Upload
others
View
9
Download
0
Embed Size (px)
Citation preview
Wednesday, April 26, 2017 Noon–1 p.m.
1 General CLE credit
Buy-Sell Agreements and Business Valuation
iiBuy-Sell Agreements and Business Valuation
BUY-SELL AGREEMENTS AND BUSINESS VALUATION
The materials and forms in this manual are published by the Oregon State Bar exclusively for the use of attorneys. Neither the Oregon State Bar nor the contributors make either express or implied warranties in regard to the use of the materials and/or forms. Each attorney must depend on his or her own knowledge of the law and expertise in the use or modification of these materials.
Copyright © 2017
OREGON STATE BAR16037 SW Upper Boones Ferry Road
P.O. Box 231935Tigard, OR 97281-1935
iiiBuy-Sell Agreements and Business Valuation
TABLE OF CONTENTS
Faculty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v
Presentation Slides . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
ivBuy-Sell Agreements and Business Valuation
vBuy-Sell Agreements and Business Valuation
FACULTY
Paul Heidt, Morones Analytics LLC, Portland. Mr. Heidt serves as the Director of Valuation Research and provides business appraisals and lost earnings analysis, as well as general and litigation research. He has worked on business valuations for different purposes including transactions, gift and estate tax, reorganizations, marital dissolution, litigation, and succession planning. He is a member of the American Society of Appraisers and is an Accredited Senior Appraiser (ASA) in Business Valuation. Mr. Heidt previously served as managing editor for Economic Outlook Update, a quarterly economic publication used in appraisal reports and books contributing to the body of knowledge in the business valuation profession.
Alina Niculita, Morones Analytics LLC, Portland. Ms. Niculita specializes in business valuation and business valuation litigation support. She has worked with businesses from many industries and of all sizes on matters including transactions, buy-sell agreements, gift and estate tax, marital dissolution, bankruptcy, reorganizations, ESOP, financing, and intangible assets and personal versus enterprise goodwill. She is a member of the CFA Institute and the American Society of Appraisers. She is a Chartered Financial Analyst (CFA) and Accredited Senior Appraiser (ASA) in Business Valuation and holds two Master of Business Administration degrees, from the Joseph M Katz Graduate School of Business at the University of Pittsburgh and the Czech Management Center in Celakovice, Czech Republic. Ms. Niculita has authored or coauthored several business valuation articles, book chapters, and books, including (with Shannon Pratt) The Lawyer’s Business Valuation Handbook, 2nd edition, published by the American Bar Association. She has spoken on business valuation topics to various audiences.
viBuy-Sell Agreements and Business Valuation
1Buy-Sell Agreements and Business Valuation
Prepared by Alina Niculita, CFA, ASA, MBA
Paul Heidt, ASAMorones Analytics, LLC
Most of your clients who have multi-owner businesses or practices have existing buy-sell agreements
If they do, in most cases, they can be improved
If they don’t, they should
2
2Buy-Sell Agreements and Business Valuation
If you have a copy of your client’s buy-sell agreement on file, review it in light of this presentationIf not, or if you think the agreement needs revision, call your client
If the client has an agreement, suggest sending it to you for review
If the agreement needs revision, suggest revising it
If the client does not have an agreement, suggest that you draft one for them
3
Buy-sell agreements are contracts between companies and their owners
Buy-sell agreements define what will happen with the owner’s interest when certain events occur
Called trigger events
These events may be separations from the company, disability, or divorce
4
3Buy-Sell Agreements and Business Valuation
Entity purchase agreementsThe company buys the interest from the departing owner
Unless the entity resells the interest, the proportionate interests of all the remaining owners are increased
Cross-purchase agreementsOne or more individuals or entities buys the interest from the departing owners
These can become very complex as the number of owners increases
5
Hybrid agreementsCan take on a variety of forms
Usually give the entity the first right of refusal to buy the interest of the departing owner
If the entity declines, the interests usually are offered to other owners, generally, but not always, on a pro rata basis
If the other owners decline, the entity may still buy the shares
It may or may not be binding on the entity to purchase if others decline
