It’s Time to Review Your Buy-Sell Agreement

Buy-sell agreements are commonly referred to as the "prenuptial agreements of the business world." Made by and between the owners of a privately held business, these legally binding agreements outline what happens if an owner were to leave the business, whether due to death or resignation. Perhaps most important, a buy-sell agreement stipulates what the newly available shares are worth—as well as who can buy them.

Andy Clausen January 10, 2019

Amid the rush of running a business, it’s easy to let your buy-sell agreement to become an afterthought. But if any of the language in your buy-sell agreement becomes stale, you and your partners could be left with a mess if the agreement were to be triggered. If you haven’t looked at your buy-sell agreement in a while, consider reviewing it—particularly the language included in your agreement’s valuation clause—as soon as possible.

 

What is a valuation clause?

The section of a buy-sell agreement that addresses the worth of the company shares is known as the valuation clause. As you might expect, the valuation clause dictates how the company’s value will be determined at the time the buy-sell agreement is triggered. Typically, these clauses call for shareholders to determine a company’s value using one of three methods:

  1. Referencing a fixed-price valuation
  2. Using a formula to calculate the valuation
  3. Following a process for hiring an appraiser

Here’s what you should know about each method.

 

Fixed price valuation

In buy-sell agreements that call for a fixed-price valuation, the owners must agree on a valuation of the business when initially drafting the agreement. Then, the owners must update the agreed upon valuation each year. But things change. A fixed price doesn’t account for all the variables that affect a company’s valuation, even if it’s updated annually. And in many businesses, the annual valuation update may never take place.

Formula valuations

Valuation clauses may include a formula to be used to calculate the valuation. Ideally, an attorney will consult with an appraiser to design the formula. But here’s the problem: the chances of getting an accurate valuation using a formula aren’t so great. Similar to a fixed price, a formula cannot account for unforeseen events that impact the company’s valuation.

Appraisal process

Valuation clauses that call for an appraisal process will deliver the most accurate valuation, but the process must be agreed upon as fair to all parties. For instance, the clause could require the valuation to be conducted by a single appraiser, or it might require multiple appraisers and an average of their valuations. Furthermore, it could call for an initial appraisal followed by annual reappraisals, or an appraiser is simply selected and written into the agreement. Regardless, this approach can go a long way toward helping all shareholders have peace of mind that they’re being treated fairly.


Take a look at your buy-sell agreement today.

If you’re party to a buy-sell agreement, consider reviewing its valuation clause to make sure the language accurately reflects you and your business partners’ wishes. Having an owner leave the business, regardless of the reason, can be a stressful experience. Knowing that your buy-sell agreement won’t leave you out in the cold can help to alleviate some of the worry, and allow you to focus on taking the right next step.

If you have questions about your company’s valuation, please don’t hesitate to contact me.