Buy Sell Agreements Example Slides
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1 You’ll Never Think About Buy-Sell Agreements the Same Way Again Z. Christopher Mercer, ASA, CFA Mercer Capital
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Transcript of Buy Sell Agreements Example Slides
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You’ll Never Think About
Buy-Sell Agreements the Same Way Again
Z. Christopher Mercer, ASA, CFAMercer Capital
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Three Questions to Ask Your Clients
Do you have a buy-sell
agreement?
If so, what type of agreement is it?
Do you know what your buy-sell
agreement says?
There are six defining elements that must be
in every process agreement if you want the valuation process
and, therefore, the agreement, to work
How is your buy-sell agreement
funded?
How life insurance proceeds are treated
can make a big difference in the valuation of the
company
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1Do You Have a
Buy-Sell Agreement?
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The “Wayne” Story
1964 1974
» Wayne’s Dad makes investment in start-up in 1964
$250,000 for 25%
Buy-sell agreement fixes price at $1.0 million ($250,000 for 25%)
» Wayne’s Dad dies in 1974
Buy-sell agreement was never updated
Company paid $250 thousand for the 25% interest
Company successful over next decade, Value grows to $5.0 million
Human Fallout
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What Is a Buy-Sell Agreement?
Buy-sell agreements are agreements by and between the shareholders (or equity partners of whatever legal description) of a privately owned business and, perhaps, the business itself
They establish the mechanism for the purchase of stock
following the death (or other adverse changes) of one of the
owners
In the case of corporate joint ventures, they also establish the
value for break-ups or for circumstances calling for one
corporate venture partner to buy out the other partner
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Buy-Sell Agreements
Require agreement at a point in time
Relate to transactions that will or may occur at future points in time
Define the conditions that “trigger” the buy-sell provisions
Determine the price(s) at which the specified future transactions will occur
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How Do Buy-Sell Agreements Get Created?
Something happens Have a company
Do a deal
Invest in a company
Attorney says “You have to
have a buy-sell agreement!”
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How Do Buy-Sell Agreements Get Created?
» Owners, shareholders, and investors often resist
Exercise in future thinking
Focused on adverse
possible future events
No one wants to think
about dying
Procrastination is the name of the game (or avoidance!)
Brings up uncomfortable
differences
Age
Capital Participation
Insurability
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How Do Buy-Sell Agreements Get Created?
» Attorney finally drafts something
Little or no review by shareholders
Maybe it gets signed
Into the drawer (or lockbox or file), until…
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Potential “Trigger Events”
» Q Quits
» F is Fired
» R Retires
» D Disabled
» D Death
» D Divorce
» B Bankruptcy
» Others?
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Get Agreement. Now.
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Based on how price is determined
1. Fixed price agreements
2. Formula agreements
3. Shotgun agreements
4. Process agreements
Types of Buy-Sell Agreements
Valuation
Processes
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1. Fixed Price Agreements
Advantages
Easy to understand, easy to negotiate – the first time only!
Inexpensive
»Easy for attorneys to draft
»No appraisers required
Disadvantages
Fixed prices are seldom updated, even over periods of many years. Inequities are almost certainly a result of out-of-date fixed price agreements
Easy to set an initial price, but may be difficult to reset as time passes and interests diverge
The longer period of time between updates to fixed price agreements, the greater the potential for a divergence of the interests of the various parties
Betting that the other guy(s) will die first!
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Fixed Price Agreements are often out of date when inked!
If your client has one, update it now!
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2. Formula Agreements
»Examples Multiple of EBITDA – (5 x EBITDA)
»Less debt?
Book Value»“Shareholders’ equity per the
audited financial statements at the end of the fiscal year immediately preceding the valuation date.”
State a single formula to be
applied to balance sheet and/or income
statement metrics
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2. Formula Agreements
Advantages
Easy to understand, easy to negotiate – the first time only!
