The message of this short video post is simple. Many buy-sell agreements will fail to deliver the fair market value of interests sold following trigger events, even if the valuation of the interests are exactly on point. I’ve written briefly about this topic before, but provide elaboration here.
Assume that the valuation process for a buy-sell agreement determines the fair market value of a 20% interest to be $10.0 million.
In this short video post, I talk about how the operation of that buy-sell agreement (or any similar agreement) might deny the fair market value of the stock sold to the seller. The problem likes in the promissory notes that are often issued for purchases following trigger events.
In this video post, I talk about some numbers to make the central point of why buy-sell agreement participants should focus on any promissory notes to be issued. The figures below the video provide the numbers for anyone interested in the detail of my logic.
The fair market value of the interest discussed is determined to be $10.0 million, and the promissory note to be issued is $8.0 million as follows:
The note is a ten year promissory note with an interest rate of 2%. It provides for equal annual payments of $891 thousand as shown below. The figure also shows that an appraiser, on a hypothetical basis, has found that a market rate of interest for the note sould be 6.0%.
Finally, in the last figure, we show the fair market value of the 2% promissory note, based on a market rate of interest of 6.0%, to be substantially lower than the fair market value of the face amount (and therefore, of the stock for which it is exchanged).
The point of this short post is simply this: the promissory note issued pursuant to a buy-sell agreement may not provide the fair market value determined for the stock sold if the note has an inadequate interest rate or other unfavorable (from the holder’s viewpoint) features.
Until next time, be well!
Valuation is important for business owners for many reasons. One of these reasons is for the operation of buy-sell agreements. If you are thinking about your buy-sell agreement (and you should be), then take a look at Buy-Sell Agreements for Baby Boomer Business Owners, my Kindle book on the topic.
I’ve priced it at $2.99 so you won’t have to think about the expense. So click on the image of the book. You will be taken to Amazon. Then buy the book. Don’t be mislead by the price. It is a full-length book. If you like it, as most readers have, please take a few minutes and review the book on Amazon!
Additionally, my two most recent books are available in an Ownership Transition Bundle. The bundle, priced at $35 plus s/h, has been attractive to many business owners, appraisers, and attorneys.