Fixed price buy-sell agreements are seemingly simple from a valuation viewpoint. All the owners and a company have to do are agree on a value for the business and record that value in their buy-sell agreement. Most of the time, the owners do agree on a fixed price when agreements are initially signed.
The problem lies in the fact, that in most cases, the initial fixed prices are seldom updated.
Time passes and value changes. Time passes and owner situations change. Time passes and it just gets more difficult to sit down and talk about value to update fixed price agreements. And so, the owners don’t do it.
Time passes and there is a trigger event. If my experience is indicative, the initial fixed price has never been updated. With changing value, there is likely a large discrepancy between the initial fixed price and the current “fair market value” of the business.
If the current value is higher than the original fixed price, the company and remaining shareholders would achieve a windfall with the bargain purchase from a triggered shareholder. However, if the current value is lower than the original fixed price, the selling shareholder would achieve a windfall.
What’s a windfall among friends whose interests have diverged? It is likely expensive litigation unless there is a solution to the problem in the buy-sell agreement. If you think that is a good idea, read this post.
A Bad Solution
We’ve seen a number of fixed price buy-sell agreements with a provision calling for an appraisal process if the fixed price is more than a certain period old (like two years or more). Those processes are generally about 150 words in length, plus or minus, and came from a template somewhere.
The problem is that they do not describe workable valuation processes, so when they bust, litigation and a contentious valuation process ensue. A bad solution, despite seeming okay when an agreement is signed, is not a good idea.
A Better Solution
As I’ve said in my books, blog posts, and speeches, the best solution for “fixing” a fixed price buy-sell agreement is to get rid of the fixed price and replace it with a valuation process. I recommend the Single Appraiser, Select Now and Value Now process that is described in Buy-Sell Agreements for Closely Held and Family Business Owners. After an initial appraisal, the selected appraiser provides reappraisals each year to update the price. Everyone knows what will happen and has an evolving knowledge about the expected buy-sell agreement price.
The next best solution is to add a single appraiser valuation process as the “fix” in the event that a fixed price is out of date when a trigger event occurs.
That process is called the Single Appraiser, Select Now and Value Later valuation process. The appraiser is selected and written into the fixed price agreement. If the buy-sell agreement is triggered and the fixed price is outdated, the selected appraiser is called upon to provide the (binding) valuation for purposes of the agreement.
In both of the single appraiser processes noted above, the standard of value, level of value, and all other aspects of defining an appraisal are detailed in the agreements. Then, there is little likelihood for problems with these matters.
Conclusion and Coming
Fixed price buy-sell agreement pricing mechanisms are not good and seldom work. The problems with these agreements can be “fixed” if the parties focus on the future and take steps today to solve future problems before they occur.
To help solve these problems, I have drafted a new book on buy-sell agreements. It will be of great interest to attorneys because, in addition to providing descriptions of valuation processes like mentioned above, there is template language for drafting the valuation portions of buy-sell agreements.
If you would like to be on the list to receive notification upon this new book’s publication, just send me an email and we’ll let you know the minute the book is available. The working title is Buy-Sell Agreement Handbook for Attorneys. It will, of course, be of interest to business appraisers and business owners, as well.
Let us know:
If you would like me to review a buy-sell agreement from business and valuation perspectives, call me (901-685-2120) or email me and we can work out the details.
It is time to fix busted fixed price buy-sell agreements. So let’s work together to do just that.
In the meantime, be well!