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Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning
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Buy-Sell Agreements :: Convergence of Business Succession & Shareholder Planning


This fall 2009 presentation discussed valuation issues in buy-sell agreements as well as how the economic downturn impacted business value.

This fall 2009 presentation discussed valuation issues in buy-sell agreements as well as how the economic downturn impacted business value.

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  • 1. Timothy R. Lee, ASA Birmingham Estate Planning Council » September 3, 2009 Buy-Sell Agreements Convergence of Business Succession & Shareholder Planning
  • 2. Who We Are MERCER CAPITAL Among the largest business valuation offices in the nation and the largest in the Southeast serving a national and international clientele MERCER CAPITAL INVESTMENT BANKING M&A and transaction advisory services for buyers and sellers, focusing on mid-market corporate development and divesture activities, reorganizations, fairness opinions, and strategic alternatives assessment
  • 3. Overview of Services
    • Valuation
      • Tax compliance
      • Employee Stock Ownership Plan valuation
      • Corporate valuation services
    • Transaction advisory services
      • Fairness and solvency opinions
      • Buy-sell agreements and private company transactions
    • Litigation support and expert testimony
      • Business Damages
      • Shareholder Disputes
      • Divorce
    • Public and private company financial reporting
      • Purchase Price Allocation
      • Impairment Testing Services
      • Alternative Investment Portfolio Valuation Services
    • M&A and investment banking
  • 4. Economic Review – History
  • 5. Economic Review – Where Are We?
  • 6. Economic Review – Where Are We?
  • 7. Economic Review – Where Are We?
  • 8. Economic Review – Where Are We?
  • 9. Economic Review – EESA, Now ARRA Graphics courtesy of
  • 10. Economic Review – What’s Next?
    • High unemployment recovery
    • High inventories and weak income suggest slow recovery with limited push from consumers
    • Low capacity utilization suggests significant capacity to increase output without new capital spend and hiring
    • High deficits foreshadow increasing inflation in the long-run
    • Energy and commodity issues still loom from emerging world demand and geopolitical instability
    • Taxation issues still murky
    • Consensus WSJ economist poll suggests +/- 1% growth in real GDP for 2009-Q3 (deceleration of bad trends, trend inversion)
  • 11. Valuation Issues Abound
    • Valuations at the peak or trough of the business cycle are difficult
    • Valuations in an environment of financial distress and unknown paradigms are even more difficult
    • Some practitioners struggling with the most basic element of present value mechanics – the discount rate
      • Equity market returns distorting historical data
      • Treasury yields extraordinarily low
      • Increasingly difficult to support equity premiums
    • Growth assessments require more scrutiny
    • Financing constraints and loan-to-value ratios suggest compromised valuations for many assets and businesses
  • 12. The Segue » New Realties = Revised BSAs
    • Old formulas are likely meaningless
    • Old fixed price agreements are likely stale
    • Multi-appraiser processes are more costly than ever and likely to lead to greater conflicts on value
    • Legal and valuation professionals have more obligation than ever to bring these matters to our clients’ attention
    • Client resistance to fees and challenging discussions reflect tendencies of fear and procrastination – “things will eventually get better and then we’ll fix it”
    • Nobody getting younger – likelihood of trigger events rising
  • 13. Buy-Sell Agreements - Trigger Events
    • Q Quits
    • F Fired
    • R Retires
    • D Disabled
    • D Dies
    • D Divorced (?)
