You’ve spent years building your business. Late nights, hard calls, calculated risks that paid off. But what happens to all of it when someone leaves?
Half of all privately owned businesses will change hands in the next decade, a transfer worth more than $6 trillion. It’s the largest generational transfer of wealth in history. Yet 75% of those owners don’t have an exit plan. And 25% haven’t done any financial or estate planning at all. No roadmap. No safeguards. No agreement on what a fair deal even looks like.
That’s not just a gap in planning. It’s a threat to everything a business owner has built. And one agreement could change all of it.
Why a Buy-Sell Agreement is Non-Negotiable
A buy-sell agreement is a legally binding contract between business owners that spells out what happens to ownership when someone dies, retires, becomes disabled or wants out.
Without one, owners are left scrambling to agree on terms in the middle of a crisis. Surviving partners may not have the cash to buy out a departing owner’s share. Families may fight over what’s fair and the IRS may dispute the business value.
A strong agreement takes all of that off the table. It locks in a clear process for determining value and gives buyers a defined path forward, while an accurate valuation helps ensure sellers or their families receive a fair price. It’s not paperwork. It’s protection.
Five Buy Sell Agreement Types and Their Risks
The type of agreement a business chooses determines how ownership is valued, how disputes get resolved, and how much risk stays on the table.
Fixed Price
Owners set the value at a specific dollar amount, stated in dollars or a per-share value. The risk is the price is likely out of date and there is no agreement on a way to update it.
Formula
Uses a calculation, like a multiple of earnings, to determine value. Formulas are east to calculate and communicate, but they can produce unreasonable results over time, and there’s often no process to adjust them.
Multiple Appraiser
Two or more appraisers determine value. Each party retains their own appraiser, and a third may be brought in to provide a sole opinion, resolve differences or select the most reasonable valuation. It offers a defined process and gives both parties a voice, however, but it’s expensive, time-consuming and can create uncertainty in the final price and a perception of bias.
Single Appraiser
Single appraiser employed to determine value and is often the preferred type of agreement for business owners. All parties sign off on the appraiser selection, understand the valuation methodologies and can resolve any lack of clarity before a triggering event. Annual revaluations reduce uncertainty in the process and final price.
Valuation Details Every Business Owner Should Know
A business is only as protected as the process used to determine its value. If the wrong details are in place, or missing entirely, someone walks away with less than they deserve.
The valuation date is critical. This is the “as of” date that anchors the entire appraisal. Values change over time. Also, valuations can only include information known or knowable as of the valuation date, which ensures an accurate reflection of what the business is worth at the time of a triggering event. The agreement needs to spell out the standard of value being used. Fair market value, fair value and investment value all produce different numbers. Providing a clear definition of value will avoid the potential for misinterpretation.
Get it wrong, and the number may not reflect what the business is worth at the time of a triggering event. Also, it needs to spell out the standard of value being used. Fair market value, fair value and investment value all produce different numbers. Choosing the wrong one can leave an owner or their family shortchanged.
A strong agreement should address:
- Who conducts the appraisal and what qualifications they bring to the table
- Who pays for it. When a single appraiser is selected at signing, the company typically covers the cost. When multiple appraisers are involved, each party usually pays for their own.
- Which financial statements are used. The most recent fiscal year can leave a significant gap between the valuation date and the latest financial data. Trailing 12-month financials as of the most recent quarter or month end are generally preferred because they capture the most current picture of the business.
One more thing to watch: life insurance. In Connelly v. United States, the Supreme Court ruled that life insurance proceeds used to redeem a deceased owner’s shares don’t reduce the taxable value of those shares for estate tax purposes. Owners relying on life insurance to fund a buyout could face a larger tax bill than expected.
Don’t Risk What You’ve Built. Let CBIZ Protect It.
Valuation professionals are uniquely qualified to assist business owners and attorneys with drafting these agreements. Connect with a CBIZ advisor to help build a buy-sell agreement that protects your business, partners and family.
Frequently Asked Questions
IRS Section 2703 refers to certain requirements for buy-sell agreements:
- The agreement must be a bona fide business arrangement
- The agreement is not a device to transfer property for less than full and adequate consideration in money or money’s worth
- The agreement’s terms are comparable to similar arrangements entered into by persons in an arms’ length transaction.
Absent clear specifications, there is no assurance that an appraiser will be qualified to provide the valuation. Naming an appraiser with a business valuation credential from a professional appraisal association will provide some level of assurance that the appraiser will follow ethical and professional standards when performing the work.
A buy-sell agreement should be reviewed regularly, especially after major ownership, financial, tax or operational changes. Annual reviews help confirm the valuation method, funding approach, appraiser selection process and triggering events still reflect the business as it operates today.
The three generally accepted approaches used to determine the fair market value of a business are the income, market and cost approaches. Under the income approach, value is measured as the present worth of the company’s anticipated future net cash flows. The market approach involves the review of pricing and performance information for public companies deemed generally similar to the subject company and similar businesses that have been sold. The cost approach utilizes one or more methods based on the discrete cost of reproducing specific assets and liabilities.
© Copyright CBIZ, Inc. All rights reserved. Use of the material contained herein without the express written consent of the firms is prohibited by law. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein. Material contained in this publication is informational and promotional in nature and not intended to be specific financial, tax or consulting advice. Readers are advised to seek professional consultation regarding circumstances affecting their organization.
“CBIZ” is the brand name under which CBIZ CPAs P.C. and CBIZ, Inc. and its subsidiaries, including CBIZ Advisors, LLC, provide professional services. CBIZ CPAs P.C. and CBIZ, Inc. (and its subsidiaries) practice as an alternative practice structure in accordance with the AICPA Code of Professional Conduct and applicable law, regulations, and professional standards. CBIZ CPAs P.C. is a licensed independent CPA firm that provides attest services to its clients. CBIZ, Inc. and its subsidiary entities provide tax, advisory, and consulting services to their clients. CBIZ, Inc. and its subsidiary entities are not licensed CPA firms and, therefore, cannot provide attest services.