6
4Buy-Sell Agreements and Business Valuation
Minority owners have the right to sell on the same price and terms if the controlling owner sells
Gaining popularity in recent years
A company may even require that minority interests be sold when a buyout occurs
Most buyers want to buy 100% of a company, not acquire minority owners who could be a nuisance
7
Fixed priceParties may agree on a fixed price at which the ownership interest will be purchased
There should be a provision for updating
Perhaps between or among the parties
Preferably by an appraiser every year or two
FormulaAlmost impossible to create a formula that will be fair to all parties at the time of the triggering event
8
5Buy-Sell Agreements and Business Valuation
Negotiation among parties
Provide for a periodic meeting (usually annual) among the parties to agree on a price that will prevail for a defined period of time (usually a year) if a triggering event occurs
Need a provision for how the value will be determined if the parties cannot agree on a price or if they fail to meet
9
Shotgun agreements
The party can offer to buy (or sell) ownership interests to another party and the other party has the right (or obligation) to sell (or buy) the interest at the price offered
Independent outside appraisal
Can be by a single appraiser or a panel of appraisers
10
6Buy-Sell Agreements and Business Valuation
We highly recommend that you retain a business appraiser at the drafting stage of the buy-sell agreement
Usually several hours
May pitfalls can be avoided by gaining the insight of those who have dealt with resolving the valuations under many diverse wordings of buy-sell agreements
11
We also recommend that the appraiser be present at the signing of the buy-sell agreement to answer questions about the valuation provisions
Not only parties to the agreement, but also spouses should be present at the signing meeting
Helps to make sure all parties to the agreement understand the implications of the valuation language going into the agreement
12
7Buy-Sell Agreements and Business Valuation
Standard of value
Level of valueMinorityProportionate share of enterpriseDepends on triggering event
“As of” date
Appraiser qualifications (if outside appraisal)
Definition of triggering event
13
Strategic valueThe price one could expect to achieve selling a buyer with synergies
CompetitorCustomerSupplier
Also known as acquisition value
Fair valueThe value of a company as a whole, without any discounts for lack of control or lack of marketability
Also known as control value
14
8Buy-Sell Agreements and Business Valuation
Fair market value
Usually, the value of the company as a whole, less discount for lack of control and lack of marketability
May buy-sell agreements use the term “fair market value” without some or all of the parties realizing that means discounts from a pro rata value of the company as whole.
15
The date as of which the interest is to be valued
Values of companies and interests in them can change drastically, even in short time
Internal and external factors
Common to have “as of” date the date of the triggering event
For convenience, the “as of” date should be set on a date when financial statements normally would be prepared
End of the month prior to the triggering event
16
9Buy-Sell Agreements and Business Valuation
Any or all the following events may trigger implementation of the buy-sell agreement:
Death
Disability
Divorce
Severance of employmentSome companies distinguish between quitting and being firedThis distinction could lead to a dispute
17
Some buy-sell agreement list exceptions to the previous list
Some buy-sell agreements may distinguish between the terms of the buyout in different circumstances
The company may specify fair value in the case of death
The company may specify fair value less 20% in the case of termination
18
10Buy-Sell Agreements and Business Valuation
If the buy-sell agreement calls for an appraisal, it should specify that the appraiser be qualified
If the buy-sell agreement names the specific appraiser or appraisal firm, it should address the selection of an alternate if the individual or firm is not available
19
We recommend that the buy-sell agreement specifies that the appraiser have accreditation from one or more of the following:
American Society of Appraisers: FASA, Fellow of the ASA; ASA, Accredited Senior Appraiser; AM, Accredited Member.AICPA: ABV, Accredited in Business Valuation.National Association of Certified Valuation Analysts: CVA, Certified Valuation Analyst; AVA, Accredited Valuation Analyst.Institute of Business Appraisers: MCBA, Master Certified Business Appraiser; CBA, Certified Business Appraiser.
