Buy-Sell Agreements

Set Price (Schedule A) Method

The set price method is the first method of valuation. I often call this the Schedule A method because the owners usually attach a schedule to the back of the buy-sell agreement with the value on it. For example, suppose that MythiCo and its four equal shareholders use this valuation method and value MythiCo shares at $1,000 apiece. This is the amount they would put on Schedule A.

This method has a host of problems associated with it—so many, in fact, that I have never recommended it to anyone—yet I continue to see lots of buy-sell agreements that use this valuation method. What are the problems? For starters, who says that the owners are good judges of the value of their businesses? Valuing entities and interests in entities is its own profession today, and there’s a lot to know.

The skill sets of operating an entity and of putting a value on it, or on any interest in it, are unrelated. It has been my experience that owners have little idea of what their business is truly worth, and the wrong answers vary from too high to too low. The bottom line is that very few owners should attempt to set their own prices in a buy-sell agreement without a qualified business appraiser’s assistance.

If that problem alone was not enough to stay away from the set price method, consider this: most of these Schedule A valuations are supposed to be updated every year or every other year by mutual agreement. There are at least two related problems here. The first is that most owners forget to update the Schedule A value until something happens to trigger the buy-sell agreement, which is too late, as that favors either the buyer or the seller, depending on whether the price agreed on is too high or too low. The second problem is that when Schedule A is about to be revisited and one of the owners is near death or disabled, then that compromised owner will be at a distinct disadvantage as the other owners may purposely set the price too low, betting that the teetering owner will soon have a triggering event happen first.

One thing is clear: if you are going to disregard my advice here and use a Schedule A valuation, then you ought to have a fail-safe backup method, such as an appraisal, when the parties either fail to update Schedule A for a period of time (two or three years at the max) or they are unable to agree on the value to place on Schedule A. Otherwise, please do yourself and your loved ones a favor and avoid Schedule A valuation methods like the plague!