| Buy-sell agreements exist in many, if not most, | | | | some other standard. These words can have |
| closely held businesses having substantial size and | | | | dramatically different interpretations. Some |
| or value. And they exist between corporate joint | | | | agreements simply specify "the value" of the |
| venture partners in many thousands of | | | | company or interest. What's an appraiser to do |
| enterprises.Buy-sell agreements are agreements | | | | then? Which value? The likelihood of a successful |
| by and between the shareholders (or equity | | | | appraisal process diminishes greatly if this critical |
| partners of whatever legal description) of a | | | | defining issue is not clear.2. Level of value. Will the |
| privately owned business and, perhaps, the | | | | value pursuant to the buy-sell agreement be |
| business itself. They establish the mechanism for | | | | based on a pro rata share of the value of the |
| the purchase of stock following the death (or | | | | business or will it be based on the value of an |
| other adverse changes) of one of the owners. In | | | | interest in the business? The differences bring |
| the case of corporate joint ventures, they also | | | | minority interest and marketability discounts into |
| establish the value for break-ups or for | | | | potential play, and wide differences in |
| circumstances calling for one corporate venture | | | | interpretations of value. Two appraisers could |
| partner to buy out the other partner.Buy-sell | | | | agree regarding the value of a business, but if one |
| agreements (or put agreements in some cases) | | | | applies a marketability discount, their conclusions |
| are more important than most business owners, | | | | can be significantly different, and confusion results. |
| shareholders and boards of directors realize. I've | | | | This is an issue that needs to be crystal clear in |
| often said that buy-sell agreements are written | | | | your agreement.3. The "as of" date for the |
| under the assumption that the other partner is | | | | valuation. Believe it or not, some buy-sell |
| going to die first - and one of the partners is | | | | agreements are not clear about the date as of |
| right!Seeing two different buy-sell agreements | | | | which the valuation(s) should be determined by |
| recently put the topic at the top of my mind and | | | | appraisers. This can be extremely important, |
| triggered a couple of memories, as well.Never | | | | particularly in corporate partnerships and joint |
| UpdatedThe other day I reviewed a buy-sell | | | | ventures when the occurrence of events other |
| agreement that was perfectly fine on the day it | | | | than the death of a partner typically establishes a |
| was signed by a company's two major | | | | valuation date. We were involved in major litigation |
| shareholders - more than ten years ago. The | | | | a couple of years back where it took two |
| agreement states that the parties will reset the | | | | arbitrations and several nationally known |
| value each year.Since then, the company has | | | | appraisers to resolve what was a dispute over |
| more than tripled in size and value. However, the | | | | the appropriate valuation date. Fortunately for our |
| valuation in the buy-sell when it was signed | | | | client, the arbitration panel agreed with our |
| remains in effect today because it was never | | | | interpretation of the buy-sell agreement from a |
| updated.This creates no significant problems - | | | | valuation viewpoint.4. The funding mechanism. |
| unless something adverse happens to one ofthe | | | | Many buy-sell agreements do not provide a |
| shareholders. In that case, one shareholder would | | | | specific funding mechanism, either through |
| benefit from a bargain purchase price and the | | | | insurance, sinking funds, or pre-agreed payment |
| other's family would suffer a true economic loss. | | | | terms. An agreement is no better than the ability |
| With this item now in the open, those | | | | of the parties and/or the company to fund any |
| shareholders are working to update the document | | | | required purchases at the agreed upon price.5. |
| as rapidly as possible.Formula PricingMany business | | | | Qualifications of appraisers. Some buy-sell |
| owners want to create a formula to establish the | | | | agreements provide a specific list of firms that |
| pricing if a buy-sell agreement is triggered. And | | | | the parties agree are mutually acceptable, either |
| quite a few buy-sell agreements have them, | | | | for a single appraiser option or for the |
| usually with disastrous long-term results. However, | | | | multiple-appraiser options. In other cases, the |
| this is not uncommon because this is an | | | | specific, individual qualifications of appraisers are |
| inexpensive alternative to hiring a business | | | | spelled out (e.g., credentials from a major |
| appraiser. Almost anyone can put a few numbers | | | | credentialing organization, experience in appraisal, |
| into a formula, whether it calls for book value at | | | | experience with the industry, etc.).Credentials can |
| the preceding fiscal year-end or 4.5 times a 3-4-5 | | | | be important. I reviewed a draft buy-sell |
| year (pick one) average EBITDA - less debt, of | | | | agreement for an acquaintance a couple of years |
| course. (I've actually seen the exclusion of debt to | | | | ago. His company was a $100 million, highly |
| determine equity value omitted as part of the | | | | successful service organization. The draft buy-sell |
| formula!)The questions is, will formula results be | | | | stated that the appraiser should be an "accredited |
| fair for both sides in all circumstances? I won't | | | | general appraiser" in the state of |
