How a Covenant not to Compete Affects Value in Buy-Sell Agreements

When someone sells a privately-held company, the buyer usually insists that the seller sign a covenant not to compete. In fact, in over 20 years of business sales and acquisitions, I have yet to see a purchase agreement without a covenant-not-to-compete (CNTC) provision. Now let’s say that your Company or its shareholders purchase all of a departing 50% shareholder’s interest for fair market value; is it reasonable to expect that the selling shareholder would not compete with the Company? I think so.
Yet, many buy-sell agreements (BSA’s) are silent on the non-compete issue, allowing the departing shareholder to receive full value for their shares AND start, join or back a competing business. I briefly surveyed the last 10 buy-sell agreements that I’ve reviewed for valuation purposes, and found that fully half of them were missing a non-compete provision!
A covenant-not-to-compete provision in a BSA usually restricts the selling shareholder from soliciting customers and employees, and otherwise competing with the Company for a specified length of time within a specified geographic area. A CNTC is considered an intangible asset of the Company and may have significant value. Stated differently, the Company’s shares, post transaction, may have significantly less value without a covenant not to compete from the selling shareholder. CNTC’s have value because they protect the future revenue and profitability of the Company.
How does the absence of a covenant not to compete affect share value?
One common approach to valuing a CNTC is called the differential valuation approach; where the business is valued under two scenarios. The first valuation scenario assumes that a CNTC is in place, and the second scenario assumes that it is not. Another approach involves determining the present value of the potential future economic damages that would occur as a result of competition. In either case, the valuation expert’s job is to determine the net impact on revenue, margins and future cash flows arising from potential competition by the selling shareholder. The difference in company value for each scenario is the value of the CNTC.
To project cash flows, the business appraiser will have in-depth discussions with company management to understand and develop assumptions regarding:
  1. Seller’s business expertise in the industry and general ability to compete
  2. Seller’s intent to compete
  3. Seller’s economic resources
  4. Seller’s contacts and relationships with customers, suppliers, and other business contacts
  5. Seller’s age and health
  6. Seller’s intent to reside in the geographic area
  7. Barriers to entry that would limit the seller’s ability to compete
  8. Probability and timing of seller competing
  9. Probability that competition will harm the company
  10. Potential damage to the company due to the seller’s competition
  11. Ability of the company to prevent a customer from leaving
  12. Buyer’s interest in eliminating competition
  13. Duration and geographic scope of the (typical) CNTC
  14. Enforceability of the CNTC under State law
If valuing a CNTC sounds time consuming, subjective, speculative and expensive, it is.  You could be faced with a situation like this if your buy-sell agreement doesn’t prohibit competition. Or someone could be buying shares at a premium someday.
What does your buy-sell agreement say?
The main objective of a buy-sell agreement is to provide for the orderly and reasonable transfer of shares in the event an owner dies or leaves your Company. Yet many BSA’s don’t accomplish this because terms are ambiguous or incomplete, leading to contentious disputes and litigation when a trigger event occurs. Exit Strategies regularly appraises businesses for buy-sell events, and in doing this work we get to read lots of buy-sell agreements (and other corporate documents governing the transfer of shares), and witness firsthand how they don’t operate as originally intended by the parties.
As a business valuation expert, I recommend that you: a) have a buy-sell agreement, b) understand what it says, c) are convinced that it accurately reflects the intentions of your shareholders, and d) have great legal, tax, financial and valuation advisors to help you get it right. Otherwise you may have a time bomb ticking away in your file cabinet.
If you have any questions regarding non-compete or other buy-sell agreement provisions that affect valuation, Email Al Statz or call him at 707-778-2040.

Your Buy-Sell Agreement: Disaster Waiting to Happen? Needs a Tune Up? Or in Good Shape?

