In a buy-sell agreement, where the shareholders or corporation agree to purchase the shares of a deceased or disabled shareholder (i.e., management succession) for a stipulated price, a professional appraisal is the best way of independently determining that price. Buy-sell agreements typically either specify the actual price at which the ownership interest is to change hands given the specified circumstances, or specify the procedure by which a price is to be determined. To combat the perception that buy-sell agreements are value-fixing techniques, the IRS has tightened the rules so that a buy-sell is judged null and void unless it meets three tests: (1) the agreement must be bona fide, (2) the agreement is not a device to transfer property to family members at less than fair market value, and (3) per IRC 2703(b)(3), the terms of a buy-sell entered into after October 8, 1990 must be “comparable to similar arrangements entered into by persons in an arm’s-length transaction.” Typically, only an experienced business appraiser will have the experience and comparable transaction data to satisfy the intent of the IRS in this test.
Further, Delphi can consult with attorneys in the drafting phase of a buy-sell agreement. It is imperative that all parties are aware, and more importantly, take action, in executing a buy-sell agreement with care and diligence to ensure a successful buyout, upon a triggering event. As valuation professionals, we have unfortunately experienced, first-hand, the life-altering ramifications of poorly crafted agreements – with all of the intended and unintended consequences of the language incorporated in these agreements. Given this experience, we can address these issues up front. However, should we work with an older buy-sell agreement with onerous language, Delphi has the experience to understand the ramifications and how to handle the many scenarios that may be of interest to the IRS or to the various parties subject to the buy-sell agreement.