A Last Will and Testament for Your Business Part 2

In part 2 to "A Last Will and Testament for Your Business," I discuss the Buy-Sell Agreement's method for valuing the business so that a departing owner's interest is acquired, whether at death, disability, deadlock, dissociation, or some other terminating event.  The author is not a certified appraiser, and this article discusses general concepts.  You should check with your lawyer (or better this firm) for legal advice, as this article should not be construed as legal advice!

There are three main approaches to valuing a business in a buy-sell agreement.  First, there is an agreed value.  The owners can agree to the value of the business in the agreement, with the value of the interest equal to the proportionate part of that value.  The drawback of this approach is that as time changes, values change.  Thus, this typical approach will require the parties to updates the value every 6 months or 12 months.  The bigger drawback is that humans tend not to take care of updating formalities, due to focus on the business, or they may simply not agree to a new value.  To counter those problems, when I use this approach, I place an expiration date on the agreed value, which will then require a different method to value the interest to get acquired.  

The second approach is a formula-based approach.  Some business owners know that they will sell their business at a certain multiple of EBITDA, which is "Earnings Before Interest, Taxes, Depreciation, and Amortization."  However, as market conditions change, so does the multiple that buyers are paying.  Further, private equity firms or a strategic buyer who wants to get rid of your business may well overpay, so this approach will generally take into account what a private buyer (without private equity or venture capital) who wants to operate the business would pay.

The third approach is an appraisal, my favorite.  Appraisal companies will review public company comparable prices, data from reported private sales (some from their own data) and their own appraisals, and current market conditions, including M&A trends.  While it costs, I believe it is the best approach.  The cost can be divided between selling and buying parties or against a party who is forced out due to a contract breach or termination of employment.