20
11Buy-Sell Agreements and Business Valuation
If there is to be a single appraiser, he or she may be named in the buy-sell agreement
Most practitioners believe it is preferable to name a firm rather than individual
Higher likelihood of the individual being unavailable when the triggering event occurs
21
If firm or individual is unavailable, there needs to be a process by which an appraiser can be chosen
We recommend the choice being made by a neutral party
Judge
State’s corporation commissioner
Head of a regulatory body
22
12Buy-Sell Agreements and Business Valuation
If the parties don’t want to name a firm or individual in the buy-sell agreement, a common procedure is to have each side submit several qualified appraisers when the triggering event occurs and come to an agreement
May require multiple submissions
Must be a procedure in the agreement to break a deadlock
If a firm is named, it is essential that the lead appraiser is accredited
23
Advantages:
Eliminates future uncertainty over the selection of the appraiser
Cost is reasonably known
The selected appraiser can be viewed as independent
The appraiser’s valuation process is seen by all the parties at the outset
A baseline is created
24
13Buy-Sell Agreements and Business Valuation
Advantages continued:
The subsequent appraisals tend to become less time consuming and expensive than other alternatives
The parties should gain confidence in the process
The parties always know the value for the buy-sell agreement (helpful in financial planning)
The appraiser’s knowledge of the company and industry will grow
25
Some buy-sell agreements call for two appraisers (one appointed by each side)
A third appraiser may be appointed by the two appraisers if the first two appraisers are apart by some percentage
In most buy-sell agreements, the percentage limit is usually set at 10%
Then the average of the two sets the price
26
14Buy-Sell Agreements and Business Valuation
We suggest the percentage limits be set a little more broadly
15% to 25%
The 10% limit is probably workable for real estate appraisal, but business appraisal is far more complex
27
Selection of the third appraiser should be made at the outset of the process
Greater likelihood of a quick agreement at this stage
More contentious later on
Selection of the third appraiser should be left to the sole judgment of the first two appraisers
Making the choice subject to client approval usually delays the process and can cause increased contentiousness between the parties
28
15Buy-Sell Agreements and Business Valuation
The role of the third appraiser variesUsually is provided with access to the work of the first two appraisers
Generally is allowed to contact the first two appraisers
Value arrived at by the third appraiser:Sometimes the final value, or
Bounded by the high and low value of the first two appraisers, or
Averaged with the closer one of the first two appraisers
29
AdvantagesProvide a defined structure
All parties know, at least generally, what the process will be in advance
Fairly commonly known and understood by attorneys who know the problems with fixed price and formula agreements
The illusory benefit – the false sense that my appraiser will protect my interest
30
16Buy-Sell Agreements and Business Valuation
Disadvantages
Expensive and time consuming
Price is not determined in advance
Potential for dissatisfaction with process for all parties
Uncertainty over what will happen when a trigger event occurs and the final price
Distracting for management
31
The buy-sell agreement should specify how the appraisers are to be paid
Sometimes the company pays the entire bill of the appraisers
More commonly, in a multi-appraiser scenario, each side pays the appraiser it selects and the company pays the third appraiser
32
17Buy-Sell Agreements and Business Valuation
Since the payout may be substantial relative to the company’s normal cash flow, the payment terms may be spread out, usually at the company’s option
The typical payment period is five years, but we have seen payment periods up to ten years
33
There may be no interest, but usually there is either a fixed rate of interest or a specified method of setting the rate
The U.S. Treasury rate for the term of the payout period
Moody’s BBB bond index rate
Usually, even if the company elects a payout period, it reserves the right to pay it off sooner
34
18Buy-Sell Agreements and Business Valuation
Unless the company’s articles of incorporation or bylaws contain language as to who can own interests in the company, many buy-sell agreements have language about rights of first refusal
A right of first refusal specifies that, if an owner wants out, before they can sell to a third party, the remaining owners or the company have the right to match the third-party offer
35
Normally, the right of first refusal acts to discourage offers because it requires the offeror to keep the offer open for the specified period of time that the right of first refusal specifies for the company or other owners to decide whether to match it