Inexpensive
»Easy for attorneys to draft
»No appraisers required
Disadvantages
No formula selected at a point in time provides reasonable and realistic valuations over time
Changes occur in companies, industries, local, regional, national and world economies, some or all of which can impact the “true value” of an enterprise relative to any set formula
Formulas, if not specified carefully, can be misinterpreted – or are subject to multiple interpretations
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If your client has a formula agreement, have someone calculate the formula result as if there were a trigger event now, and
then deal with any issues that arise
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3. Shotgun Agreements
» Concept is that the initial offering side (which will that be?) virtually has to name a “reasonable” price, i.e., one at which he would be willing to buy or sell
» Assumes both parties have equal financial capacities and knowledge about the business and its prospects to engage in either a buy or a sell transaction
One side makes an offerOther side has a choice
to sell at that price
In the alternative, if other side decides not to sell, may have the right to buy (no obligation)
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3. Shotgun Agreements
Advantages
Pressure on offering party to establish a “fair” price
Disadvantages
Parties seldom have equal financial capacities and may have different knowledge about the business
Minority shareholders may be at a disadvantage
»Easier for a 90% shareholder to acquire 10% than vice-versa
»Smaller shareholder, unable to swing the big deal, may have to offer lower price than “fair” in order to insure capability to either buy or sell, and therefore, receive a lower price on sale
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4. Process Buy-Sell Agreements» A buy-sell agreement provides a valuation process employing
one or more appraisers
» Value is determined by the appraisers in a manner defined in the buy-sell agreement
» Two types of process buy-sell agreements:
Multiple Appraiser Single Appraiser
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4. Process Buy-Sell Agreements» Your client’s buy-sell agreement should be
PredictableUnderstandable
Likely to achieve
reasonable resolutions
Helpful in the wealth
management process
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4. Process Buy-Sell Agreements» Recommendation
» Good for clients’ businesses
» Excuses, excuses, excuses…No excuses, really
Single Appraiser Select Now, Value Now Value Regularly
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Recommendation Single Appraiser
Agreement
Select Now,Value Now
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Single Appraiser Agreement Select Now & Value Now
Advantages
1. Selected appraiser viewed as independent
2. Appraiser’s valuation process is seen by all parties at the outset
3. Appraiser’s conclusion is known at outset and has established a baseline price for the agreement
4. Because process is observed at the outset, all parties know what will happen when trigger event occurs
5. Because the appraiser must interpret the “words on the pages” in conducting the initial appraisal, any issues regarding lack of clarity of valuation-defining terms will be resolved
6. Selected appraiser must maintain independence with respect to process and render future valuations consistent with terms of agreement and with prior reports
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Single Appraiser Agreement Select Now & Value Now
Advantages (Continued)
1. Subsequent appraisals, either annually or at trigger events, should be less time-consuming and expensive than other alternatives
2. Parties should gain confidence in the process
3. Parties will always know the current value for the buy-sell agreement (helpful for planning all-around)
4. Appraisers’ knowledge of the company and its industry will grow over time, enhancing confidence for all parties with the process
5. Creates a means of maintaining pricing for other transactions, thereby enhancing “the market” for a company’s shares
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2Do You Know What
Your Buy-Sell Agreement
Says?
27The Six Defining Elements of Process Buy-Sell Agreements
Standard of ValueQualifications of
Appraisers
Level of Value Appraisal Standards
The “as of” date Funding Mechanism
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» Normally fair market value
Willing buyer, willing seller….but buyers of what?
» Fair value
Defined under state law A defined term, of sorts, under accounting rules
» Investment value
From the perspective of whom?
» “The Value,” “Going Concern Value,” and on and on and on…
Defining Element #1 –Standard of Value
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Defining Element #2 – Level of Value» Which level?
In other words, the value of what?
» Should be specific
Refer to specific language and specific page in book (preferably mine!)
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Defining Element #2 – Level of Value
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Defining Element #2 – Level of Value
Price we hope to get if we sell the company together
Price the rest of us can reasonably pay if we have to
buy out someone else
“Fair market value of the (minority) interest”
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Defining Element #2 – Level of Value
$100 Per Share
$60 Per Share
$140 Per Share
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Defining Element #3 – The “As Of” Date
» Defines the situation at the Company,
Within the Industry
National Economy
Pricing from Guideline Cos.
