Does Your Buy-Sell Agreement Specify a Standard of Value?

Although the buy-sell agreement could be one of the most important and far reaching agreements that a business can have, it is also the least understood, and most frequently ignored.  When asked about buy-sell agreements, many business owners don't know if they have them, have not ever read them, or don't understand what they say.

We were recently engaged to value a business owned by two brothers.  In order to understand the assignment and prepare an engagement letter, I asked about the standard of value specified in the buy-sell agreement.  The control owner thought that the standard was fair market value, and the minority owner thought that the standard was fair value.  The difference between these standards of value can be substantial.  Is anyone surprised to find out that the agreement does not even address this important issue?

Without going into the technical details, the fair market value standard generally results in a lower value because it considers discounts for lack of marketability and lack of control.  The fair value standard usually results in a higher value because it does not consider such discounts.

In New Jersey,the  fair value standard is used in valuations performed for divorce and shareholder oppression matters.  However, it is not limited to those purposes and may also be used in buy-sell agreement, if specified by the agreement..

Does your buy-sell agreement specify a standard of value?  Do all parties to the agreement understand the standard of value and the result that it will yield?  Do yourself a favor; get out your buy-sell agreement and read it.  If you don't understand what it says, ask your CPA or attorney.  Although it may be a difficult conversation, it will be much more difficult and expensive to address the controversial issues when the agreement is triggered by a retirement or death.

Buy-sell agreements only work if their result is fair to all parties.  Everyone thinks that they will be able to work forever, but that is just not the case.  When the time comes, no one knows if they will be a buyer or a seller.  Ask your CPA to calculate the price of your business, using the provisions of your agreement.  Is the result fair?  If not, it is time to consider changing agreement to yield a fair result.