How to Determine a Business’ Value for Buy-Sell Agreements
Video by Attorney Kevin O’Flaherty
Article written by Illinois Attorney Kevin O’Flaherty
In this article we explain how to determine value for buy-sell agreements. For some foundational information about buy-sell agreements, checkout our article: Buy-Sell Agreements for Closely-Held Corporations, LLCs and Partnerships Explained.
A buy-sell agreement allows business owners to plan in advance for how an owner and the business will part ways upon the occurrence of certain triggering events such as the death or disability of an owner, the voluntary decision to terminate ownership either through a routine sale of stock or through retirement, or the company’s decision to part ways with the owner with or without cause.
A well drafted buy-sell agreement should contain all of the following components:
- What events will trigger an optional or mandatory sale of an owner’s ownership interests to the company or to the other owners?
- When a triggering event occurs, how will the ownership interest be valued?
- What will the terms of the purchase be and where will the money for the purchase come from?
Methods for Assessing a Business’ Value
A buy-sell agreement will typically provide for an assessment of the business’ value in one of three ways:
- An agreed-upon value;
- Fair market value at the time of sale;
- Use of a formula to determine value.
Using an Agreed-Upon Value in a Buy-Sell Agreement
The simplest method for determining the value of a business in a buy-sell agreement is simply agreeing upon a dollar amount at which to value the business and stating that value in the buy-sell agreement. The problem with this method is that it does not account for a potential increase or decrease in value as time passes between the execution of the buy-sell agreement and the occurrence of an event that triggers a sale.
An agreed-upon value is not generally advisable, and only makes sense for very small and predictable businesses.
