Would You Buy that Buy-Sell Agreement?

By:  S. Andrew McKay, Director of Investment Banking

In our work as investment bankers and business appraisers, we regularly encounter buy-sell, cross purchase and shareholder redemption agreements. These agreements are intended to solve succession problems and facilitate ownership transitions at key moments in the life of a company. Too often, we find that they do the opposite, confusing rather than clarifying the issues, and resulting in needless disputes among stakeholders. Because these agreements may be based on standardized legal language and are not drafted in consultation with business valuation professionals, many questions are often not addressed and left to be decided at the time the agreements are operative. By that time, however, the parties’ vested interests and intentions may collide, further complicating the process. It may even be necessary (but not always possible) to divine the intentions and wishes of a deceased shareholder, if they were not specified clearly beforehand in the buy-sell agreement.

Some of the weaknesses, from a valuator’s standpoint, that potentially exist in buy-sell agreements are presented below.

  • Lack of a defined standard and premise of value. The value of a company can vary depending on the “standard” or definition of value that is assumed. Fair market value is a common standard that is well understood. However, investment value and fair value are other standards that, while not as well known, might better suit the parties.

The “premise” of value for a company refers to the “highest and best” or intended use for the subject company. The valuation premise for the subject company could be for it to be viewed as ongoing (a “going concern”) or as a company in liquidation (forced or orderly). The remaining owners may plan to liquidate the company or sell its assets upon a triggering event such as the death or retirement of its founder. In this case, a “going concern” premise may not best reflect its value.

  • Failure to specify the “as of” date. The effective date of the appraisal should be clearly identified to avoid any possible confusion. For example, the agreement could provide for flexibility in the case of a triggering event caused by the death of an owner. In this case, the shareholder agreement could provide for an alternate valuation date (as allowed for valuations for estate taxes) of six months after the date of death.

A related question concerns which of the company’s financial statements will be used in the valuation. Often, a company’s internally generated interim statements are not accurate as they are not prepared in conformity with generally accepted accounting principles (GAAP). These statements may not be consistent with the company’s yearly CPA prepared GAAP based financial statements. If the “as of date” falls some period of time after the last GAAP based financial statements are issued, at what point, if any, will the internal statements be used?

  • No consideration of valuation discounts and premiums. Discounts commonly seen in valuations are for lack of control and/or lack of marketability. Also, a “key person” discount may be appropriate. If the key person is the individual whose shares are being transferred (due to death or retirement), should the valuation assume the person to be present or absent from the company on the “as of” date?

The buy-sell agreement could specify discounts in some cases but not in others, depending on the nature of the triggering event. For example, an involuntary severance of ownership might not incorporate a discount for lack of control, while a voluntary severance would consider the lack of control discount.

  • Use of “canned” valuation formulas. Shortcut formulas might include a multiple of revenues or the average of three year’s earnings divided by a capitalization rate. Formulas may also be based on industry “rules of thumb.” The problem is that these formulas, while useful for making approximations about a business’s value, may not reflect the true value. Over time, the agreed upon formulas may become even less appropriate due to changes in the business and in the rules of thumb.

  • No selection of the appropriate valuation method(s). Certainly, not all appraisal approaches and methods are well suited to all businesses. Since many shareholder disputes over valuations arise because different methods were used to value the company, it may be wise for the stakeholders to agree in advance on the selected methods to be used. That said, the appropriate methods can change over time as the company itself grows and changes. Therefore, this provision in the agreement should be periodically reviewed.

  • No provision for periodic updating of the valueThe parties may have the best intentions to maintain some idea of the current value, but fail to do so. Having an idea of the company’s current value allows the parties to avoid surprises and make good personal planning decisions. To anticipate this occurrence, the agreement should contain provisions for handling outdated value conclusions. We recommend having a yearly or every other year update of the value, depending on the size and stability of the company. In some cases a calculation analysis, rather than a business valuation, will be the appropriate choice.

  • No provision for making normalizing adjustments to the company’s financial statements. This is another area of potentially heated dispute among owners and appraisers. If there are non-operating expenses that should be added back to the subject company’s normalized earnings, it may be wise to agree beforehand that they are required adjustments. Likewise, management compensation adjustments are sometimes controversial in valuations; it may benefit the parties to document the propriety of making them before the valuation is performed. 

  • Complicated appraisal processes involving multiple appraisers. Some agreements call for the selection of appraisers by each of the affected parties, with provisions to retain a third appraiser in the event of a disagreement. In this situation, the role of the third appraiser needs to be clear. Will the third appraiser conduct a third valuation, choose between the first two valuations, or pick a number that is (presumably) in between them? Does there need to be a “trigger” level of difference in the first two appraisers’ values conclusions before the third appraiser is engaged?

  • No provision for appraiser qualifications, standards, or degree of “disinterestedness." Regardless of the parties’ decision to select a valuation firm in advance, it is advisable to specify the desired qualifications for the appraiser. Full time valuation professionals typically obtain one or more specialized valuation credentials and are bound to follow one or more sets of professional appraisal standards.

Another concern that is best addressed in advance is whether or not it is appropriate for the chosen valuation firm and/or appraiser to have an existing relationship with any of the parties. In some contentious settings, the perception of an appraiser as being unduly close to one of the owners can have a negative effect on the proceedings.

  • No specified funding mechanism.  Too often we find the method of funding ignored and a potential point of difference between the parties. This provision should define the source of payment for the transferred interest (life insurance proceeds, company debt, personal debt, etc.) and the terms of payment. If the source of payment will be a note from the company, what will be the security interest and the payment priority among the company’s debts? Also, if there is a life insurance policy with the company as the beneficiary; will the proceeds be added to its value or ignored?

  • Problems with rights of first refusalWhen there is a “triggering event”, obviously something needs to happen to the subject interest – it needs to be transferred. However, the agreement may not be binding in this respect. While there may be a right of first refusal, first for the company and then for the remaining owners to purchase the interest, what if they are refused? If there is no binding requirement to purchase the interest, there is no guarantee that the intended transaction will ever occur.  Also, should the existence of a right of first refusal be considered in the context of a discount for lack of marketability?

  • No provisions for decisions affecting the stock value following “trigger” events.  Depending on the defined “as of” valuation date, corporate actions taken between the triggering event and the valuation date can dramatically affect the company’s value. For example, the company could distribute retained earnings, thereby lessening its remaining value. Other corporate actions (such as selling corporate assets) could impact the value. What types of actions are permitted, and which are not? 


We find buy-sell and cross purchase agreements to be complicated animals. A perfunctory agreement lacking in-depth consideration of the specific circumstances and the implications of the triggering events many fail in its intended mission to promote the company’s and owners’ best interests. It may therefore be prudent to review your company’s documents with appropriate advisors and consider appropriate changes.

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