Formula Buy-Sell Agreements

With formula buy-sell agreements, it is my recommendation to review the multiples in the agreement and determine if they reflect current reality.  Additionally, you will need to determine what earnings to apply to the multiple.  As in the previous example, let’s say the formula in the buy-sell agreement is value = 3.0x EBITDA.   If the agreement is silent as to how EBITDA is determined, then disagreement and/or misapplication can apply. 

In a valuation context, there can be several valid adjustments to EBITDA such as: non-recurring income and expenses, income and expenses related to non-operating assets, lease payments to a related party and adjustments to owner compensation (among others).  Any adjustments should be specifically included and identified in the buy-sell agreement formula to avoid uncertainty in the formula calculation.  Keep in mind, any adjustments to EBITDA can create swings in the company value. 

Further, it is important to identify the appropriate timing of the earning stream. For example, does the agreement specify that the last twelve months of EBITDA should apply? Last calendar year? Last fiscal year? Three-year average EBITDA? Five-year average? Each of these can alter the value depending on company characteristics. The point is that none of these are technically wrong, but if not defined, the formula is subject to differing interpretations.