family for a while, buying them time to sell the business or establish new leadership. It can also provide the business with the extra equity necessary to hire a transitional CEO or increase management salaries after you’re gone.

Beyond life insurance, you should have a written contingency plan in place to transition business leadership and ownership if you die or become incapacitated.

Contingency Letter

Many business owners have life and disability insurance and a trust, will, power of attorney, medical directive and related documents in place, but few have prepared a letter of guidance to their spouse and family on what to do with their company if something happens to them. We have a Sample Contingency Letter that we share with clients that don’t already have something like this in place.

Whether your plan involves a family member or key employees stepping into your leadership shoes, whether it involves a sale of the company or transfer to existing partners or employees, you’ll want to sit down and talk through your plan with everyone involved, including your spouse, partners and leaders, attorney and CPA.

 

Sorry for the morbidity here, but all of us business owners need to put our entrepreneurial optimism aside once in a while to plan for the worst. There may be nothing worse than losing a loved one, than when that tragedy is compounded by the stress and conflict that results when survivors are left with a distressed business and no clear plan for moving ahead.

For advice on contingency planning or selling a business, contact Al Statz, founder and CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com.

Buy-Sell Agreement Valuation Resources

/in , /by Al Statz

Every business with two or more shareholders should have a buy-sell agreement. A buy-sell agreement is a legally binding contract that restricts and governs how shares are priced and transferred between shareholders or partners of closely-held businesses when certain trigger events occur. Arguably, valuation is the most important (and argued over) aspect of buy-sell transactions.

A good one-third of our business valuation work relates to internal equity transactions, and because this is an area of our practice that we are extremely involved in and passionate about, we’ve authored many articles about buy-sell agreements over the years. This post is a compendium of those articles, for easy reference:

Exit Strategies Group’s Buy-Sell Agreement Valuation Articles

  1. Choices of Pricing Methodologies in Buy-Sell Agreements
  2. Pros and Cons of Price Formulas in Buy-Sell Agreements
  3. Hidden Problems with the Price Formula in Your Buy-Sell Agreement, and Solutions
  4. How a Covenant not to Compete Affects Value in Buy-Sell Agreements
  5. Does My Buy-Sell Agreement Establish Value for Estate Purposes?
  6. Funding Your Buy-Sell Transactions
  7. Four Questions Your Buy-Sell Agreement Should Answer
  8. The Dismal D’s of Buy-Sell Agreements (shareholder departure, disinterest, divorce, death, disability, etc.)
  9. Buy-Sell Agreement Categories (as defined by the relationship between the parties to the agreement, i.e., the individual owners and their business entity.)
  10. Your Buy-Sell Agreement: In good shape? Needs a tune up? Or disaster waiting to happen?
  11. Your Buy-Sell Agreement – Keep It Current Before It Costs You Money and Grief!
  12. One Business Appraiser that All Parties Know and Trust

Finally, a summary of Exit Strategies Group’s services relating to buy-sell agreements.

MCLE Workshop for Attorneys

Our team also developed a free workshop for attorneys titled, “Avoiding Landmines in Buy-Sell Agreements: A Valuation Expert’s Perspective.” This program qualifies for 1.0 hour of MCLE credit and has been attended by over 250 attorneys so far. Contact Joe Orlando for further information.

Exit Strategies Group provides business valuation and consulting services to business owners and attorneys, to help them create, fix and administer buy-sell agreements (BSA’s). Feel free to check out these articles, and don’t hesitate to reach out to one of our senior appraisers with a related question or potential need.

Al Statz is the founder and President of Exit Strategies Group, Inc. For further information on this subject or to discuss an M&A, exit planning or business valuation question or need, Email Al or call him at 707-781-8580. 

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

/in /by Al Statz

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 alstatz@exitstrategiesgroup.com.

Four Questions Your Buy-Sell Agreement Should Answer

/in /by Al Statz

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?

/in , , /by Al Statz

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

/in /by Al Statz

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 alstatz@exitstrategiesgroup.com.

Pricing Methodologies in Buy-Sell Agreements

/in , /by Jim Leonhard

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. 

Funding Your Buy-Sell Transactions

/in , /by Al Statz

Al StatzA properly structured Buy-Sell Agreement (BSA) ensures a market for owners’ equity when they leave the business, restricts the transfer of shares to unwanted parties, and lays out a set of rules and processes that mitigate the overall risk of uncertainty when a trigger event occurs. However, without having adequate funding mechanism(s) in place, a well-intentioned buy-sell agreement may not satisfy the shareholders needs when a trigger occurs.

In this post I’ll briefly outline the three most common funding sources that we find when reviewing buy-sell agreements for business valuation purposes.

  1. Life insurance is the safest bet in case of the death of a shareholder. The proceeds are paid out promptly, and if any additional payment is required one of the other methods can be used to facilitate full payment. Several tax and administrative issues need to be considered depending on whether the shareholders or the corporation owns the policies. The type of policy — term, variable or whole life — is also a consideration. The premiums for whole life are substantially higher than for term, but it builds cash value that can be used even if a death doesn’t occur. The BSA should be specific in how life insurance proceeds are to be treated for business valuation purposes.
  2. Seller financing is often used in BSA’s. Price and terms of the note should be clearly spelled out: full payment upon a trigger event? Or a down payment, term, and rate? Some agreements adjust the rate annually to reflect market rates, where others leave the rate fixed or pegged to a benchmark rate as of the buy-sell date. What about protection in case of default? My point is that there is no prescribed way. Obviously financing is a negotiation that can be as creative or as simple as the participants deem practical.
  3. Corporate cash or a bank loan that provides funding is another funding. However, cash isn’t always an option for small, closely-held firms that lack large cash reserves. Securing a bank loan for buyouts is often challenging, especially when a firm has just lost a key executive.

As a fourth option, we occasionally see clients partner with a private equity group to buy out a departing shareholder. By doing this they can also gain access to new capital to support future growth. This type of funding is usually only available to companies with a few million dollars in annual free cash flow. We know a lot of private equity groups and can make introductions when appropriate.

It’s important to point out that these funding options are not mutually exclusive, and are often used in tandem to fund the buyout of a departing shareholder.  We recommend that not only should a buy-sell agreement and the valuation be updated every year or so, but also that funding options be reevaluated and updated based on the company’s financial position, ownership and current valuation.

Exit Strategies brings independence and over 100 years of cumulative business valuation and M&A transaction expertise to every engagement. Founder and president Al Statz is available for free confidential consultations. You can reach him via email or by phone at (707) 781-8580.