An Ounce of Prevention is Worth a Pound of Cure

I can’t tell you how many times I’ve heard from business owners and their spouses that a key person became disabled or died and left an operating closely-held business in turmoil. What, no Buy-Sell Agreement? Ask anyone who has been selling and appraising business for a number of years and they will tell you this sort of thing is common. All businesses with more than one shareholder should have a Buy-Sell Agreement (“BSA”) in place. Even when companies have BSAs, they are poorly written, causing divisive and expensive issues down the road. All multi-owner businesses need a well-written BSA to transfer shares in a fair and efficient manner when a shareholder dies, becomes incapacitated, is involved in a marital dissolution, quits or is fired, retires, or the company enters bankruptcy (aka,”Trigger Events”).

Exit Strategies’ accredited appraisers perform numerous business valuations each year, and because this work requires us to review corporate documents, we can say with some authority that many privately-held companies have problematic Buy-Sell Agreements from business, funding and valuation perspectives. When we come across B-S Agreements (pun intended), most often the owners didn’t want to invest the money to do it properly, or they just didn’t understand how import it was to have a viable BSA in place at the outset. Unfortunately, those who experience costly litigation, internal disputes, business erosion and family problems learn a painful lesson later on.

Shareholders have three choices when deciding on how shares will be priced when one of the aforementioned trigger events occurs:

  1. Fixed Price: Shareholders agree on a set price. Unfortunately, the price is likely years out of date and the shareholders usually have not agreed on a way to update the price.
  2. Price Formula: Shareholders agree on a formula to calculate future pricing. Chances are, no one has calculated it lately and because of changes in the company, economic and industry conditions over time, the formula price may be higher or lower than fair market value at the time of the trigger event. Also, it’s often seen where the shareholders haven’t agreed on ways to make necessary/appropriate adjustments to the formula.
  3. Valuation Process: Shareholders agree on a process employing one or more appraisers to determine the value of shares using guidelines specified in the BSA. There are two types of process BSAa: Multiple Appraiser and Single Appraiser. Multiple appraiser agreements call for the selection of two or more appraisers to develop one, two, or three appraisals whose conclusions form the basis for the final price. If that process sounds time consuming, cumbersome and expensive, IT IS!! It can also be divisive. Single appraiser agreements call for the selection of one appraiser whose valuation sets the final price. The choices are to a) select the appraiser and value upon a trigger event; b) select the single appraiser now and value at the trigger event; or c) select the single appraiser now, value now, and of course value again when a trigger event occurs.

Our Recommendation is to SELECT ONE APPRAISER NOW and VALUE NOW

  • Select Now – If the shareholders creating the buy-sell agreement name the appraiser at the time of the agreement, all parties have a voice and can sign off on the selection. Early on, when everyone’s interests are aligned, this is a relatively easy decision to make. Doing it after a trigger event, when interests have diverged, is very difficult.
  • Value Now – Once selected, the chosen appraiser provides a baseline valuation, which is a fantastic way to put all shareholders on the same (price) page. We often provide a draft report, and give everyone time to provide comments for consideration before the report is finalized.

Reasons why selecting a single appraiser now and appraising now is the best choice for closely-held companies when creating a Buy-Sell Agreement:

  • The selected appraiser is viewed  as independent by everyone
  • Because the appraiser must interpret the BSA language related to valuation when conducting the initial appraisal, any issues regarding lack of clarity or inconsistency with the owners’ intentions can be resolved up front
  • The valuation process is observed by all shareholders at the outset, so they all know what will happen when a trigger event occurs (no surprises)
  • The concluded value establishes a baseline price (no surprises)
  • The selected appraiser maintains independence with respect to process and renders future valuations consistent with the BSA terms and prior reports
  • Subsequent appraisals, either annually or at trigger events, should be less time consuming and less expensive
  • Parties will likely gain confidence in the process
  • Parties will always know the current value for the Buy-Sell agreement, which is helpful for personal or estate planning purposes
  • The initial valuation gives the shareholders a roadmap to increasing value if that is their objective.
  • The appraiser’s knowledge of the company and industry grows over time, enhancing confidence for all parties
  • Creates a means of maintaining pricing for other transactions, thereby enhancing “the market” for a company’s shares


Valuation is a key piece of any shareholder buy-sell agreement. If you need help with the business valuation provisions of your buy-sell agreement, or need a valuation for a trigger event, feel free to Email Bob Altieri or call him at 916-905-5706. 

