Litigation + Valuation Perspectives

Demystifying Valuation, Economic Damages + Forensic Accounting

Is it time to update your buy/sell agreement?

I am often asked to review the provisions in a buy/sell agreement related to the question as to how value is determined. This sometimes occurs when there is a triggering event. Unfortunately, in those circumstances, we simply determine value based on the agreement. Sometimes the resulting value is favorable to one party to the detriment of another. Other times the language of the agreement is subject to interpretation resulting in unnecessary disputes and possibly litigation. There are advantages, disadvantages and pitfalls to avoid in drafting these agreements.

I reviewed a recent agreement that defined the purchase price for triggering events to be determined pursuant to a formula. The benefit to a formula driven approach is simplicity (as long as the formula is well-defined) and valuation certainty. The challenge with a formula approach is that, while the formula may reflect a fair price at the date of the agreement, it may also become quickly out of touch with actual value for a future transaction.

Another agreement had a defined value agreed on by the shareholders with periodic updates required. However, updates are frequently not performed. In addition, it should be clear whether the agreement requires a determination of value of the enterprise or value of the minority interest to be valued.

Certain terms have specific meanings in the finance, accounting and valuation literature, and care should be taken in selecting those terms to avoid misinterpretation or unintended results. Some common terms include:

  • “fair market value”
  • “fair value”
  • “book value”
  • “net book value”
  • “net income”
  • “generally accepted accounting principles”
  • “accounting principles consistently applied”

An alternative to a formula approach is a process-driven value determination. As an example, the agreement might provide that the value is to be determined by a qualified appraisal performed by a qualified appraiser. The appraiser could be pre-selected or agreed on by the parties upon a triggering event. If the parties could not agree on the appraiser to be selected, a mechanism could be created to determine the appraiser to be retained. Periodic appraisals could also be performed with either named appraisers or through a selection process.

Other considerations include the options/rights of the parties and the terms of payment for any purchase of equity interests in the Company on a triggering event. Care should be taken that the terms of payment are aligned with the cash flow requirements of the business and the estate planning requirements of the parties.

These are just some of the basic considerations for a properly aligned buy/sell agreement. Now might be a good time to revisit your buy/sell agreement and consider updates.

Have questions? Our litigation + valuation professionals help clients in a variety of industries including construction, dealerships, restaurants, technology and more.

Steve Koons, CPA, ABV, CFF, ASA