    • O Others
  • 14. Categories of Buy-Sell Agreements
    • Cross-Purchase Agreements
      • Between shareholders
    • Entity-Purchase Agreements
      • Where the entity does the purchasing
    • Hybrid Agreements
      • Where there may be interplay between the rights of the shareholders to purchase and those of the company
  • 15. Types of Buy-Sell Agreements Fixed Price Agreements Formula Agreements Process Agreements
  • 16. Fixed Price Agreements
    • Have fixed prices
      • Shareholders agree on a price
      • Price is written into the agreement
      • Usually, parties to agreement state in the agreement that they will update the price each year
  • 17. Fixed Price Agreements - Disadvantages
    • Parties seldom update the fixed prices, even over periods of many years
      • Real life examples abound
    • Inequities are almost certainly a result of out-of-date fixed price agreements
      • Real life examples abound
  • 18. Formula Agreements
    • State a single formula to be applied to balance sheet and/or income statement metrics
    • Examples
      • Multiple of EBITDA
      • Multiple of Pre-tax Income
      • Book Value
      • Multiple of Book Value
    • No formula can withstand changes in circumstances
      • Valuation metrics can change with time
      • Non-recurring items
      • Often too backward-looking
  • 19. Types of Process Agreements Multiple Appraiser Agreements Single Appraiser Agreements
  • 20. Multiple Appraiser Agreements
    • Advantages
    • Provide a defined structure
    • All parties know, at least generally, what the process will be in advance
    • Fairly commonly known and generally understood by attorneys (who know the problems with fixed price and formula agreements)
    • Illusory Benefit – False sense that “my appraiser” will protect “my interests”
    • Disadvantages
    • Price not determined now
    • Potential for dissatisfaction with the process for all parties
    • Danger of advocacy
    • Uncertainty over what happens at trigger event
    • Uncertainty over final price if the process is invoked
    • Problems with any other aspect of the operation of the agreements are deferred until a trigger event
    • Expensive
    • Time-consuming
    • Distracting for management
    • Potentially devastating for affected shareholders and their families
  • 21.
    • Advantages
    • Selected appraiser viewed as independent
    • Appraiser’s valuation process is seen by all parties at the outset
    • Appraiser’s conclusion is known at outset and has established a baseline price for the agreement
    • Because process is observed at the outset, all parties know what will happen when trigger event occurs
    • Because the appraiser must interpret the “words on the pages” in conducting the initial appraisal, any issues regarding lack of clarity of valuation-defining terms will be resolved
    • Selected appraiser must maintain independence with respect to process and render future valuations consistent with terms of agreement and with prior reports
    Single Appraiser Agreements Select Now & Value Now
  • 22.
    • Advantages (continued)
    • Subsequent appraisals, either annually or at trigger events, should be less time-consuming and expensive than other alternatives
    • Parties should gain confidence in the process
    • Parties will always know the current value for the buy-sell agreement (helpful for planning all-around)
    • Appraisers’ knowledge of the company and its industry will grow over time, enhancing confidence for all parties with the process
    • Creates a means of maintaining pricing for other transactions, thereby enhancing “the market” for a company’s shares
    Single Appraiser Agreements Select Now & Value Now
  • 23. Single Appraiser Agreements Disadvantages
  • 24. Six Defining Elements of a Process Agreement Standard of Value Level of Value “ As of” Date Appraiser Qualifications Appraisal Standards Funding Mechanism
  • 25.
    • Standard of Value
      • Normally fair market value
      • “ The value” is not operative
    Six Defining Elements of a Process Agreement
  • 26.
    • Level of Value
      • Which level, specifically?
      • Second source of confusion
      • The value of my business is often control
    Six Defining Elements of a Process Agreement
  • 27. Six Defining Elements of a Process Agreement
  • 28. Six Defining Elements of a Process Agreement Price we hope to get if we sell the company together Price the rest of us can reasonably pay if we have to buy out someone else “ Fair market value of the (minority) interest”
  • 29. Six Defining Elements of a Process Agreement $100 Per Share $100 Per Share $60 Per Share $140 Per Share
  • 30.
    • The “as of” Date of the Appraisal
      • Defines the situation at the Company, within the Industry and National Economy, and the pricing from guideline companies and comparable transactions
    • Appraiser Qualifications
      • ■ Credentials ■ Industry experience
      • ■ Experience in appraisal ■ Reputation
    • Appraisal standards to be followed
      • ■ ASA Business Valuation Standards
      • ■ Principals of Appraisal Practice and Code of Ethics of the ASA
      • ■ Uniform Standards of Professional Appraisal Practice
    Six Defining Elements of a Process Agreement
  • 31.
    • Who buys?
      • Other shareholders
      • Company
      • Other shareholders and/or company
    • Life insurance
    • Adequacy of funding
    • Nature of mechanism
      • Cash (is there a sinking fund?)
