Page 8 - Asset Valuation

S8 | Monday, May 16, 2016 | Asset Valuation
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Building the Better
Buy-Sell Agreement
By CLyDe tinnen anD PatriCia m. Lee
Apple is one of the largest and most cel- ebrated companies in the world. Apple, like so many start-ups, began with three friends in a garage, Steve Jobs, ronald Wayne and Steve Wozniak, who founded Apple Com- puter on April 1, 1976. The least known mem- ber of the trio is Mr. Wayne, who purportedly wrote the three men’s original partnership agreement and originally owned 10 percent of what would eventually become the most valuable company in the world. however, less than two weeks into the life of the enterprise, Mr. Wayne relinquished his equity for less than $1,000. So how and why did he sell equity that would eventually be worth $70 billion for less than $1,000? As the story is told, the why was Mr. Wayne’s concerns about assum- ing personal liability for the debts of Apple (if not paid, creditors may generally enforce their debt claims against the personal assets of general partners). The how is explained by a commonly used business arrangement called a “buy-sell” agreement.
‘Buy-Sell’ agreements, the business pre-nup: Buy-sell agreements are arrange- ments between owners of a business where one or more owners agree that they will pur- chase the interest of an owner who withdraws or becomes deceased. often the agreements may include transfer restrictions which pro- hibit transfers of stock to outsiders without the consent of the other owners or provisions that commit each owner to sell, and the busi-
ClyDe tinnen and PatriCia m. lee are partners with Withers Bergman in Greenwich and New York, respectively.
ness or the other owners to buy, ownership interests at a fixed or determinable price upon the occurrence of specific events in the future. essentially, a buy-sell agreement is similar to prenuptial agreement between business own- ers, which details the financial aspect of the unwinding of the business relationship. In lieu of a separate agreement, buy-sell provisions for closely held corporations may be included in shareholders’ agreements or organizational documents for the corporation. Buy-sell provi- sions are among the most fiercely negotiated
assumptions as to their probable role in the future, for example, if there is a large disparity in the financial means of the owners or other factors which indicate a disparity in power, each owner may negotiate as if that role is a foregone conclusion. differences in percent- age ownership of the corporation may also affect the negotiations. For example, major- ity owners may consider that their major- ity position should be valued with a control premium which would discount the purchase price to be paid for owners with a minority
business. In any event, if one of the owners receives an offer for his shares from a third party that is higher than the purchase price determined pursuant to the agreement, such owner will obviously resist being bound to sell his shares for less to his co-owners or the company. The events triggering the right to sell may include termination of employ- ment (with or without cause), death, disabil- ity, rights of first refusal or first offer, among others, and accordingly the valuation method must account for such different events.
Third, selecting a valuation methodology is contentious because owners (and their advisors) may have different views about which methodology is appropriate. There are a variety of conventional methods that are used (described below), but none of the methods is universally accepted and reason- able people can disagree about which method is best suited to value the specific business in question.
Fourth, even if the owners are able to agree upon a valuation method at the time of the agreement, unforeseen conditions that occur in the future (when the value of the business is actually determined under the agreement) will almost always result in some unintended benefit or detriment to the various parties to the agreement with the party perceiving itself being aggrieved commencing litigation. Any method that results in grossly inequitable treatment or forfeiture by a selling owner is likely to be so challenged. A year after leav- ing Apple, Mr. Wayne received $1,500 for his agreement to forfeit any claims against Apple, which had then converted from a partnership to a corporation (an action that would have fully protected Mr. Wayne from his personal liability concerns had he implemented the conversion instead of selling his interests back to his co-founders). The Apple settle-
The event that triggers the right to buy or sell may drastically affect the expectations of the owners and the actual value of the corporation.
provisions of such documents and often the subject of litigation among shareholders when the provisions are invoked. More often than not, the method of establishing the purchase price is the central issue in the debate or dispute.
Why are valuation methodologies so dif- ficult to agree upon? It is difficult to agree on the methodology to determine the purchase price for a number of reasons. First and fore- most, valuation methodologies are conten- tious because the interests of the co-owners are adverse to one another. naturally, sellers want the price to be high and buyers want the price to be low but which owner will be the buyer and which will be the seller? Since generally, owners do not know when forming the corporation who will be the buyer and who will be the seller, there should be a rea- sonable and balanced negotiation between the owners. however, there may be factors at inception which will lead the parties to make
ownership position, while minority owners will hope to purchase shares at the same price as the majority owner can.
Second, the event that triggers the right to buy or sell may drastically affect the expecta- tions of the owners and the actual value of the corporation. For example, while a business may be worth millions under the management and direction of one of the owners, the same business may be worth drastically less upon her death. The key owner may rightfully want to ensure that her family benefits from her superlative contributions to the business, however, it is also reasonable to expect that the other owners may not desire to overpay for the business in her absence, especially if there is no life insurance or other financing in place to fund the purchase from her estate. Similarly, the owners may want to discount the purchase price to buy the interests of an owner that is terminated for cause (e.g., illegal activity) that results in the liabilities to the
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