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.