Summary
Well-written Buy-Sell Agreements have triggering events that call for a third-party business valuation. Business Appraisal FL|GA|HI has deep experience valuing companies for buy-sell agreements.
How to Value a Company for Buy-Sell Agreements
Table of contents
- How to Value a Company for Buy-Sell Agreements
Buy-Sell Agreements for Closely Held Companies and Their Value
As a business owner, you know the importance of a buy-sell agreement. Business owners execute these contracts with each other. They establish the guidelines that allow for exits, shareholding, and funding for purchases. Certain events trigger the need for a 3rd party business valuation or business appraisal.
These buyout agreement guidelines, however, are especially important for owners. They enable you to plan for parting ways with partners. Events that could occur include purchasing life insurance, death, disability, divorce, family member disagreements, conversion to a limited liability company, or retirement. Please read our article on common business partner issues.
Drafting a Buy-Sell Agreement with a Business Valuation Provision
Business owners should work with an attorney to navigate the process of drafting such agreements. Doing so ensures that owners minimize financial risk should one of the triggering events occur.
Ideally, the agreement should be drafted when the business is initially created. This is because the interests of the business owners most closely align at that point. However, as time goes on, the interests of each business owner may diverge, resulting in a more complex negotiation process for drafting the buy-sell agreement.
Regardless of when drafted, an effective buy-sell agreement will include the following components:
- This is a list of the kinds of events that will trigger an optional or mandatory sale of an owner’s ownership interests to the company or the other owners.
- A description of how ownership interests will be valued when a triggering event occurs.
- An explanation of the terms of purchase and an agreement as to where the money for the purchase will come from.
- Valuation provisions that discuss the ownership interest and what market approach methods and discounts will be used.
In addition to the components, a buy-sell agreement will also require an assessment of the business value. A business appraisal, or business valuation, reflects the current economic value of a business. Please read our article on the business valuation process.
The approach to conducting an appraisal may vary among evaluators and industries. However, the factors included in such analysis tend to be the same. Overall, you can calculate a business’s financial health by assessing its team, assets, earnings, growth, and losses within the context of its specific industry.
Assessments for buy-sell agreements tend to assess the business value in one of three ways: determining an agreed-upon value among the business owners, assessing the fair market value at the time of the sale, or approximating value based on formulas.
Regardless, when drafting a buy-sell agreement for your business, it is best to work with expert analysts like BA FL|GA|HI, who can help you at every stage of the valuation process.
1. An agreed-upon value in a buy-sell agreement
This method is the simplest way to appraise the business when executing a buy-sell agreement. The business owners would need to agree upon the dollar amount to value the business and include that figure in the agreement.
However, valuing the business this way fails to account for potential changes in value as time progresses between when the agreement was drafted and the occurrence of a trigger event that would initiate a sale.
Because of this, we don’t typically advise assessing the value of all businesses this way. Instead, relying on an agreed-upon value may be suitable for small and predictable businesses.
2. Fair market value at the time of sale
The most accurate way to conduct the appraisal is to determine your business’ fair market value at the time of sale. Professional appraisers like BA FL|GA|HI can work with you to determine the value of a potentially departing owner’s ownership.
Additionally, this method ensures that you account for certain factors, like growth and intellectual property, that may increase or decrease your business’s true worth.
3. Using a formula to determine the value of the business
Employing this method, appraisers can help you determine valuations specific to your business and industry.
Typically, the valuation will consider earnings before tax, depreciation, and amortization (EBITDA) to account for the assets minus the liabilities. Additionally, a multiple of earnings, adjusted seller discretionary earnings, or book value may be considered.
Buy-Sell Agreement Valuation Conclusion
A buy-sell agreement is important because it restricts the owners’ ability to transfer their interests to unwanted individuals. To facilitate this restriction, the agreement tends to specify the events in which owners would be able to liquidate their assets. Essentially, an exit strategy is created for the co-owners to avoid potential conflicts in the event that a triggering event was to occur.
Business owners must determine the business entity’s value to create a buy-sell agreement. To do so, they should consult expert appraisers like those at BA FL|GA|HI. Doing so ensures that your appraisal is accurate and complete, which will be needed to execute the buy-sell agreement of your small or medium business.
Add the dynamics of family members to the above and who the remaining owners are, and it gets even more complicated.
Contact BA FL|GA|HI today to meet with our expert and eager business appraisers. We are ready to discuss your owner’s interest situation and the valuation services that are best suited for your business.