| prove it here by boring you with multiple | | | | domicile. An accredited general appraiser is |
| examples, but no rigid formula can realistically | | | | qualified to appraise residential or possibly small |
| determine the value of a business over time with | | | | commercial real estate. This error was fixed in |
| changing company, industry, and economic | | | | the next draft!6. Appraisal standards to be |
| conditions. That's why many buy-sell agreements | | | | followed. Some buy-sell agreements go so far as |
| use an appraisal process.Three AppraisersAs | | | | to name the specific business appraisal standards |
| mentioned above, I reviewed two buy-sell | | | | that must be followed by any selected appraisers. |
| agreements recently. The second agreement | | | | For example, I have seen agreements that state |
| involved the use of what I call "one-two-three | | | | that the appraiser(s) must follow the Uniform |
| appraisers, rock!" The drafters of this type of | | | | Standards of Professional Appraisal Practice and |
| agreement seem to believe that if it is good to | | | | the Business Valuation Standards of the American |
| retain one appraiser to value a business, it is | | | | Society of Appraisers.What's so hard about |
| better to retain two, or even three. As an | | | | specifying these things? I've had clients tell me |
| appraiser, I suppose I should prefer this | | | | that they have a hard time talking about some of |
| mechanism. After all, it increases the odds of our | | | | these issues with their fellow shareholders when |
| firm being hired.While I don't know the genesis of | | | | they are creating their buy-sell agreements. It |
| this, many buy-sell agreements are written where | | | | makes people think about things they don't want |
| the valuation mechanism involves multiple appraisal | | | | to think about. But think about them you |
| firms. Variations go like this:1. The buying party | | | | must.The process of drafting a buy-sell |
| shall retain one independent appraiser, and the | | | | agreement requires the parties to address |
| selling party another. They will both provide | | | | important issues in balanced form at the outset. |
| valuation opinions. If the values are within 10% or | | | | In doing so, they are forced to realize that each |
| 15% or 20% (pick-a-percent), the price for the | | | | party could be a buyer - in the event of the |
| buy-sell agreement will be the average of the | | | | death of a partner - or a seller. Actually, if one |
| two. If they are more than pick-a-percent apart, | | | | thinks about being a seller, it is actually his or her |
| the price will be determined by the average of | | | | estate that will be the seller. This can be tough |
| the third appraiser's value and that of the one | | | | stuff to deal with.As I've said in numerous |
| closest to him or her.2. The buying party shall | | | | speeches, if you think it is difficult to address |
| retain one independent appraiser and the selling | | | | these issues with your partner(s) in the here and |
| party a second. They do not provide appraisals. | | | | now, just think how difficult it will be when one of |
| Rather, it is their job to mutually select a third | | | | you is in the hereafter!Know this. If these defining |
| appraiser. Having been one of the original two | | | | elements, including the pricing mechanism, are |
| appraisers in several situations, I can tell you that | | | | unclear in your (or your clients') buy-sell |
| this is not as easy as you might think! This third | | | | agreement(s), they will be the only thing you will |
| appraiser will provide a valuation of the business | | | | be able to think about following a trigger event |
| (or interest). The third appraiser's conclusion is the | | | | until the situation is resolved. Absent a clear |
| agreed upon transaction value. If you are the third | | | | agreement, this can take lots of money, lots of |
| appraiser, that's an awesome responsibility, one | | | | time, and create lots of hard feelings. And dealing |
| that I've undertaken on several occasions.3. The | | | | with the issues under adverse circumstances will |
| buying party shall retain one independent appraiser | | | | absolutely distract you from the business of |
| and the selling party a second. Both will provide | | | | running your business.The Bottom LineYou |
| valuation conclusions which, if close enough | | | | probably don't spend much time at night thinking |
| together (pick-a-percent), will be averaged. If the | | | | about your (or your clients') buy-sell agreement(s). |
| conclusions are more than pick-a-percent apart, | | | | Take my word for it, you shouldn't. You should be |
| the original two appraisers shall select a third | | | | thinking about your buy-sell agreement now, in |
| appraiser. Again, this is not as easy as one might | | | | the light of day, and working to get a clear |
| think. The third appraiser must then pick one of | | | | agreement that works for you and your fellow |
| the two appraisals as the more correct valuation, | | | | shareholders or partners.I never practice law, |
| and that will be the transaction price. That's pretty | | | | because to do so requires a license. So I don't |
| dicey, too, and I've done it.And there are probably | | | | have any legal opinions. I prefer to think of them |
| other variations on this theme.A Single | | | | as business opinions.1. If you are a business owner |
| AppraiserThere are at least two versions of the | | | | or shareholder and your buy-sell agreement has |
| single appraiser pricing mechanism.1. The | | | | not been updated within the last year (or if you |
