Buy-Sell Agreements (CONT’D FROM PAGE 28)
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designing a valuation formula agreeable to everyone, then setting it in stone for use later. This also carries risks. “While a clearly defined formula can avoid the problem of ambiguity, the problem is that industries, markets and business operations change over time,” says Harms, “A formula that makes sense today may not make sense five or 10 years down the road when the buy-sell agreement has to be used.” Regular Appraisals The secret to success, say consultants, is to schedule periodic appraisals with parameters that are clear and acceptable to all family members. “All parties should un- derstand the approaches to value being used and the assumptions being made,” says Harms. “That will reduce uncertainty and cut down on the potential for conflict later when a trigger event occurs.” How often should the appraisals be done? For the best results, say consultants the appraisal should be done annually. “It’s a lot less expensive to do that than to deal with the costly infighting that can otherwise result,” says Z. Christopher Mercer, CEO of Mercer Capital, Memphis. Periodic appraisals offer an important fringe benefit: knowledge about a business’s confirmed value that can help manage the family wealth. “Valuations can help fami-
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ly members understand the rate of return they’re receiving on their investment in their private company,” says Mercer. “And just like any other investment, that rate is based upon three points: a beginning value, an ending value, and the interim distributions.” Mercer offers an example: If a company stock valued at a hundred dollars one year increases to $112 a year later, then the shareholders have enjoyed a 12 percent return on their investment. If the company has also paid them a $3 distribution then their total return on investment has Assessing the value of a family business is one thing. Scraping together sufficient cash to purchase a depart- ing owner’s stock is another. Buy-sell agreements should address funding sources to obviate a lot of scrambling around when disaster strikes. Insurance policies can provide funds for the purchase come to 15 percent. Funding The Stock
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