A Case Study: How Buy-Sell Agreements Affect Value and Marketability

I recently testified in a marital dissolution case in which there existed a 10-year-old buy-sell agreement among the owners of a privately

held, family-owned company. The well intentioned drafters of the buy-sell agreement sought to provide for the following:

  • No sales to outside shareholders, keeping the shares in a defined family group.
  • No changes of ownership percentage among current shareholders, keeping ownership ratios among siblings constant.

To accomplish these goals, the buy-sell agreement prevented the shareholders from:

  • Transferring any shares, except as defined in the agreement
  • Creating any mechanism for transferring shares, except as defined in the agreement
  • Amending the agreement unless there was unanimous approval of the shareholders

An agreement that is overly restrictive in the terms that limit the transfer of shares can have serious adverse effects. For example, the unintended consequences of this well-intentioned agreement, meant that:

  • No reasonable willing buyer could be found to meet the terms of the agreement.
  • The interests of the shareholders were almost entirely unmarketable
  • The fact that a “willing seller” existed was moot.
  • It was impossible for one shareholder to access wealth without approval of all others

Beware unintended consequences 

Buy-sell agreements can accomplish a number of goals for shareholders. Very often, the goals include limiting transfer of the shares to a defined group, and creating a mechanism whereby the price of transfer is easily determinable. A well-written buy-sell agreement can provide peace-of-mind for a privately-held company’s shareholders, a sense of continuity, a sense of determinability and a sense of finality for shareholders.

Our engagement here was to analyze the marketability of the shares, considering the existence of the restrictive buy-sell agreement. Having reviewed hundreds of restrictive operating agreements, shareholders’ agreements, buy-sell agreements, and partnership agreements, we are accustomed to analyzing discounts for lack of marketability. In all of the agreements we have reviewed, this is the first that rose to the level of creating a completely unmarketable interest. Although this result was unintended, it was clearly the effect.

Before entering into a buy-sell agreement, it pays to know how such pacts will affect your organization’s – or your interest’s – value and marketability.

If you have comments or questions about this article, or would like more information on this subject matter, please contact us.
Bryan Fleming

Valuation
bfleming@pcecompanies.com
Orlando Office

407-621-2100 (main)
407-621-2113 (direct)
407-621-2199 (fax)