Advanced Underwriting Consultants

Question of the Day – October 11

Ask the Experts!

Here’s the question of the day.

Question:  What’s the biggest mistake you typically see in a client’s business buy-sell agreement?

Answer:  The biggest mistake that business owners can make is to not have a written buy-sell agreement!

If the owners of a business do have a written buy-sell agreement, one of our pet peeves is when the valuation provisions don’t yield a predictable business buyout price.  For example, we often see valuation clauses that look like this:

The fair market value of a deceased owner’s interest shall be the percentage of the owner’s ownership interest in the Company multiplied by the fair market value of the Company, which will be determined as follows:  within 15 days after receiving notice of the death of a Member, each of the Company and the legal representative of the deceased Member will select an accountant, business appraiser, or investment banker (each an Initial Appraiser) to determine the fair market value of the Company.  The two Initial Appraisers will determine the fair market value of the Company as of the last day of the month immediately preceding the month in which the deceased Member dies and will make such determination within 30 days after the expiration of such 15-day period (such 30-day period is hereinafter referred to as the Initial Appraisal Period).  If the two Appraisers cannot agree on the fair market value of the Company within the Initial Appraisal Period, then the two Initial Appraisers shall select an accountant, business appraiser, or investment banker (the Third Appraiser) within 15 days after the expiration of the Initial Appraisal Period. A majority of the Initial Appraisers and the Third Appraiser will determine the fair market value of the Company within 30 days following the appointment of the Third Appraiser and shall notify the Company, the surviving Member, and the estate of the deceased Member of the fair market value of the Company. 

While such a valuation method can work, it feels unnecessarily cumbersome and unpredictable for most businesses and their owners.  We usually recommend that the owners use a formula, based on easily ascertainable business metrics, to value the business for buy-sell purposes.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.