Business Valuation for Business Owners – By Zachary M. Sharkey, a book review
You probably know by now that I am a huge proponent of the Buy-Sell Agreement (“BSA”) for business partnerships. The BSA serves as a sort of pre-nup for small businesses owned by two or more people or entities. As a business lawyer, I wanted to learn more about some of the accounting principles a certified business valuation expert would use in determining a business’s value. Introducing, Mr. Zachary Sharkey, CFA, CPA/ABV, a new friend and author of Business Valuation for Business Owners.
Zach’s approach to the topic at hand is both comprehensive and digestible. His writing style is straightforward and chopped into bite sized chunks, which helps this non-numbers guy move through it quite easily.
The book is broken into five sections, with each section tackling a different issue in business valuations.
Section One is all about why a business owner might want a valuation and how to properly select a valuation expert.
Section Two describes the standards of value, levels of value, and premises of value.
Section Three is all about the various approaches to valuations and the methods behind them.
Section Four briefly touches on capital, discounts, control premium, and how to navigate a valuation report.
Section Five puts all this knowledge into easy to grasp cautionary tales and warns of the pitfalls many business owners fail to see.
Naturally, given my profession, Section Five really spoke to me and caused me to think about how I help small business owners succeed.
The Buy-Sell Agreement
Zach points out many business attorneys routinely fail to see the need for a buy-sell agreement or they fail to fully develop it. Zach routinely comes across BSAs that are incorporated into the company’s organizational documents. (i.e. LLC operating agreements or partnership agreements.) Tackling BSA provisions in these organizational documents is possible; however, not typically recommended because these BSA provisions are not typically fully developed.
Of perhaps even more concern, Zach has discovered BSA provisions in clients’ organizational documents and the business owners did not know they existed. Zach and I share this discovery in common, it happens a lot more often than it should. One suggestion I have to alleviate this problem, draft a separate buy-sell agreement and incorporate that into the organizational documents by reference.
After a short discussion about buy-sell agreements, Zach dissects the three common approaches to BSA valuations. (1) price based on a formula, (2) price is fixed, and (3) price determined by a process. His analysis of the three approaches is, in my opinion, spot on. Option (3), determining price by a process, is typically the best fit for most small business owners. Under this approach, the owners of the company create a process in which an appraiser, or multiple appraisers, conduct their valuations at some set time.
Zach’s recommendation is to pick an appraiser now, value now, and re-valuate on an ongoing basis. This certainly makes for a best practice and I cannot argue with his reasoning. At the same time, if a business owner is not quite ready to commit to this level of involvement, there are other ways to incorporate this process later, such as upon the occurrence of a triggering event.
Here are seven quick points to summarize my thoughts on Zach’s book, particularly as it relates to buy-sell agreements:
- If you have a multi-owner business, you benefit greatly from a well drafted buy-sell agreement.
- Your BSA should usually base the ‘sale’ price on the Fair Market Value (FMV) of your company.
- Your BSA should usually incorporate a process approach to valuation, rather than fixed price or formula.
- Your BSA should define who is qualified, if not previously selected, to conduct the valuation. (ASA, AICPA, IBA, NACVA, CFA, CPA, etc)
- Your BSA should define what counts as a triggering event. (death, disability, divorce, bankruptcy, quits, retires, etc)
- Your BSA should outline the funding mechanism for the purchase/sale.
- Your advisors should keep you well-informed of the current value of your company. This help you ensure funding is available.
I would like to thank Zach Sharkey for writing this book. Zach’s work is by far the most comprehensive and ‘non-salesy’ business valuation books I have read. If you would like to learn more about Zach, or about his book, you can find his information at the following website, https://www.gatewayvalue.com/. If you would like to learn more about how you can use a Buy-Sell Agreement to protect your small business, contact Welch Law today.