36
19Buy-Sell Agreements and Business Valuation
Every owner does not have to be a party to the buy-sell agreement
For example, it may not be appropriate for a control owner to be a party to the agreement
Passive owners may not be parties to the agreement, or may only be subject to certain triggering events, such as death or divorce
37
Ideally, when the buy-sell agreement is first adopted, the price is set by an appraisal, and the appraisal is updated every year or two or when a significant event occurs
AcquisitionLoss of a significant contractMajor business interruption
This often does not happenPrice could then be unfair to one party or the other
38
20Buy-Sell Agreements and Business Valuation
Make sure that the buy-sell agreement does not conflict with other company documents
Articles of incorporationOperating agreementPartnership agreementBylaws
If the buy-sell agreement conflicts with other corporate documents, the articles and/or bylaws will probably prevail
39
If the buy-sell agreement is funded with life insurance, it is common to have a lump-sum payment up to the net proceeds realized from the life insurance and extended payments on any balance
If funded by life insurance, the buy-sell agreement would specify whether or not the insurance proceeds are a company asset
Involves substantial tax ramifications and sometimes valuation ramifications
40
21Buy-Sell Agreements and Business Valuation
In a repurchase scenario, the company would the beneficiary
In a cross-purchase scenario, the owners or their estates would be the beneficiaries
41
If all the provisions in this presentation have been followed, implementation should proceed smoothly when the triggering event occurs
If a formula price has been specified, either a CPA or a business appraiser should be able to compute the amount of the payment based on the formula
They should be instructed to resolve any ambiguities before staring their computations or appraisals
42
22Buy-Sell Agreements and Business Valuation
The parties should execute engagement letters with the experts specifying that the engagement is in accordance with the buy-sell agreement as of a given date and document specification
43
Like most valuation matters, courts are all over the map with respect to the impact of buy-sell agreements in divorce cases
The IRS regulations may have some impact, but we suggest, if this may be an issue, to study the case law in the jurisdiction where the matter is likely to come up
Most professionals advise against leaving any interest in the company to the non-operating spouse
44
23Buy-Sell Agreements and Business Valuation
For estate and gift tax, the buy-sell agreement may be:
Binding for other purposes, or
May be given no weight at all, or
May be given some weight along with other approaches and methods of valuation
45
Section 2703 of Internal Revenue Code Chapter 14, enacted October 8, 1990, requires that in order to be binding for estate, gift, or generation-skipping tax purposes, any buy-sell agreement created or significantly modified after that date must meet the following criteria:
It is a bona fide business arrangement
It must not be a device to transfer the property to the natural objects of the transferor’s bounty (such as family members) for less than adequate and full consideration in money or money’s worth
Its terms must be comparable to similar arrangements entered into by persons in an arm’s-length transaction
46
24Buy-Sell Agreements and Business Valuation
All owners have relatively equal interests and all work in the business
The business has one dominant control owner and one or more minority owners who collectively have no control
47
All the owners are passive outsiders; none work in the business
Some owners work in the business and others do not
The family-owned business where all or substantially all of the owners are family members
48
25Buy-Sell Agreements and Business Valuation
Call your clients who have interests in businesses or professional practices
Force those that have buy-sell agreements to review them and those that don’t to instigate one
Be sure that all parties to the agreement fully understand its implications and its impact on them
49
“Understanding Buy-Sell Agreements,” Hugh Gottschalk, J.D., webinar by Business Valuation Resources, September 12, 2008.
“The Lawyer’s Business Valuation Handbook: Understanding Financial Statements, Appraisal Reports, and Expert Testimony,” 2nd Edition, by Shannon Pratt and Alina V. Niculita, American Bar Association, 2010, pp. 499-500
“PPC Guide to Business Valuation,” 22nd Edition, Fishman, Pratt, and Griffith, 2012.
“The Ten Most Common Mistakes of Buy-Sell Agreements,” Drake, Whiteley, and McDevitt, Journal of Financial Planning, July 1992.
50
26Buy-Sell Agreements and Business Valuation
Questions?
Alina Niculita, CFA, ASA, [email protected]
Paul Heidt, [email protected]
51
27Buy-Sell Agreements and Business Valuation
28Buy-Sell Agreements and Business Valuation