Buy-Sell Agreement: Purpose, Problems, and Process
Unfortunately, handshake deals often fail and leave shareholders with few, if any, good options. A Buy-Sell agreement is a very important contract to protect shareholders against this risk. A few key provisions are: providing liquidity at fair terms with reasonable price; a funding mechanism affordable to the firm; restricting who can own shares. The agreement should be in place BEFORE a trigger event occurs (i.e. death, disability, divorce, bankruptcy, and firings to name only a few).
Think of the buy-sell as pre-nuptial agreement among shareholders. Trigger events create a buyer and a seller and the potential for conflict.
The buy-sell is vital for legal, tax, insurance, and valuation contingencies. Yet in our appraisal work many buy-sell agreements are either non-existent or outdated, and fail to address company changes such as ownership, size, valuation metrics, etc. Valuation is a typical focal point in litigation: buyers want a lower price, sellers a higher price. Language that isn’t clear as to level or standard of value, will likely go to court where value gets diluted.
There are three types of buy-sell agreements: formulas, fixed-price, and valuation process. Formulas and fixed-price agreements are easy to understand and less expensive. However, simplicity often fails to capture the economic value of the business. A full valuation process, done by an accredited appraiser, is a much more robust way to understand business value.
Buy-Sell Agreement Reviews
A buy-sell agreement is a legal document drafted by an attorney. Generally, lawyers aren’t immersed in the nuances of valuation theory and its language. Often they will address valuation with a “multiple” of EBITDA or some other simplied rule of thumb. Simple doesn’t always result in an accurate assessment of business value. We can advise from a business, economic, and valuation perspective recommending changes to areas which could become problematic. It’s a sound practice to have the business valued as industry or economic conditions change. The buy-sell should also be reviewed to ensure it’s current.
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A Buy-Sell agreement (BSA) serves several key purposes for business owners. A well-articulated BSA creates a ready market and liquidity to a selling owner, and should establish price, terms, and financing for the transfer. In short it spells out a process so that all...