Comparable Transactions
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Defining Element #4 – QualificationsQualifications of appraisers
Education
Credentials
Experience in appraisal
Size of the firm
Continuing education
Valuation Training
Nature of firm’s business
Industry experience
Reputation
Compliance w/Prof. Standards
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Defining Element #5 – Appraisal Standards to be Followed
The Institute of Business Appraisers Business Valuation Standards
and Rules of Professional
Conduct
ASA Business Valuation Standards
Principals of Appraisal
Practice and Code of Ethics
of the ASA
Uniform Standards of Professional
Appraisal Practice
Professional Standards of
NACVA
Other professional standards? Specify
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Defining Element #6 – Funding Mechanism
» Who buys? Other shareholders Company Other shareholders and/or
company
» Life insurance
» Adequacy of funding
» Nature of mechanism Cash (is there a sinking fund?) Notes
• Down payment• Terms• Interest rate• Security
What does your buy-sell agreement say about the treatment of life insurance
proceeds in the event of the death of a shareholder subject to it?
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Quest
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Handout
Yes No Unknown
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Unknown
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4 Yes No Unknown
Yes No Unknown Valuation Mechanism
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Yes No
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Yes No Unknown
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19 20 If Yes, Was It a Good Experience? 20a
Yes No Unknown
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Yes No Unknown Hints
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As of specified trigger events, the month-end immediately prior to the trigger event, etc.
Background, experience, education, credentials, good looks, industry experience, etc.
Uniform Standards of Professional Appraisal Practice, American Society of Appraisers, etc.
Has Your Buy-Sell Agreement Ever Been Triggered?
Standard of Value Defined?
Level of Value Stated?
The "as of" Date Defined?
Qualifications of Appraisers?
Appraisal Standards?
Fair Market Value, Fair Value, Investment Value, "the Value," Going Concern Value, Other
"No minority or marketability discounts," "Financial Control Level," Value of "the Interest"
Is the Agreement Signed by All Necessary Parties?
When was it last updated?
When was it originally signed?
Do you have a Buy-Sell Agreement?
Fixed Price?
Formula Mechanism?
Three Appraiser Process?
Single Appraiser Process?
Quits - Voluntarily
Fired
Retired
Disability
Basic Information
Do you Know Terms of the Notes?
Funding the Buy-Sell Agreement
Defining the Valuation Process
Trigger Events
Is there Life Insurance?
Is it Owned by the Company?
Use of Proceeds Specified?
Is there Note Financing?
Appraisal Process
Valuation Mechanism
Year (Approx. OK)
Death
Divorce
Other
When was the Fixed Price Last Updated?
What is the Formula?
When was it Last Calculated?
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Questions to Consider
» Is there a reasonable probability that the agreement will operate to effectuate a reasonable transaction when trigger events occur?
» Are all shareholders who should be subject to the agreement parties to it?
» Do the shareholders who are parties to the agreement understand how the agreement will operate to determine prices and terms for future transactions?
» Has the agreement been reviewed by legal counsel to ensure compliance with applicable laws and statutes?
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Questions to Consider
» Are the six defining elements of value as outlined in this presentation clearly specified?
» Will the pricing mechanism provide a reasonable value if and when trigger events occur in the future?
» Is the funding mechanism in place and workable?
» How do you resolve differences?
40Questions to Consider Nature, Size & Ownership of Equity
Parties to consider in discussions about the buy-sell agreement?
Groups of shareholders and relative ownership maintenance?
Active vs. passive shareholders?
Restrictions under loan agreement?
Multiple classes of ownership?
Age of shareholders?
State law considerations?
ROFRs?
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Potential “Trigger Events”
» Q Quits
» F is Fired
» R Retires
» D Disabled
» D Death
» D Divorce
» B Bankruptcy
» Others?
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Questions to Consider Financial Statements / Corporate Information
» Financial statements to be used
» Information “known” or “reasonably knowable” as of the valuation date
Most recent fiscal yearTrailing 12 months at
most recent quarter-endOR
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Questions to Consider Process Timetables
» When is appraisal due from appraiser?
» Access of parties to talk to appraiser» What happens to valuation date in the event of avoidable or unavoidable
delays?
» Is owner of interest still a shareholder?
» Is appraisal conclusion binding?
No change Interest beyond _ days Reset the date
Vote? Distributions?
Dispute resolution process
Will a draft be supplied to all interested parties?
