Several other issues related to valuation should appropriately be addressed in your buy-sell agreements. The following discussion is by no means exhaustive, but includes items that are helpful in minimizing problems or uncertainties with the operation of process buy-sell agreements. While some of these items may seem obvious when identified, they are quite often overlooked or are unclear in buy-sell agreements.

Financial Statements

It is enormously helpful to specify the financial statements to be used by the appraiser(s). In the absence of specification, the parties must agree on the financial statements to be used, or else the appraiser(s) must decide. Significant differences in valuation conclusions can result from the selection of financial statements of different dates and quality. This confusion should be avoided.

Possible alternatives for specifying financial statements include:

  1. Most Recent Audit, or the audited financial statements for the most recent fiscal year relative to the valuation date. Note that there is room for confusion here. Assume that the fiscal year is the calendar year. Suppose that the trigger date for a valuation process is January 15, 2007. The most recent audit was issued as of December 31, 2005 on April 27, 2006. If the buy-sell agreement calls for the use of the most recent audit available on the trigger date, the financial data may be more than one year old as in this example.The agreement might specify that if a trigger event occurs between the end of a fiscal year and the issuance of the audit for that year, the appraisers would rely on the audit when it becomes available. That audit would then be used for the rest of the fiscal year.In the alternative, if the trigger date was December 15, 2006, the most recent audit would be the 2005 audit issued in April 2006, but internal financial statements for the full year 2006 would be available within weeks, and the audit for 2006 would be available in three or four months, perhaps within the timeframe that appraisals would be prepared.Suffice it to say that disagreements over which audit (i.e., which fiscal year) to use as the base for financial analysis could cause material differences in the concluded results. Note that the confusion could result whether the buy-sell agreement required the use of either the most recent audit or the most recent fiscal year statements.
  2. Trailing 12-Months at the Most Recent Quarter-End (Month-End) to the Trigger Date. In the absence of specific guidance, many appraisers, if not most, would utilize financial statements for the most recent twelve months as of the quarter-end (or month-end) immediately prior to the trigger date. Use of the trailing 12 months would automatically include the most recent fiscal year (and audit, if available), and would also include any routine year-end adjustments for that year-end.We generally recommend the use of the trailing 12-month financial statements for the most recent quarter-end preceding the valuation date (or month end, depending on the completeness and quality of the monthly financial statements).

Process Timetables

Many buy-sell agreements provide for unrealistic timetables, and therefore, begin with process problems from the outset. The typical buy-sell process contains a number of phases where time is required:

Time to Get Process Started
It takes time to kick off a valuation process. If the trigger event is the death of a shareholder, no one will be focused on the buy sell agreement until the passage of a reasonable time. On the other hand, if the trigger event is a retirement or termination, the parties may be ready to initiate the buy sell agreement process immediately.

Time to Select Appraiser(s)
Most process agreements call for the parties to retain an appraiser. If a company or a shareholder is beginning from scratch to select an appraiser(s), it can easily take 30 to 60 days or more to identify firms, review qualifications, interview appraisers, and select an appraiser(s).

  • Some agreements allow only 30 days for this process, which may be unrealistic for one party or the other.
  • Some agreements are silent regarding the selection process, thereby providing no pressure for the appraisal process to get started (or concluded).

Many process agreements call for two appraisals at the outset. If they are within a designated percentage of each other, no further appraisals are required. If not, however, the two initial appraisers must agree on a third appraiser. This process takes time – often considerable time. Some agreements provide timetables for this process and others do not. In some agreements, the sole role of the first two appraisers is to select the third appraiser. The same time issues relate to this selection. Allow at least 30 to 60 days for this process. (The obvious way to avoid this time lag in getting appraisals started is to select the appraiser at the initiation of the buy-sell agreement using one of the single appraiser processes previously discussed.)

Time to Prepare Appraisal(s)
Once selected, the appraiser(s) must prepare their appraisal(s). Experience has taught that the appraisal process normally takes from 60 to 90 days. Mercer Capital engagement letters typically state that we will use our best efforts to provide a draft valuation report for review within 30 days of an on-site visit with management. We hit that target the great majority of the time, and most often miss it because of client-related issues. Note that the entire process would still take 60 days or more, depending on how quickly the client responds to the information request, schedules the visit, and how long the client takes to review the draft. It takes many companies 30 to 60 days to provide the basic information that we require prior to the on-site visit because the activities of running their businesses preclude prompt action.

If a third appraiser is retained, this appraiser will require time for his or her process. If this is the only appraisal being provided, the process normally takes from 60 to 90 days. If there have been two appraisals already, the third appraiser may be helped by the fact that the company has already developed most of the information that will be required. On the other hand, being the third appraiser can be a fairly dicey situation. In addition to preparing one’s own appraisal as the third appraiser, it is also necessary to review the appraisals of the other two firms. Allow at least 30 to as many as 90 days or more for this process.

Time to Review Draft Appraisals
The procedures of many appraisal firms call for the preparation of draft reports to be reviewed by management, and in the case of some buy-sell agreements, by all sides. This review process will generally take from 15 to 30 days or more, particularly in contentious situations.

Time to Arrange Financing or to Close
Once the appraisal process has been concluded, it normally takes some time to bring the process to closure. The company may be allowed 30 days, or some amount of time to close the transaction.

We can summarize the process timelines to get a picture of how the various types of process agreements might look in operation. You may be surprised at how the various processes actually lay out, regardless of what the written timetables suggest.

The existence of defined timetables in agreements serves to keep the parties focused on the timeline; however, they are seldom binding.

  • Multiple Appraiser processes can be accomplished in the broad range of 100 to 200 days or so if the initial process involving two appraisers is conclusive. If it is necessary to select and retain a third appraiser, it is likely that considerable additional time will pass before resolution occurs. It is not surprising for a multiple appraiser process involving three appraisers to take six months to a year or more to complete.
  • The Single Appraiser – Select Now, Value Now option is potentially the most rapid option for process buy-sell agreements. If a trigger event occurs after the initial appraisal, the valuation process will be known by all parties, and the appraiser will be familiar with the company. This option should be able to be accomplished within six weeks or so, on the short end, and four months on the longer end.
  • The Hybrid or Single Appraiser with Multiple Appraiser Options can take as long as the typical multiple appraiser option; however, the probability of it being accomplished in much shorter time is significant. If the parties agree on the concluded value of the “third appraiser,” this option is akin to the Single Appraiser – Select Now, Value Now option and can be accomplished accordingly.

Note that the estimates here assume that there is no litigation and that the parties are generally cooperating to move the process along.

The bottom line is that it is good to agree on realistic timelines in your buy-sell agreements. It is then easier to ask the various appraisers and other parties to stick to them. The operation of process buy-sell agreements can take a long time. This means that the process may be a considerable distraction to management, particularly when significant transactions are involved. It should be obvious, but the prolonged operation of a buy-sell agreement can not only be distracting, but frustrating and confusing to the family of a deceased shareholder, or to a terminated employee.