Valuation & Litigation Services Blog

Buy-sell agreements valuation

Drafting Considerations for Attorneys Blog Series – Valuation Structures in Buy-Sell Agreements

The fields of law, accounting and valuation are only continuing to become more complex.  Given the overlap in these areas of specialty, it is increasingly important for attorneys to have an understanding of the accounting, tax and valuation effects of the legal agreements they draft.  Armed with this knowledge, lawyers can produce the intended outcome for their clients and minimize unintentional consequences and compliance burdens.  If you would like to download our full eBook, which includes all of the blogs in this series, you can do so here.

Valuation Structures in Buy-Sell Agreements

There are three primary approaches to valuing an ownership interest under a buy-sell agreement for purposes of setting a purchase/sale price:

1.) Appraisal – If an appraisal provision is included in the buy-sell agreement, a valuation of the company/ownership interest is prepared by a third-party valuation expert. Some of the key considerations are as follows:

  • Standard of value / valuation date / level of value
  • What credentials must the valuation expert possess?
  • Will a single-appraiser or multiple-appraiser model be used?
  • If a multiple-appraiser model is used, how will the final value be selected?
  • How will the valuation expert be selected?
  • Must the valuation expert be independent from the company’s accountant?
  • How will appraisal costs be allocated among the parties involved?
  • What level of analysis/deliverable will be required?

As with any buy-sell valuation structure, there are both pros and cons to the appraisal method:

  • Pros
    • Most accurate value that considers the current status of the business, industry and economy as of the valuation date
    • Theoretically should be no “winner” or “loser” based on the value/transaction price
    • The value should be transparent and understandable to all parties involved
  • Cons
    • Time consuming
    • Expensive
    • Can be burdensome if multiple appraisers are involved

2.) Formula – If a formula is utilized in the buy-sell agreement, the value of the company for purposes of a buy-sell transaction among the owners is based on the stated formula. Some of the key considerations are as follows:

  • Upon what metric upon will the formula be based?
    • Revenue
    • EBITDA
    • Net Income
    • Book Value (beware – this rarely has any correlation to fair market value)
    • Other financial metrics
  • Formula should produce an appropriate value when initially established
  • Standard of value / valuation date / level of value
  • Does the formula accurately determine equity value (and not an enterprise value)?
  • Will the formula be revisited in the future and updated if necessary? If so, how often?

As with any buy-sell valuation structure, there are both pros and cons to the formula method:

  • Pros
    • Often simple to apply
    • Less expensive to implement and execute than an appraisal
  • Cons
    • Changes in the business, industry and economy may not be accurately considered
    • Difficult to reflect expected growth or decline in the business
    • Formulas can get stale
    • If initial formula is not reasonable, the valuation results are likely to be unreasonable in future years
    • May differ materially from value that would be determined in an appraisal

3.) Agreed-Upon Redemption Price – If the buy-sell agreement calls for an agreed-upon redemption price, the value of the company is based on the agreed-upon value determined by the owners (at whatever time interval is stated in the agreement). Some of the key considerations are as follows:

  • Standard of value / valuation date / level of value
  • How often will the agreed-upon redemption price be updated?
  • Are there any mechanisms in place to ensure that updates to the agreed-upon redemption price are made as required?
  • What happens if there has been no recent update to the agreed-upon price before a triggering event?
  • How will the agreed-upon redemption price be determined?
  • What happens if the parties cannot agree on a redemption price?

As with any buy-sell valuation structure, there are both pros and cons to the agreed-upon redemption price method:

  • Pros
    • Simple to apply (assuming the owners can agree on a value)
    • Least expensive to implement and execute
    • Agreement of parties on value avoids valuation issues
  • Cons
    • The agreed-upon redemption price will likely become stale over time
    • Requires agreement of parties to set and update the agreed-upon redemption price, which can be difficult to obtain in practice
    • May differ materially from value that would be determined in an appraisal

Continue reading about the key accounting, tax and valuation considerations of buy-sell agreements in our e-book: Drafting Considerations for Attorneys: Buy-Sell Agreements, Accounting, Tax, and Valuation Issues. Click here to download your free copy.

To learn more about how a business is valued or to gain insight on the financial and economic issues that affect today’s business world, call the experts in the Valuation and Litigation Support group at 440-449-6800. Please email Sean Saari if you would like to learn more about buy-sell valuation considerations.

Drafting Considerations for Attorneys

This entry was posted in Mailchimp RSS, Valuation & Litigation Services and tagged , , , , , , , , , , , , , , , , , , , , . Bookmark the permalink. Follow any comments here with the RSS feed for this post. Comments are closed, but you can leave a trackback: Trackback URL.
© Copyright 2016 Skoda Minotti | Privacy Policy | Disclaimer | Remote Support
Cleveland 440-449-6800 | Akron 330-668-1100 | Tampa 813-288-8826
Website designed and developed by Skoda Minotti Strategic Marketing