When a business is started, one common way to raise capital is by selling shares in the business or offering shares as part of a compensation package to help secure a talented individual for your company. But what happens when a shareholder wants to leave the business? If you want to retain control of the company, you'll need to buy out their shares. How do you know what a good price is for the shares? One of the best ways to approach this problem is through the valuation of a company. Let's take a good look at how a business valuation can help determine price when buying out an exiting shareholder.
Buying Out an Exiting Shareholder: Using a Business Appraisal to Reach a Fair Agreement
However the situation has come about, when one shareholder wants to leave a business, you want to ensure you can control those shares. But what value do those shares have? How do you determine a fair price? The shares may have had a particular value when you opened your company, but as your company has grown and changed, it's become more difficult to put an exact figure on the shares. To determine their value, you need to know your company's appraised value. But how is that figure determined? You could base the value on the sale of similar businesses in your area, but those businesses often have many differences that make it difficult to compare...and are the rumors of what the business sold for real or a bunch of B.S.? In this situation, many companies use business valuations to determine a fair price for a share buy out.
Exiting shareholders are bought out for a wide range of reasons. Sometimes it's a good one, because they're retiring or moving to a great new location, and you want to make sure that they're getting their fair share of the equity in the business to ensure they do well in their new situation. Sometimes you're dealing with a difficult situation, where the split is on bad terms, such as partners not getting along, differences in vision for the short-term and long-term goals of the company, differences in your work ethic, divorce, or similar issues. The exiting shareholder in this situation may be demanding a share price you feel is too high for the business to reasonably bear. Anytime there are multiple owners in a business, it's wise to have a buy/sell agreement in place ahead of time to plan for these types of unforeseen events. That way, everyone knows ahead of time what the policy is and agrees on how the valuation of the business is to be handled in these situations.
When you know what your company's shares are worth, you know you're making a fair offer instead of worrying about whether you're overpaying or stripping the business of the vital capital needed to remain in operation. Business appraisals are a great way to determine value when buying out an exiting shareholder in your company. It also gives you a baseline tool for many other business purposes, which you can read about in our other blog posts.