{"id":11117,"date":"2018-11-04T09:49:54","date_gmt":"2018-11-04T16:49:54","guid":{"rendered":"https:\/\/www.keytlaw.com\/azllclaw\/?page_id=11117"},"modified":"2018-11-10T15:55:46","modified_gmt":"2018-11-10T22:55:46","slug":"test","status":"publish","type":"page","link":"https:\/\/www.keytlaw.com\/azllclaw\/test\/","title":{"rendered":"Take the Does Your Buy Sell Agreement Suck Test"},"content":{"rendered":"

by Richard Keyt<\/a> and Richard C. Keyt<\/a>, Arizona LLC attorneys who have formed 10,000+ Arizona LLCs and have 406 five-star reviews on Google, Facebook & Birdeye<\/a><\/p>\n

If you are a party to a Buy Sell Agreement or an Operating Agreement that has buy out provisions you owe it to yourself to take the following test and find out if your agreement sucks and needs to be replaced. If your answer to any question below is Yes, your agreement sucks and needs to be replaced asap.\u00a0 One No answer means that if a buy out were to occur under your agreement either the buyer or the seller will love the value of the membership interest being sold and the other party will be extremely unhappy because the appraiser’s value will surprise everybody.<\/p>\n

Click on a plus + symbol<\/strong> below to read the answer to a question.<\/p>\n<\/div>

<\/i><\/i><\/span>Question 1: Does your agreement set forth valuation assumptions the appraiser must use when preparing an appraisal?<\/span><\/a><\/h4><\/div>
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Warning<\/strong>:\u00a0 This is a huge issue that if not addressed is guaranteed to cause one party to be very happy and the other party to be very angry after an appraisal.<\/p>\n

Homer owns 51%<\/span>\u00a0of World Wide Widgets, LLC.\u00a0 Ned owns 49%<\/span>\u00a0of the company.\u00a0 The company has one asset, 1,000 shares of stock of a public company that would generate $1,000,000 if the company sold the stock today.\u00a0 Even an inexperienced valuation person should find the value of the company is $1,000,000, but what are the values of each member\u2019s membership interest in the company?<\/p>\n

Valuing the members\u2019 interests is where a problem arises if the agreement does not state how the appraiser is to value the membership interests of the members.\u00a0 Consider the following:<\/p>\n

Example 1<\/strong>:\u00a0 The\u00a0<\/span>value of a membership interest being sold is the prorata share of the value of the company determined without any discounts for lack of marketability or minority interest or increases for control or marketability.\u00a0 Without these considerations the value of Homer\u2019s membership interest is 51% of $1,000,000 or $510,000 and the value of Ned\u2019s membership interest is 49% of $1,000,000 or $490,000.<\/span><\/p>\n

Example 2<\/strong>:\u00a0The value of a membership interest being sold is determined after taking into account discounts for lack of marketability and minority interest or increases for control and marketability.\u00a0 With these considerations the value of Homer\u2019s membership interest is $714,000 because his 51% membership interest value is increased by 40% because Homer has control of the company and his membership interest is marketable.\u00a0 Ned\u2019s 49% membership interest would be valued at $269,000 after a 40% discount because it lacks control and is not marketable.<\/span><\/p>\n

Bottom line<\/strong>:\u00a0 The difference in values in example 1 vs. example 2 is huge.\u00a0 If there were a sale Homer would get $204,000 under example 2 than under example 1 and New would get $196,000 less under example 2 than example 1.\u00a0 Don\u2019t leave the decision as to which valuation assumptions the appraiser should use to the discretion of the appraiser.\u00a0 The members of your LLC need to decide which valuation assumptions to use and put the appropriate language in your Buy Sell Agreement.\u00a0 Your agreement must tell the appraiser whether or not to consider or not consider increases for control and marketability and decreases for lack of control and marketability.\u00a0 If your agreement is silent on these issues then the parties are at the mercy of the appraiser who may unilaterally decide to apply or not apply increases or discounts.<\/p>\n<\/div><\/div><\/div>

<\/i><\/i><\/span>Question 2: Does your agreement provide that the purchase price of of a member\u2019s membership interest will be determined by a fixed value agreed to by the members years ago?<\/span><\/a><\/h4><\/div>
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If the answer is yes you need a new Buy Sell Agreement because: (i) the value stated in your agreement is probably way out of date, and (ii) most importantly the value is merely the members\u2019 guess as to what a membership is worth rather than an accurate current value.\u00a0 The owners of a company have no clue as to the value of the company because they are not qualified appraisers.\u00a0 If you were to die and the company is required to pay your loved ones the value of your interest don\u2019t you want the amount paid to equal the actual value of your membership interest rather than be determined by a guesstimate of the members?<\/span><\/p>\n<\/div><\/div><\/div>

<\/i><\/i><\/span>Question 3: Does your agreement require that the person who appraises the value of the company and membership interests have high level appraiser credentials?<\/span><\/a><\/h4><\/div>
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Valuing a company and a business is not something you want an inexperienced and valuation ignorant person to do.\u00a0 You would not ask your accountant to perform surgery on you because you know your accountant knows nothing about surgery so why would you let a person who lacks the valuation knowledge and credentials to value your company?\u00a0 If your agreement does not state the required qualifications of the appraiser or if the qualifications do not require the appraiser to have one of the credentials listed below then you need a new agreement.<\/p>\n

My Buy Sell Agreement requires appraisals be performed only by a professional appraiser who has one or both of the following credentials for at least ten years:<\/p>\n