44Questions to Consider Who Bears the Cost of the Appraisal(s)?
» Cost of appraisal process
Both sides bear own
expenses?
Company pays for
process?
Fairness to minority
shareholders?
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3How is your Buy-Sell Agreement Funded?
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Funding the Buy-Sell Agreement» Most buy-sell agreements with companies of significant size
and ownership greater than 2-3 are corporate purchase agreements
» Life insurance typically purchased by company
» Key question: Is life insurance intended –
» It makes a big difference!
As a funding vehicle (to be used to acquire stock of deceased shareholder)?
As a corporate asset (to be included in value before determining price to be paid to deceased shareholder)?
OR
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True Story: Life Insurance
Dead
What happens now?
48Funding MechanismWhat about Life Insurance Treatment for Valuation Purposes?
Harry Proceeds are a Funding Vehicle Company (Estate) Sam
1 Stock Ownership (Shares) 100.0 50.0 50.02 Stock Ownership (%) 100.0% 50.0% 50.0%3 Pre and Post Life Insurance Value ($m) $10,000.0 $5,000.0 $5,000.04 Life Insurance Proceeds $6,000.05 Repurchase Liability ($5,000.0)6 Post-Life-Insurance Value $11,000.0
7 Repurchase Stock ($5,000.0) $5,000.08 Retire / Give Up Stock (50.0) (50.0)9 Remaining Stock 50.0 0.0 50.0
10 New Stock Ownership (%) 100.0% 0.0% 100.0%11 Post-Life Insurance Value of Co. $11,000.0 $0.0 $11,000.012 Post Life Insurance Proceeds $5,000.013 Net Change in Value from Repurchase $1,000.0
49Funding MechanismWhat about Life Insurance Treatment for Valuation Purposes?
Harry Proceeds are a Corporate Asset Company (Estate) Sam
1 Stock Ownership (Shares) 100.0 50.0 50.02 Stock Ownership (%) 100.0% 50.0% 50.0%3 Pre-Life Insurance Value ($m) $10,000.0 $5,000.0 $5,000.04 Life Insurance Proceeds ($m) $6,000.0 $3,000.0 $3,000.05 Post-Life Insurance Value ($m) $16,000.0 $8,000.0 $8,000.06 Repurchase Liability ($8,000.0)7 Post-Life-Insurance Value $8,000.0
8 Repurchase Stock ($8,000.0) $8,000.09 Retire / Give Up Stock (50.0) (50.0)
10 Remaining Stock 50.0 0.0 50.011 New Stock Ownership (%) 100.0% 0.0% 100.0%12 Post-Life Insurance Value of Co. $8,000.0 $0.0 $8,000.013 Post Life Insurance Proceeds $8,000.014 Net Change in Value from Repurchase ($2,000.0)
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The “Catfish” Story
1978 1987
1978
5 guys purchased catfish processing company
Paid $2.0 million, with $500 of equity (pro rata, 20% each)
Buy-sell agreement entered into
4 of 5 worked in company
1987
One of partner/shareholders dies Company is debt-free and is worth
$5.0 million
Buy-sell agreement says appraiser will determine “the fair market value of the interest” owned by the deceased (i.e., a 20% minority interest)
Acquisition period documents were clear that intentions of parties were that value be determined as pro rata value of company
Appraiser made all parties aware of conflict between documents. Valued on enterprise and minority interest basis. Parties ultimately agreed on price very close to enterprise value
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Defining Elements per BSA
Defining Elements Section 12.41. Standard of Value
2. Level of Value
3. The “as of” date
4. Appraiser Qualifications
5. Appraiser Standards
6. Funding
Fair market value
“the value of the interest”
Specified
Mercer Capital named
ASA/USPAP through credentials of
appraisers
Agreement silent – no life insurance
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Buy-Sell Agreements: Ticking Time Bombs or
Reasonable Resolutions?
The Buy-Sell Audit Checklist
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Questions?» Z. Christopher Mercer, ASA, CFA
901.685.2120
http://www.linkedin.com/in/zchristophermercer
» Mercer Capital
5860 Ridgeway Center Parkway, Suite 400 Memphis, Tennessee 38120www.mercercapital.com
