Formula buy-sell agreements can be a useful tool for company owners.   If there is a formula provision in your buy-sell agreement, then I recommend going through the formula and fully understanding what is going to happen once the provision is triggered.  If the formula yields results that are problematic or creates issues between the owners, then the problems should be addressed by all interested parties.  Granted, these conversations can be very tough, but with proper planning many obstacles can be overcome.  At least an honest assessment can lead to clarity for all involved.  Remember: the formula will be triggered and interpreted as agreed to by the parties – you should try and take an active role early on. 

If you have not yet entered into a buy-sell agreement and think that a formula is the best course of action then plan accordingly.  Take steps to specifically lay out what goes into the formula and tend to it on an annual basis.  Often it is useful to attach an example to the buy-sell agreement outlining how the formula will be calculated going forward. 

Ultimately, I don’t recommend using a formula for a buy-sell agreement. Primarily due to the reality that owners don’t often revisit the formula until something happens. By then the multiples are likely outdated, the business has substantially changed and/or the owners are at odds.

Some other items should be included and specifically delineated in a formula buy-sell agreement.  If the formula is a based on an EBITDA multiple this will yield an entire company value – the equity and debt.  To determine an equity value, long-term debt will need to be subtracted from the resulting value.  It is important to specify the timing and identify the debt to be subtracted to reach an equity value.  Additionally, it is my recommendation to list the appropriate shares/units outstanding to reach a per share/per unit price for the transaction.  Other recommended practices:

·         Determine how to treat instances of excess cash on the balance sheet and when the entity will have excess cash;

·         Determine how non-operating assets will be treated in the formula;

·         Identify and agree on who is actually going to be performing the calculations pursuant to the agreement; and

·         Determine and agree how life insurance proceeds are going to be treated and the impact on the value.

As you can see, what starts off as a pretty simple process using a formula can get quite complicated. If these considerations are not documented it will lead to differing interpretations which can lead to large value swings and inconsistencies.