Value is addressed in the Buy-Sell agreement. It can be a fixed price, a formula to determine value, or a process to determine value.
A fixed price is perhaps the easiest to understand and the most at risk of rewarding one party at the expense of another. It may be a reasonable measure of value today, but as time passes it may have little relevance to actual value on a triggering event.
A formula agreement provides a formula to determine value which can be as simple or complex as the owners agree. In practice they tend to be simple and fairly easy to understand, often based on a multiple of revenue or EBITDA. When using a formula, it is important to define the terms of the formula clearly so years later when the agreement is triggered there is no confusion as to what is included or excluded from the formula. There is a risk that as times change and your business evolves, that the formula may become irrelevant and potentially rewards one party at the expense of another.
The process driven agreement is one in which the value is determined by a defined process and usually requires the use of one or more appraisers to determine the value of the ownership interest. In this case it is important to provide sufficient direction so the appraiser(s) understands the standard of value, premise of value and valuation date among other considerations. It is also important to allow a significant amount of time for the appraiser(s) to perform their work. The appraiser of appraisal firm can be selected either in the agreement or later based on qualifications. If the appraiser(s) are to be selected at a later date, the appraiser qualifications (for example, an appraiser holding a current professional designation of “Accredited Senior Appraiser” from the American Society of Appraisers) should be specified in the agreement.
If multiple appraisers are to be used, the agreement should address how difference in value conclusions are resolved. The values can be averaged, used as the basis for a negotiation, or a third appraiser can be selected (often by the first two appraisers) either to determine which appraisal is more reasonable or to provide a third appraisal for consideration. Often if the first two appraisals are reasonably close, plus or minus 10% or 15% for example, you might elect to average them. If the difference is greater than that, you may require a third appraiser. All these things should be specified in the agreement.
Buy-Sell Agreements can have legal, tax and valuation ramifications, so you should consult experts in each of these fields when drafting or modifying a Buy-Sell Agreement.