Corporate Buy-Sell Agreements: “Look-Back” Clauses can Help Get to “Yes”
Buy-sell Agreements are essential for San Diego businesses. This is true whether the business is a general partnership, a small closely-held corporation, a limited liability company, or another corporate form. A buy-sell agreement sets the terms and conditions under which the ownership of a business can be sold or transferred. The goal of a well-drafted buy-sell agreement is to provide the owners with “exit strategies” and to limit the expense of litigation when the need for “exiting” is looming. If the procedures and parameters for the exit are agreed to in advance, when everyone has friendly feelings toward one another, then, hopefully, the process will go smoothly and litigation can be avoided. An experienced San Diego corporate attorney can help draft a top-notch buy-sell agreement for your business.
For obvious reasons, the most difficult provisions to negotiate are the purchase price provisions. These provisions involve many issues including:
- The valuation method — asset-based, revenue or cash-flow based, and other methods
- Valuation discounts
- Terms of the payout — lump sum cash-out or payout over time
- Length of the payout — if applicable
- Interest on any remaining payouts post-closing
The interplay of price and valuation methods can be complex. The owners being bought out want the highest price. But, from the vantage of a minority investor/owner, the typical valuation methods used will often apply deep discounts for lack of marketability and for lack of control. It is not unusual for a business appraiser to combine both discounts and reduce the valuation by 50%. As a result, many minority investors/owners want to contractually eliminate use of the discounts for purposes of valuation. This can generate heated disagreement.
One possible solution is to negotiate what is often called a “look-back” clause. These types of clauses allow for additional payments to be made if the entire business is sold within a short time period in the future — say, one to two years. This sort of clause can help the parties get to “yes” because it eases some of the fears held by minority-interest owners and eliminates a potential sense of unfairness. Typically, a look-back clause is only triggered if the per-share (or per-ownership unit) price obtained in the later sale is higher than the per-share price paid during the buy-out. Because discounts are almost always applied, the look-back clause is almost always triggered.
Take an example: Assume that the buy-sell agreement requires that the valuation method must combine asset and profit/cash flow methods. Based on that method, the appraiser sets the per-share value at $100 per share. However, the appraiser applies a 40% minority-ownership discount and the buyout closes for $60 per share. If the majority-interest owners sell the business within a year at $100 per share, the former owner/s will be paid an agreed-upon additional amount — say, an extra $20 per share.
Call San Diego Corporate Law Today
For more information, call corporate attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard’s law practice is focused on business, transactional, and corporate matters and he proudly provides legal services to business owners in San Diego and the surrounding communities. Call Mr. Leonard at (858) 483-9200 or contact him via email. Like us on Facebook.