Buy-Sell – Don’t Let Your Attorney Write the Valuation Provisions
By: Jay Sickler
You wouldn’t let your oral surgeon replace a torn ACL in your knee. Likewise, you shouldn’t let your corporate attorney draft the language governing the company’s share value in your buy-sell agreement.
In my opinion, most shareholder disputes regarding share valuation could have been avoided had the buy-sell valuation language been drafted with the help of a valuation professional. These buy-sell agreements are often drafted by corporate counsel without a clear understanding of how shares are valued by professional appraisers.
I was recently provided a real-world (and executed) LLC operating agreement which included the following paragraph outlining how the member units are to be valued under certain circumstances:
The first sentence makes no sense to a valuation professional. It reads like the adults speak in a Charlie Brown TV special. Do you remember? Sounds are coming out of the adults’ mouths, but no discernible words are spoken.
The terms “fair market value” and “fair value” are used interchangeably in this first sentence. Which is it to be – fair market value or fair value? The two terms have very different meanings in the valuation community.
Fair market value has been defined by my professional standards and by the IRS as the price at which property would change hands between a hypothetical, willing buyer and a hypothetical, willing seller. Fair market value considers discounts for control and/or marketability.
Fair value is generally not defined by my profession and has a very different meaning than fair market value. Fair value is referenced in various state court rulings with respect to shareholder oppression and corporate squeeze-out litigation. Some state courts have determined that fair value does not consider any discounts and is simply the pro-rata value of the business.
It’s highly unlikely that two adverse parties will ever agree on a value based on the above buy-sell agreement language. Even professional appraisers will struggle to interpret the first sentence. Did the parties and the attorney who drafted this agreement intend to include consideration of both lack of control and lack of marketability discounting under fair market value?
Or, by inserting the term fair value, did the attorney intend this sentence to mean that no discounts would apply, as some courts have held in a number of fair value cases over the years?
Don’t let the attorney drafting your shareholder buy-sell or LLC operating agreement do so without engaging the services of a fully accredited business valuation specialist. The modest additional cost at the drafting stage pales in comparison to the costs and angst of shareholder litigation down the road, when shareholders eventually part ways.
I have valued companies for over 30 years and have been an expert witness in numerous shareholder disputes. I would be happy to be part of your transaction team and help draft your buy-sell agreement.
Give me a call at 503-467-7901.