Best Valuation Method for Buy-Sell Agreements

ACEC News / Education

November 14, 2019

Best Valuation Method for Buy-Sell Agreements

In buy-sell agreements for many engineering firms, “valuation is the most difficult issue because there is no ready market for closely held businesses,” says Mike Baker, managing partner of Dent Moses LLP, an accounting firm in Birmingham, Ala.

There are four primary valuation methods: Book value, Formulas, Appraisals, and Agreed-Upon Value.

“Book value is simple but not always appropriate,” says Baker.

He says formulas are easy to apply but don’t provide enough flexibility. “You’re working with historical data, which don’t take into account sudden changes in the business.”

Appraisals are Baker’s least favorite option. “They’re expensive and take a long time.”

“My favorite method is Agreed-Upon Value,” he says. “It allows for discretionary adjustments if you know that the coming year is going to be better or worse.

In this method, the owners meet annually to agree upon a value. Using a variety of data, such as Zweig formulas, multipliers of revenue, or EBITDA formulas, they set a value that controls when new owners get in or existing owners leave over the next 12 months.

“I also like it because it may be the only time you get everyone together and just talk about the value of the firm,” says Baker. “And it often gets into a discussion about what you can do to increase that value.”

Baker recently presented an ACEC online class on how to optimize a buy-sell agreement. To download the On-Demand webinar, click here.

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