Buy-Sell Agreement Categories

The three types of Buy-Sell Agreements (BSA) are defined by the relationship between the parties to the agreement, i.e., the individual owners and their business entity.

Cross-Purchase Agreements are agreements between and among the owners of a business entity that requires the other owner(s) to purchase the interests of owner who has triggered the BSA. Cross-purchase agreements have common elements, including:

  • Funded by life insurance owned by business owners on the lives of other owners.
  • As the number of owners and the market value of the business rises, they can become unworkable.
  • Typically individual owners are required to finance ownership shares not related to a death and they may not have that ability.

Entity-Purchase Agreements require the business entity (corporation, partnership or LLC) to purchase the owners’ interest when a trigger event occurs. The entity must then define or provide the funding to complete the transaction. The actual funding may come from the purchase of life insurance, financing from a third party or the selling owner(s), cash in the business, or some combination thereof.

Hybrid Agreements give the entity the “right of first refusal” to purchase the interests in when a trigger event happens. Should the entity decline to buy the interests, it may offer the shares to the other owners according to their current ownership percentage or to selected owners. If the entity has refused to purchase the interests initially and the other owners elect not to purchase the interests, the entity is required to purchase the interests. Funding for the purchase is often via a combination of self-financing by the business, notes payable from selling owners, and life insurance.

Proper business valuation is essential for Buy-Sell Agreements to operate the way they were intended. For more information about business valuation as an element of Buy-Sell Agreements, please contact Jim Leonhard at 916-800-2716 or jhleonhard@exitstrategiesgroup.com.

The Dismal D’s of Buy-Sell Agreements

Al StatzWell-written Buy-Sell Agreements enable orderly share transfers upon the occurrence of certain events during the life of a business. They also prevent litigation that can quickly create a lose-lose situation for business owners. This article presents a list of 27 trigger events and common issues addressed in buy-sell agreements. For fun each item on the list begins with “D”. Buy-sell issues are unpleasant to think about; which is why owners often put off addressing them and why we call them Dismal D’s. However, it’s only good business to have a plan in place that protects company and shareholder interests when these events occur.  And they will occur.

The Buy-Sell Agreement Dismal D List

  1. Departure (quits or leaves)
  2. Disinterest (mentally but not physically leaves)
  3. Discharge (fired)
  4. Divorce
  5. Death
  6. Disagreement
  7. Deadlock (major disagreement)
  8. Disability
  9. Distress (within the business)
  10. Default (personal bankruptcy)
  11. Disqualification (licensing, regulatory, etc.)
  12. Disclose (confidentiality)
  13. Donation (donate or gift stock)
  14. Do not compete
  15. Dual entities (e.g. holding and operating)
  16. Dilution
  17. Drag-along rights
  18. Distribution policy
  19. Dividends and Distributions after a trigger
  20. Dispute resolution
  21. Death benefits (life insurance)
  22. Down payment and debt (buyout financing)
  23. Determination of value (fixed price, formula, or independent valuation)
  24. Defining elements of any valuation engagement
  25. Discounts (for minority interests)
  26. Different discounts (depending on trigger type)
  27. Dueling appraisers

Items #1-14 are common trigger events. Items #15-27 are common issues to be negotiated and addressed in the BSA. Items #22-27 are nearest and dearest to our hearts as business valuation experts. Arguably, valuation is the most important (and argued over) aspect of buy-sell transactions.

The above list is intended to be a starting point for consideration by shareholders. They should work with their partners, attorney, CPA and business appraiser to understand and address all of these issues.  “Daunting D List” may be a better description!

Not only is it critical to have a BSA (yes, many businesses don’t have one), but it’s also vital that the BSA be kept up to date. Owners come and go. Shareholders’ personal, family and financial circumstances change over time. Likewise, businesses are not static and economic and industry conditions, services offered, customers, management depth competition are in a constant state of flux – all key factors in valuation.

