NOTE: The following article is from the collection of articles in our Automobile Dealership Buy/Sell Newsletters. The newsletter deals with the complex area of buying and selling automobile dealerships. Some of the material may not be up to date because of changes in the law from the date shown at the end of the article. This article is not to be taken as legal, accounting, tax, or other advice. You should consult your own professionals for such advice and for any updating of the information provided.
Buy-Sell Agreements that include options for future transfer of dealership interests should not be drawn up until the prospective buyers and sellers jointly engage an appraiser. Disregard this advice at risk of considerable amounts of time and money, not to mention heartache.
All too often, buy/sell agreements are prepared by attorneys at a time when the parties are amicably looking toward a future sale. Under these circumstances, attorneys insert language into the agreement which states that the company or partnership shares or corporate stock will be valued at “market value.”
But inasmuch as business valuations are profoundly affected both by the criteria selected for valuation and the ever-changing dynamics of the economy and the industry, vague references to “market value” can lead to substantial increased costs and possibly serious future problems.
Recognizing that circumstances could trigger the need for an appraisal at some point in the future, most buy/sell agreements permit each party in a transaction to engage their own appraiser to value the business or business interests. If the values set by appraisers hired by each party differ significantly, agreements often call for the two appraisers to select a third to value the business/business interests.
Some agreements call for a third value to be accepted as the final value for buy/sell purposes; others require concurrence by at least two of the three arbitrators; others call for an average of three to be used as the final buy/sell determinant.
Given the obvious propensity for the buyer to want to pay as little as possible and the seller to want to receive as much as possible, it is not surprising that the appraisals done for each often reflect their own self-serving opinion of the value of the company and their ownership interest.
The appraiser for the buyer might value only the tangible assets on a forced or orderly liquidation value basis with the view that the business has no true worth as a going concern. The appraiser for the seller, on the other hand, might value the business on a going concern basis utilizing a market and income approach with consideration of overly optimistic projections into the future of the company’s prospective earnings.
In the first scenario, the appraisal will render a low value; in the second, the appraisal will render an extremely high value. And a third valuation may or may not be able to reconcile the disparities between the two.
On the other hand, if an appraiser is called in before a buy/sell agreement is drawn up, he or she can work with both parties to decide what criteria will be used in establishing the value of the business and the business interests, so that any future appraisal is based on pre-agreed-upon parameters.
A buy/sell agreement should address the specific scope of the appraisal, prospective purposes for subsequent appraisal requirements and the appropriate premise of value to be utilized for each purpose. It should also establish what ownership interest is to be valued, how majority/ minority interests are to be valued and how to select the appropriate appraiser to serve the interests of both buyer and seller.
If the subsequent appraisal is performed by the same appraiser who advised both parties before the buy/sell agreement was drawn up, it is of course incumbent on him or her to balance the conflicting self-interests of both parties in the fairest possible manner. When the decision is left up to two or three different appraisers and the buy/sell agreement does not clearly address the valuation criteria, process and related procedures, the valuations can differ significantly.
Choosing an appraiser to assist in developing the language of a buy/sell agreement before it is prepared is critical to avoiding the unnecessary cost of three appraisals and the grief associated with appraisals being conducted with totally dissimilar approaches that provide no resolution to any disputes.
A qualified appraiser can also be extremely helpful in both appraising the company at the time the buy/sell is executed and in assisting partners/ stockholders in developing stock options, key man life insurance limits and target incentives for growth with bonuses to be paid if certain revenue/profit goals are realized.
Once the initial appraisal which establishes the basis of value of the subject company is complete, a formula for determining subsequent values can be set forth with provisions for valuation updates at least annually.
This article was written in 1993.