What is a Buy-Sell Agreement?
In simple words, a buy-sell agreement is an agreement to provide the business ownership succession when the owner fails to take over the company, disconnects from the company or dies.
In other words, it is an agreement of valuation of the business designed to handle the future triggering events.
A typical buy-sell agreement contains the list of future triggering events, how to value the ownership interest and the financial issues upon purchasing the business.
3 Different Ways for Assessing a Business Value
A buy-sell agreement will generally gives the detailed assessment of the business which can be done in three different ways:
- Defined Process Approach
- Negotiations based on the Market Value
- Using Formula
How to Determine Business Value Using Defined Process Approach
Firstly, the defined process approach is the straightforward method to determine the value of the company. This stimulates the parties to agree upon the value of the business and states that value in the buy-sell agreement.
The disadvantage of this method is that it is not responsible for the possible increase or the decrease of the value as time passes between the occurrence of the event that initiates the sale and the execution of the buy-sell agreement.
The defined process approach is not typically advisable and take into consideration the business's current condition.
Using Negotiation to Determine a Business' Value for Buy-Sell Agreement
Secondly, by using the negotiation based on the market value, we can certainly determine the value of the business. Anyways, this can be quite expensive while comparing to the other methods.
Only the professional financial appraiser can appraise the business. The fair market value can be determined based on the interest of the owner and the shareholders provided the market value at that time of sale of the business.
Negotiation between the owners or the shareholders on the reason for buy-sell agreement to create the liquidation of the business among the family.
How to determine a Business' Value by Formula for a Buy-Sell Agreement
Finally, using the formula approach to determine the value of the business for buy-sell agreement tend to be generally comfortable by the business owners.
The formula approach in determining the value of the business produces the accountable valuation of the at that time of agreement. It may not produce the same result in the mean time of five or ten years later, because of the changing conditions within the economy, company and the environment.
In this method, the buy-sell agreement contains the formula such as a multiple of earnings before tax, depreciation and amortization by a certain numbers. Book value of the business is important and these are the assets of the company.
This approach is not same for all the business and industries. The factors of formula varies for business in different industries to determine the value of the business.
Know the Difference Between Business Value & Purchase Value in a Buy-Sell Agreement
Based on the buy-sell agreement, the value of a disjoining owner's shares may not be the exact price that the business or the other shareholders must pay.
While purchasing the business listed for sale, it is important to know the business income, the tangible assets and intangible assets associated with the business.
There may be many events or occasions in which the business owners makes an easy looking deal whereby the business have the option to purchase at a reduced price.
In such cases, the buy-sell agreement that the other shareholders or the company have the right to purchase the owners' stock at the percentage of it's actual value.