Click here for more information on how Exit Strategies’ helps with buy-sell agreements.


Business valuation plays a central role in buy-sell transactions and buy-sell agreements. Contact one of Exit Strategies’ senior advisors with any questions or for a no obligation, no cost and confidential consultation.

Your Buy-Sell Agreement – Keep It Current Before It Costs You Money and Grief!

Buy-Sell agreements (BSA’s) are an essential, and often overlooked, element in allowing shareholders to realize the value of their investment in a privately held company. The BSA’s purpose is to a) provide a market for ownership interests, b) establish the price and terms for these interests, c) specify a buy-sell process that is orderly and reasonable, and d) specify financing should a “trigger” event occur. There are several reasons this contract among owners can fail. Let’s briefly examine a few reasons why this can occur and it will become obvious why this document needs to “live and breathe” outside the confines of the corporate archives.

A BSA that is written upon entity formation, even if well-articulated, becomes less relevant as time marches on.  This happens for myriad reasons ranging from changes in business conditions and value, or changes in an owners personal situation or objectives. Language in BSA’s is often not sufficiently precise and leaves too much room for interpretation that can result in shareholder disputes and costly litigation that dilutes value for all shareholders.

There are three types of BSA’s: fixed price; formula pricing; and valuation process. Business valuation is a function of economic conditions and business fundamentals. Of the three BSA types, only the valuation process is flexible enough to fully accommodate the range of changes that can occur in a business. Fixed price and formula driven valuations may be less expensive to execute, but they are simplistic and can omit key value determinants that ultimately can prove very costly.

There are a wide range of trigger events where an owner may quit, be fired, retire, die, be disabled, or get divorced to name only a few. Each trigger event can alter the personal objectives of one or more owners, impact the business, and may have both control and valuation implications for all concerned parties.

Template-driven BSA’s frequently either omit, or do not make a clear distinction on the standard of value to be used in calculating value. For example, the difference between using an investment value standard or a fair market value standard can be very large. If the standard is not clear in the BSA, a buyer would naturally assume the lower price implied in the fair market value standard, while a seller would assume the higher price found in the investment value. Hence, if the BSA does not clearly address this issue, conflict and costly litigation is a likely outcome. Similarly, the level of value also has valuation implications that create potential for conflict if not clearly addressed in the BSA, because the difference between a controlling interest and a minority interests can be substantial.

As is now readily apparent, a well-defined and current BSA is important to accurately allocate value and keep the peace! Key elements of the BSA should seem reasonable to all owners BEFORE a trigger event (before the parties know if they will be a buyer or a seller), when it is easier to reach consensus. AFTER a trigger event this becomes difficult since there is an inherent conflict between a buyer and a seller.


Business valuation plays a central role in Buy-Sell Agreements. For more information about Exit Strategies’ BSA-related services contact one of our senior business appraisers.

