Our buy/sell agreement saga continues with some thoughts about the dynamics of family discussions on a potentially sensitive topic. If you have more than one shareholder over 12 years old (or any adult shareholders who act about that age), you’re virtually guaranteed to get bogged down on valuation.
In my experience, numerous behind-the-scenes issues can affect family members positions on stock value. The symptoms come to the forefront if some family members want to keep the business in the family forever, while others think they might want to sell someday. If the family members look at it that way, the natural result is that the buy/sell agreement discussion becomes a negotiation between buyers and sellers.
After years of study, applying very advanced algebraic principles, I’ve developed a scientifically accurate equation to express mathematically how each camp might calculate the stock price. In each case, we start with the most objective value possible – the value determined by the most competent, informed and unbiased appraiser we can find.
|Valuation by Those Who Envision Keeping Their Stock Forever (The Buyers)||Valuation by Those Who Envision Selling Their Stock Someday|
|START: Value of stock per an objective, competent and informed appraiser.||START: Value of stock per an objective, competent and informed appraiser.|
|– Discount because I do not believe the appraiser.||+ Premium because I do not believe the appraiser.|
|– Discount for illiquid/non-controlling shares. We can t afford to buy back stock as if we are selling the whole company.||+ Eliminate any discounts for lack of marketability/control because they’re not fair.|
|– Discount because you (the seller) won t be taking any risk that the company performs poorly after the sale.||+ Premium because I won’t benefit if the company does well after I sell.|
|– Discount because you didn’t work here and didn t contribute to creating the stock value.||+ Premium because I never got all the salary and perks that the other family members received.|
|– Discount because you got your stock by gift and inheritance. You never put any capital into the company.||+ Premium because I never got a dividend for the company’s use of my capital.|
|– Discount because I don’t want the kids to get too much money for work ethic and moral values reasons.||+ Premium because I need more money.|
|– Discount because I don’t want the seller to take advantage of me.||+ Premium. I don’t want the buyers to take advantage of me.|
|– Discount because I want to discourage people from selling.||But I don’t want to stay and it s not fair for you to cheat me out of my share of the value.|
|– Discount because the business can’t afford to buy people out. We need the money for capital and other needs within the business.||Baloney! Look at the big numbers on the balance sheet and the high income. Quit taking so much salary and there will be plenty of money to buy me out and spend on unnecessary business projects.|
|– Discount because I don’t want the IRS to think the business is worth so much for future gift/estate tax purposes.||That’s not my problem.|
|= The price I am willing to pay for your stock, but I don t want you to sell and the family will be forever peeved if you do.||= The price I am willing to accept, but I ll still feel cheated if the business is successful and you become wealthier than me.|
Unfortunately, it is a mathematical fact that the two equations never result in the same value.
After family members have staked claims to one side or the other, a role-play might be amusing, if not helpful. Ask them to negotiate and defend the opposite point of view. That should improve everyone s understanding of the issues.
What if that psychological approach does not shrink the difference between two sides amounts? If there is some love in the family and everyone views the business with at least some respect, it may be possible to find common ground by asking some soul-searching questions, like:
- Is family harmony worth giving in a bit on each side to avoid resentment that can tear the family apart?
- Doesn’t a low price force people to stay as shareholders? If so, doesn t it just cause them to get more frustrated over time with the risk of creating outright war (meaning a windfall for the lawyers) when they can t stand it anymore? Conversely, doesn t a high price encourage people to sell and put undue financial stress on the business?
- If a significant number of shareholders want to sell the business, shouldn t those who want to stay pay a premium to keep it?
- Do you care about the success of the business, its employees and its customers? If so, shouldn t the price be kept reasonable to avoid putting undue burdens on the business?
- If some of the owners want to cash out, isn t it reasonable to expect that the business either must contract or forgo some expansion plans until it generates replacement capital?
If that doesn’t work, tune in next month.
Ross Nager is Senior Managing Director of Sentinel Trust Company in Houston, Texas