Urgent Warning (and Solution) to Attorneys and Business Owners re Shareholder/Buy-Sell Agreement Problems

shutterstock_539658352

WARNING. Portions of the great majority of buy-sell agreements (or relevant portions of operating agreements) addressing the valuation of interests when trigger events occur are seriously flawed. As a result, they are destined to create time-consuming, expensive, and emotional disputes between buyers and sellers when they are triggered. Most attorneys and business owners do not seem to believe me, but recent experience only reinforces the need for this warning post.

Recent Problems Identified

I have had the opportunity to read several buy-sell agreements over the course of the last weeks. The message of this post is simple:

The valuation mechanisms of every one of these agreements are seriously flawed.

When I say the valuation mechanisms are flawed, what I mean is that given the “words on the pages” of the agreements, there is a high likelihood for dispute between the parties when trigger events occur. Issues found in reading these agreements recently include:

  1. Standard of value (i.e., should be fair market value) not mentioned or defined, so there was no guidance regarding the type of value to be provided by appraisers.
  2. Agreement called for 30 days to provide an opportunity for the parties to agree on value. What this really does is to provide an opportunity for the parties to get really upset with each other.
  3. Confusion (i.e., different language in two or more places) regarding whether the valuation pertains to the interest subject to the agreement or to a pro rate share of the value of 100% of the equity of the business. This confusion virtually assures a dispute will occur.
  4. Unrealistic timeframes for the selection of appraisers. One agreement basically set up a “race” to select the first appraiser. The party who did not select the first appraiser had only seven days to appoint the second appraiser. If the second party was not successful, the first party’s appraiser would be the exclusive appraiser, and the second party would not have appraisal representation.
  5. Qualifications for appraisers to be selected were not provided, leaving open the selection of literally anyone as an appraiser for a valuation process.

There were other issues, but the picture is clear. Every one of the agreements I read recently is almost assured of creating a dispute between buyers and sellers in the event of a trigger event.

Let me be clear. The agreements were drafted by competent and well-meaning attorneys in every case. The problem is that they were using buy-sell agreement templates where the valuation provisions had not been reviewed by competent valuation professionals. In my 35+ years of experience, I have not yet seen a single valuation template that provides for a valuation mechanism that has a good opportunity of working without problems.

Act Now for a Solution

The only solution for the emerging valuation problems embedded in the great majority of buy-sell agreements is review and revision. The review must be performed by competent valuation professionals working in conjunction with counsel for companies. The business owners must be involved, as well, because they must agree to amend their agreements.

Too many business owners and attorneys seem to think that the kinds of problems I have mentioned will occur only to someone else or someone else’s company. The problem, however, will occur with your company or your client’s company when trigger events occur.

To facilitate resolving the latent issues in your buy-sell agreement, I make the following offer.

For the first two attorneys (or business owners) who respond to this offer, I will read the valuation portions of one buy-sell agreement. We will then schedule a complimentary half-hour telephone session in which I will provide my comments and observations regarding problems or issues identified (from business and valuation perspectives). I will then provide suggestions for how to address the latent problems with the valuation mechanisms. If a business owner answers this offer, the telephone session will need to be scheduled jointly with corporate counsel.

To claim this, email me at mercerc@mercercapital.com.

If you are the third (or later) to respond to this offer, I will call you and discuss a workable arrangement to provide the review that I have outlined above.

New Books on the Way

  • An Attorney’s Handbook for Buy-Sell Agreements (in production).  This book provides guidance based on 30-plus years of dealing with buy-sell agreements. Importantly, it provides for the first time ever, anywhere, draft template language for the valuation portions of buy-sell agreements that will work for clients or companies.  You will not want to miss this book!
  • Business Valuation: An Integrated Theory Third Edition (with Travis Harms). The draft is due to the publisher (Wiley) shortly and will be available subject to their publication schedule. This book updates the Integrated Theory of Business Valuation and will include the Integrated Theory on an equity basis and on an enterprise (total capital) basis, as well. This book will be must reading for all business appraisers and anyone interested in business valuation.

E-mail me if you would like to be notified when these books become available.

In the meantime, be well!

Chris

Please note: I reserve the right to delete comments that are offensive or off-topic.

Leave a Reply

Your email address will not be published. Required fields are marked *

One thought on “Urgent Warning (and Solution) to Attorneys and Business Owners re Shareholder/Buy-Sell Agreement Problems