Pro’s and Con’s of Price Formulas in Buy-Sell Agreements

Exit Strategies is regularly called upon to determine the value of closely-held company shares for buy-sell transactions. Common events that trigger a transfer of shares are when a shareholder retires or resigns from employment, is fired, dies, or becomes disabled, divorced or insolvent.
There are several facets to successful buy-sell transactions, but valuation is typically the most contested issue. The pricing method prescribed in your by-laws, shareholder, buy-sell or stock restriction agreement, as the case may be, is critical to the success of your next buy-sell transaction. Chances are your agreement (if you have one) stipulates one of these pricing approaches: a) a fixed price, b) book value, c) a formula, or d) an independent business valuation by one or more appraisers.
This article discusses the pro’s and con’s of formula pricing versus an independent valuation. Fixed price and book value are almost always bad ideas, so I won’t bother with them. Valuation formulas in the Buy-Sell agreements brought to us are usually pretty simple and look something like this:
Equity Value  =  Average EBITDA in the past two years  X  a fixed Multiple
Pro’s of a Pricing Formulapick_any_two
  1. Relatively quick and easy to calculate
  2. Inexpensive to apply
If your priority is to get to a price quickly with minimum effort and expense, congratulations, job done.
Con’s of a Pricing Formula
If however you and your partners’ want to see that all participants receive and pay a fair price, a set pricing formula misses the mark more often than not. One of the basic problems is that transactions occur sometime in the future, not when the formula is fixed, and formulas become stale as business and market conditions change over time.
Also, valuation itself is a forward-looking concept, and formulas generally use historical financial metrics. In other words, an investor ultimately cares only about what his or her return will be going forward, not what it was or would have been in the past. History is important in business valuation, but should never be entirely relied upon in determining the value of a company. As experienced business appraisers we see many companies whose future prospects are significantly better or worse than their recent past performance.
Let’s go into detail on some of the problems and solutions.
Businesses change.  A static formula can’t anticipate a change in business model.  One real-life example is a company that began life as a project-based, low margin contractor/installer of security systems, and evolved over time into a monitoring company with hundreds of annual customer contracts and high margins. Since monitoring companies trade for higher multiples than construction companies, the agreed-upon valuation formula undervalued the company when one of the owners died.  Solution: Rewrite the buy-sell agreement to require an independent valuation when a trigger event occurs.
Market conditions change.  Future market conditions are unknowable, and impossible to design into a formula. Consider the example of a real medium-size photographic processing company. With the advent of digital cameras and smart phone cameras, its film processing business was in steady decline when the founding partner wanted to retire. The pricing formula, which had been set 10 years earlier, overvalued the shares at the time of the trigger event. This led to a falling out and put a heavy burden on the remaining shareholders.  Solution: Require an independent valuation, or periodically update the formula at a minimum.
Stuff happens.  Major non-recurring events that substantially alter a company’s performance can happen at any time (think major lawsuit settlement, windfall sale, plant relocation or expansion, etc.). When such events occur during the formula’s measurement period, one side or the other gets penalized. Another issue we’ve seen many times, particularly as company owners age, is that they begin to rely on fewer and fewer major customers or suppliers for most of their business, which represents a major risk factor that won’t be accounted for in a pricing formula. For many reasons, pricing formulas can be rendered obsolete when things happen.  Solution: Have an expert evaluate the entire company at the time of the transaction.
Incomplete formula.  Most valuation formulas presented to us are too simplistic. What if, for example, the above formula was used to value an asset-intensive business — let’s say a heavy construction company. If the company had been deferring capital expenditures for several years, the formula would overvalue the company. Likewise, if it had recently replaced most of its equipment, possibly to take advantage of tax incentives, the formula would likely undervalue the company.  A formula can never be comprehensive and robust enough to capture all of the unique factors that can impact a company’s value.  I could list several dozen examples of this.  Solution: Have a seasoned appraiser thoroughly evaluate the company at the time of the transaction. If you must use a formula, have a qualified business appraiser design and update it periodically.
Formula is unclear or unfair.  Some of the pricing formulas presented to us are ambiguous in one or more significant ways; others are just plain unfair to one side or the other.  Usually the owners are completely unaware of this until a real trigger event occurs, at which point they are no longer objective. Sometimes the CPA or attorney who created the formula years ago is out of the picture or doesn’t remember what they intended.  Solution: Again, an independent valuation is the best option. Having a qualified business appraiser design and update the formula is second best. At a minimum, have your existing formula reviewed by a qualified business appraiser who can spot these types of problems and recommend improvements.
In summary, a pricing formula usually yields a share price that fails to reflect true economic value at the time of transfer; which leaves at least one party very unhappy. This is why most buy-sell agreements call for a business valuation. If you must use a formula, have it designed and reviewed periodically by a professional business appraiser for the reasons discussed here. If you have business partners and don’t have a buy-sell agreement in place, I urge you to create one now, before you are faced with a trigger event.
Business valuation plays a pivotal role in internal share transfers and all business succession plans. If I can provide additional information or advice on a current situation, please don’t hesitate to call me, Al Statz, 707-778-2040 or Email alstatz@exitstrategiesgroup.com.