A buy-sell agreement explains how ownership interest in a business may be transferred if an owner wishes to sell, retires, divorces, passes away or becomes disabled (“trigger events”). An effectively designed, written and funded buy-sell agreement can help avoid undue stress and financial problems at the trigger event. However, if the buy-sell agreement isn’t supported by a business valuation prepared by an expert, it can be subject to protracted litigation. In fact, of all the elements in a buy-sell agreement there is one area that is litigated more than any other area – and it is the area of compensation paid to the departing stockholder in exchange for their stock. Such lawsuits are common because the disputed agreement was either silent or unclear about the method of valuation of the business, the process of determining the value, who will perform the valuation, who will pay for the valuation, and the timing of the payments for the stock.
There are several ways to determine the value of a business for purposes of the buy-sell transaction in the agreement. These include:
- Fixed Price Agreement
- Formula Agreement
- Blind Agreement
- Process Agreement
Ambiguity is the mother of litigation. To the extent possible, the valuation element of a buy-sell agreement should be carefully considered, discussed, and negotiated. The details of the agreement should then be described and recorded as clearly as possible in the buy-sell agreement.