Buy Sell Agreements

When was the last time you reviewed your buy sell agreement?  If you are like most business owners, the most likely answer is NEVER.  Maybe you read it before you signed it when you started the business, and maybe you didn't.  Many buy sell agreements are formula based, that is, they call for the application of a multiple to a business performance measure.  Examples of simple formula based valuation methods are 1 times sales, 5 times net income, or something in between.

The problem with formula based valuations is that a result that may have made sense ten or twenty years ago may not make sense today.  For example, a formula based on a multiple of sales is probably not fair if the business consistently loses money.  Because no one knows if they are going to be a buyer or seller until the buy sell is triggered, it is important that the agreement be fair to both parties.  If the formula isn't fair, it is not uncommon for a costly and time consuming dispute to arise.

The thing to do it get out your buy sell agreement, read it, and ask your accountant to calculate the formula value specified by the agreement, as of December 31, 2010 or any other date.  You may be surprised by the result.  Look at it from the standpoint of both a buyer and a seller, because you don't know which one you will be.  If you were the seller, would you be happy with the price that you would receive?  If you were the buyer, how do you feel about the price to be paid?  What you will probably see is that formula based valuations never yield results that are fair to both parties.

There is a simple and effective solution to the problem of formula based valuations.  That solution is to change the buy sell to require that upon the occurrence of a triggering event, the business be valued by a qualified professional.  The agreement should define the triggering event, the standard of value, and the qualifications or credentials of the valuator.  To avoid disputes, many agreements actually name the individual or firm who will preform the valuation.  It is much easier to agree on such matters when the agreement is drafted then when it is triggered and emotions may be running high.

I learned a lot about buy sell agreements when I did a prepublication review of Chris Mercer's new book  Buy Sell Agreements for Closely Held and Family Business Owners.  If you are interested in purchasing this book, you can do so at  www.mercercapital.com.

Your thoughts and comments are welcome.