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
Buy-Sell Agreements for Closely Held Companies and Their Value
As a business owner, you are likely familiar with the importance of a buy-sell agreement. Business owners execute these contracts between 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 guidelines, however, are especially important for owners. That’s because they enable you to plan in advance for how to go about parting ways from partners. Events that could occur include death, disability, divorce, or retirement.
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, one should draft the agreement when the one initially creates the business. This is because it is at that point that the interests of the business owners most closely align. As time goes on, moreover, the interests of each business owner may diverge from one another. This may result in a more difficult negotiation process for the drafting of the buy-sell agreement.
Regardless of when drafted, an effective buy-sell agreement will include the following components:
- 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 to the other owners
- A description of how ownership interests will be valued when a triggering event occurs
- An explanation of what the terms of purchase are and an agreement as to where the money for the purchase will come from
In addition to the aforementioned 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.
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 the financial health of a business 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 those at 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 at which 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 to assess 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
Determining your business’ fair market value at the time of sale would be the most accurate way to conduct the appraisal. Professional appraisers like those at 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 appreciate or depreciate your business’ true worth.
3. Using a formula to determine the value of the business
Employing this method, appraisers can help you determine valuations that are specific to your business and industry.
Typically, the valuation will consider Earnings Before Tax, Depreciation, and Amortization (EBITDA) to account for the assets less its liabilities. Additionally, a multiple of 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 owners to avoid potential conflicts in the event that a triggering event was to occur.
To effectively create a buy-sell agreement, business owners must determine the entity’s value. To do so, business owners 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 effectively execute the buy-sell agreement of your small or medium business value.
Reach out to BA FL|GA|HI today to meet with our expert and eager appraisers. They are ready to discuss your particular situation and the valuation services that are best suited for your business.