Chapter 8 - Buy and Sell Provisions and Business Valuation Basics

Question 1

The objectives of a buy-sell agreement, are to: (5)

Answer 1

• means for selling interest.
• setting the transaction price.
• Give remaining shareholders the funding required to acquire shares.
• Prevent the transfer of shares to persons not approved by remaining shareholders.
• Provide the remaining shareholders with the ability to continue to operate the business

Question 2

The purpose of a buy-sell agreement is to ___ , either when a new shareholder is admitted or when an existing shareholder leaves

Answer 2

control transfers of private company shares

Question 3

The general clause should provide a list of specific triggering events of a shareholder under which the buy-sell agreement would be acted on (7)

Answer 3

• death
• Long-term disability
• Retirement
• Marital breakdown
• Resignation
• The firing or termination
• Bankruptcy or insolvency

Question 4

This general clause is followed by others intended to establish terms for the orderly withdrawal of existing shareholders and the admission of new ones. Some of the clauses most frequently encountered are: (3)

Answer 4

• The right of first refusal
• The shotgun clause
• A mandatory offer

Question 5

What is the right of first refusal

Answer 5

obliges shareholders to give each other
the first option to purchase shares before offering them to third parties

Question 6

What is the shotgun clause?

Answer 6

adds that if the shareholders refuse the offer, they are automatically obliged to tender their own shares, at the same price and conditions

Question 7

A mandatory offer applies automatically. This clause kicks in and obliges a shareholder to sell when certain events occur, such as (2)

Answer 7

the death of a shareholder
withdrawal from the company

Question 8

A buy-sell agreement makes any form of estate planning impossible if it stipulates that

Answer 8

all shares must be sold to the surviving shareholders

Question 9

DISADVANTAGES of valuing at book value (3)

Answer 9

• Assets recorded at cost rather than FMV.
• no value assigned to intangible assets, such as goodwill.
• Net assets undervalued due to excessive caution in choice of accounting treatments.

Question 10

The two main going-concern valuation methods are:

Answer 10

• capitalization of earnings
• discounted cash flow

Question 11

capitalization of earnings method three steps involved:

Answer 11

determining the indicated earnings
selecting a capitalization rate (or multiplier) adding redundant assets

Question 12

The company’s maintainable or indicated earnings correspond to

Answer 12

average earnings in the future

Question 13

best way of determining the fairest price of valuation

Answer 13

third party appraisal

Question 14

most common remuneration of expert appraisal expressed as a

Answer 14

percentage of the value of the assets.

Question 15

AGREED VALUES
Shareholder agreements fairly often stipulate that the price at which the shares will be transferred is to be determined periodically, usually ___ , by the parties themselves.

Answer 15

annually

Question 15

LIQUIDATION VALUE APPROACH should be used only in exceptional circumstances such as when:
(3)

Answer 15

• clear that the company will not be able to survive the departure of one or more shareholders.
• company has been running up operating losses for several years.
• analysis of risks of bankruptcy casts doubt on the going-concern concept

Question 16

Procedures are usually initiated by

Answer 16

giving notice.

Question 17

The redemption of shares by the company may be financed by one or more of the following methods: (5)

Answer 17

• Using the proceeds of an insurance policy
• Using the company’s surplus cash or
  liquidating surplus assets
• Borrowing or issuing other shares of the same class or a different class
• Agreeing to extend the payment over a pre-determined period to use the company’s future cash flow
• Creating a sinking fund under which amounts are set aside to provide for the eventual redemption of shares

Question 18

If it is the other shareholders who are buying back the shares, there are fewer possibilities. (2)

Answer 18

Take out an insurance policy
rely only on their own resources.

Question 19

For a shareholder agreement to be considered as determining the value of shares in accordance with the Income Tax
Act, the agreement must meet all the following conditions. It must: (5)

Answer 19

• Require the sale of the shares at the shareholder’s death.
• Limit the shareholder’s right to dispose of their shares while alive or to use them as security.
• Indicate a set price or a method of calculating the price.
• Represent a bona fide business agreement
• value assigned does not represent a below market valuation intended to benefit the recipient.