Rock band Van Halenâ€™s 1982 world tour performance rider contained a provision (under the Munchies section) demanding a bowl of M&M candies backstage, with all the brown M&Ms removed. The consequence of even a single brown M&M found in the bowl was a forfeit of the entire show at full price â€“ and maybe even a trashed dressing room.
The motivation behind the provision was actually a hidden safety measure. If there were brown M&Ms backstage, the band knew their contract was not read in detail (and most likely the technical requirements of their contract not met regarding the stage rigging).
Reading contracts in detail can be tedious, painful and exhausting. Through my professional experiences, I have learned the importance of developing the diligence and resilience to thoroughly read and understand the relevant details in contracts. In this article, I share two short stories that involve the careful (and careless) readings of the details in buy-sell agreements and the respective impact this had on the expert witnessâ€™ valuation conclusions.
Short Story 1
A buy-sell agreement typically governs equity transactions among owners in a business if a triggering event occurs.
Early in my career, I was involved in valuing a spouseâ€™s interest in a nursing group (the â€œPracticeâ€). The members of the Practice had signed a buy-sell agreement. The buy-sell agreement contained a buyout provision of the husbandâ€™s interest in the Practice. The buyout amount for his interest was at a much higher value than could be reasonably derived under the three generally accepted valuation approaches (income approach; market approach; and asset approach). One of the details of the buyout included a five year non-compete clause.
The opposing expert valued the husbandâ€™s interest in the Practice consistent with the very high buyout value; however, the husband was nowhere near retirement age and therefore could not afford to not work for the next five years, as outlined in the buyout provision. The non-compete term was a critical detail overlooked by the wifeâ€™s valuation expert.
Short Story 2
A buy-sell agreement may also contain provisions to ensure continuation of a business by restricting the transfer of shares to unrelated parties.
Another situation where a spouseâ€™s interest in a family business (the â€œCompanyâ€) required a valuation for marital dissolution purposes. The owners of the Company were Dad (holding a 1% controlling interest) and Dadâ€™s two sons, Son [A] and Son [B], (holding a combined 99% non-controlling interest).
The owners had signed a buy-sell agreement, which included a salary continuation plan provision for Dad. The salary continuation plan paid Dad $1.0 million per year, which eliminated substantially all excess cash flow (Company earnings in excess of owner/officer compensation) of the Company, thus rendering Son [A] and Son [B]â€™s shares significantly less than without the salary continuation plan. One purpose of the salary continuation plan was to reduce the value of the shares held by Son [A] and Son [B] Â to ensure that Son [A] or Son [B] would not sell their respective shares in the Company to a third party (or transfer shares pursuant to a divorce settlement).
Opposing experts each performed a valuation under the fair market value standard of value of a 49.5 percent minority ownership interest in the Company. Expert  factored in the effects of the salary continuation plan provision and Expert  did not.
Instead, Expert  normalized Dadâ€™s compensation to reflect his duties performed. Accordingly, Expert â€™s analysis showed approximately $1.0 million more of cash flow available to the owners of the Company, resulting in a significantly higher value of the subject interest in the Company than Expert . Understanding that Dadâ€™s compensation was a contractual obligation rather than discretionary was a critical detail overlooked by the wifeâ€™s valuation expert.
The no-brown M&M clause is a clever example of what can happen when details are not carefully read and understood. The above short stories are a reminder that buy-sell agreements can contain a variety of provisions that may affect value. Notwithstanding this, from a valuation perspective, buy-sell agreements have received varying considerations by courts. These examples are also a good reminder of the importance of consulting with an experienced business valuation professional when drafting certain provisions of buy-sell agreements and other governing documents.
Contact Brian, REDW’s Business Valuation Practice Leader, at 602.730.3672 for questions about business valuation, or to discuss a project.
This article appears in the March 2019 issue of Arizona Attorney Magazine.