      • Notes
        • Down payment
        • Terms
        • Interest rate
        • Security
    Six Defining Elements of a Process Agreement What does your client’s buy-sell agreement say about the treatment of life insurance proceeds in the event of the death of a shareholder subject to it?
  • 32. Six Defining Elements of a Process Agreement Proceeds are a Funding Vehicle Proceeds are a Corporate Asset
  • 33. Buy-Sell Agreement Legal & Valuation Audit TM
    • Review the buy-sell agreement from a legal and business perspective (attorneys and owners)
      • Based on the business today, does the buy-sell agreement say what it should say (clients may resist talking about the issues, but it is critical that they do so before interests are adverse?
      • Do the trigger events reflect the business reality of today?
      • Do all parties to the agreement understand how the agreement will operate?
      • Determine appraisal issues in advance
      • Are the valuation terms clear and applicable in light of current terminology?
  • 34. Buy-Sell Agreement Legal & Valuation Audit TM
    • Review the buy-sell agreement from a valuation perspective (appraisers)
      • Are the five key defining elements of a buy-sell valuation present?
      • What do the “words on the page” say to an appraiser about the kind of value per the agreement?
      • Explain how the agreement would operate from a valuation perspective
      • Is there a current value for the buy-sell agreement?
  • 35. Helpful Resources
    • Mercer Capital resources
    • Uniform Standards of Professional Appraisal Practice (USPAP)
    • American Society of Appraisers (ASA)
  • 36. Other Resources
  • 37. MERCER CAPTIAL 5860 Ridgeway Center Parkway, Suite 400 • Memphis, TN 38120 901.685.2120 (P) • 901.685.2199 (F) Z. Christopher Mercer, ASA, CFA [email_address] Andrew K. Gibbs, CFA, CPA/ABV [email_address] James E. Graves, ASA, CFA [email_address] Timothy R. Lee, ASA [email_address] Travis W. Harms, CFA, CPA/ABV [email_address] Jean E. Harris, CFA [email_address] Questions? Matthew R. Crow, ASA, CFA [email_address] Wendy S. Ingalls, CPA/ABV, CBA, ASA [email_address] Nicholas J. Heinz [email_address] For further information, feel free to contact any of our senior professionals listed below:
  • 38. Mercer Capital’s M&A Overview 2 nd Quarter, 2009 Prepared by Timothy R. Lee, ASA & Nicholas J. Heinz, ASA 901.685.2120 MERCER CAPITAL
  • 39. M&A Deal Volume
    • Transaction volume declined in 2008 and has weakened further in 2009
  • 40. M&A Middle Market Deal Volume
    • Middle market activity has followed that of the broader market
  • 41. M&A Transaction Types
    • Approximately 50% of all deals involve privately owned sellers
  • 42. M&A Transaction Size
    • Most deals are below $100 million (approx. 80%)
  • 43. M&A Pricing Report
    • Not surprisingly, P/E multiples were low in 2008
  • 44. M&A Pricing Report
    • Average P/E multiples showed some recovery during first Q1 2009
  • 45. M&A Pricing Report
    • The disparity in multiples was large in 2008 across deal sizes
    • Size clearly matters in deal pricing
  • 46. M&A Middle Market Pricing Report
    • Middle-market multiples remain low compared to 2007 and 2008 but have increased relative to Q1 2009
  • 47. Private Equity Overview
    • Private equity firms are still experiencing difficulty
      • The number of PE deals in the last twelve months is down 43% from the prior year
      • The average P/E on a private equity deal was 17.8, whereas strategic buyers were able to pay an average P/E of 22.2
      • Credit markets remain tight
      • The capital raising environment is still difficult for private equity
    Source: Merger Stat Flashwire Monthly.
  • 48. M&A Market Summary
    • Deal volume remains low but some strategic buyers are finding attractive pricing
    • Debt markets continue to hobble private equity
    • Privately owned sellers continue to produce a considerable portion of the deal activity
    • Smaller deals are transacting at particularly low prices on a multiples basis
    • Middle market volumes and multiples have shown some signs of recovery in the last quarter – still a long way to go
  • 49.