Valuation changes over time. Yet this simple enough fact is widely forgotten or even ignored. In Chris Mercer’s insightful article, “A Problem: Fixed Price Buy-Sell Agreements,” Mercer explores the complexities of the fixed price buy-sell agreement. At the core of the problem is the fact that, as Mercer points out, “time passes and value changes.” With the passing of time values invariably change as well. Yet, many involved parties frequently fail to recognize this fact.
In particular, Mercer notes that it is possible for large discrepancies in value to arise, meaning that the initial fixed price can drift dramatically from the “fair market price” of the business. The problems this presents, once the problem is recognized, are pretty straightforward. If the value of the business is higher than the original fixed price, then litigation could be on the horizon.
Looking at the Solutions
How does one go about addressing this issue? Mercer has noted that there are “bad solutions” and “better solutions.” The bad solution involves having a provision calling for an appraisal process if the fixed price lasts longer than a given period of time. Mercer states that a typical period of time might be something like two years or even more and that these agreements are usually derived from a template.
Simply stated, this approach isn’t the best. In Mercer’s view a somewhat better solution for repairing or “fixing” a price buy-sell agreement is to forgo the fixed price altogether and replace it instead with a valuation process. Mercer’s view is that it is prudent to add a “single appraiser valuation process, as the fix in the event that a fixed price is out of date when a trigger event occurs.”
What is the Ideal Approach?
The process Mercer believes is best is called the Single Appraiser, Select Now and Value Later valuation process. In this process, an appraiser is selected and this is part of the agreement. Once the buy-sell agreement is triggered, the selected appraiser jumps into action and provides a binding valuation.
In this approach, the business is reappraised each year and a new, more accurate and up to date, price is reached. If everyone knows from day one that this is how the situation will be handled, then there are no shocks, no surprises and a reduction in the risk of litigation. Click here to read Mercer’s article and learn more.