| agreement states that the parties select an | | | | don't understand it if it has), run, don't walk, to |
| appraiser at the time of a trigger event. Some | | | | your corporate attorney to talk through these |
| buy-sell agreements provide for the parties to | | | | issues.If you or your attorneys don't understand |
| agree on a single appraiser. If you think it is | | | | the valuation nuances of your buy-sell agreement, |
| difficult for two appraisers to agree on a third | | | | don't hesitate to bring in a qualified business |
| appraiser, it can be even more difficult for two | | | | appraiser to read the agreement from a valuation |
| parties with adverse interests - and yes, the | | | | perspective and to tell you what he or she thinks |
| interests will be adverse at the moment of a | | | | it means - or if there is legitimate room for |
| trigger event.There is a great deal of uncertainty | | | | misunderstanding between appraisers. Find out |
| in this process because neither party likely has | | | | what needs to be done, make the necessary |
| any idea how the selected appraiser will work or | | | | decisions, and fix the document. It will never be |
| what their work product will look like. So this | | | | easier than right now.2. If you are a trusted |
| process can feel something like a crap shoot to | | | | adviser to a business owner or significant |
| the parties involved.Once selected, however, the | | | | shareholder, I would suggest making contact for |
| appraiser provides an appraisal, and that's the | | | | the explicit purpose of discussing the buy-sell |
| price for the transaction. Unless, of course, one | | | | agreement and subjecting it to formal review and |
| party disagrees vehemently with that conclusion | | | | or revision.3. If you are an executive or director |
| and litigation ensues.2. The agreement states that | | | | of a large company with multiple joint ventures |
| the parties select an appraiser at the time of the | | | | involving substantial resources, you can bring great |
| signing of the buy-sell agreement. I have | | | | value to your company by requesting a review, |
| recommended this choice of pricing mechanism | | | | from legal and valuation viewpoints, of all existing |
| for years - with a twist. My suggestion is that the | | | | buy-sell and/or put agreements with |
| parties retain a mutually agreeable, independent | | | | appraisal-type pricing mechanisms.Remember this |
| appraiser at the time of the negotiation of the | | | | about buy-sell agreements - someone will buy and |
| buy-sell agreement. The appraiser provides an | | | | someone will sell. You just don't know who that |
| appraisal, and the parties agree that this is the | | | | will be when you sign the agreement. Your |
| initial value for pricing if the agreement is | | | | agreement needs to work for you and your |
| triggered. All parties know the appraiser, see the | | | | family whether you are the buyer or seller. And it |
| methodologies they (the firm) have employed, | | | | needs to work for your partner(s) and their |
| and are comfortable, at the outset, that the | | | | families (or their shareholders) whether they are |
| valuation is reasonable and mutually agreeable.The | | | | the buyers or sellers.This is important. Send this |
| parties then agree that the selected appraisal firm | | | | article to any of your friends who own |
| will reappraise the business for purposes of the | | | | businesses. They will benefit greatly from taking |
| buy-sell agreement every (or every other) year | | | | time to review their buy-sell agreements. And |
| or so, and that the reappraisal will re-establish the | | | | send this article to attorneys, accountants, or |
| price for buy-sell transactions. If the appraisal is | | | | other advisers of businesses. They can bring |
| "stale" at a trigger event (say more than six | | | | great value to their clients by suggesting a review |
| months or a year or pick-a-period old), the | | | | of their buy-sell agreements from legal and |
| appraiser will reappraise as of the date of the | | | | valuation viewpoints.Z. Christopher Mercer is the |
| trigger event.This form of pricing mechanism has | | | | founder and CEO of Mercer Capital Management, |
| the benefit of relatively greater consistency and | | | | Inc., one of the leading business valuation and |
| certainty for all parties. Appraisal methodologies | | | | investment banking firms in the nation.Chris has |
| should be consistent from one appraisal to the | | | | prepared, overseen, or contributed to hundreds, if |
| next, or else the appraiser should make explicitly | | | | not thousands, of valuations for purposes related |
| clear the reasons for any methodological changes | | | | to M&A, litigation, and tax, among others. He is a |
| that influence the appraisal conclusion.More | | | | prolific author on valuation-related topics and one |
| Comments on StructureIt should be clear that the | | | | of the most sought after speakers on business |
| pricing mechanism in a buy-sell agreement can be | | | | valuation issues for national professional |
| important to the outcome of a purchase event | | | | associations and other business and professional |
| when it is triggered.Before concluding this | | | | groups.Chris also authors a web log, or blog, called |
| discussion of pricing mechanisms, let's note some | | | | MERCER ON VALUE, which can be found at and |
| of the other important issues that need to be | | | | discusses what he observes in the world and |
| addressed when formulating your buy-sell | | | | business from the perspective of value, broadly |
| agreement:1. Standard of value. Will the value be | | | | defined. |
| based on "fair market value" or "fair value" or | | | | |