When was that buyout provision last updated?
The buyout provision of an owner’s agreement must be carefully drafted and regularly reviewed. If it is not, the buyout may not be legally enforceable – or serve the owners’ current needs. In the case of Namerow v. PediatriCare Associates a stale buyout provision came back to haunt a retiring owner. 

Retirement Triggers Buyout
In 2000, the members of PediatriCare entered into an operating agreement. It gave retiring members the right to have their interest purchased by the remaining members and the practice once they reach age 60 and have provided at least 25 years of service to the practice.

The agreement stipulated a fixed buyout amount of $2.4 million. It required the members to update the valuation annually, but they failed to do so. The agreement further provided that, if the parties failed to agree on a revaluation for more than two years, the practice’s value would equal the last stipulated value, adjusted to reflect changes in “net worth” on the buyout date. 

Experts Define “Net Worth”
The issue at trial was the buyout price for a retiring member’s 25% interest. his expert defined net worth as “the excess of assets over liabilities.” He assumed that the stipulated value in 2000 included goodwill beyond the book value of net tangible assets. The expert applied various metrics to value goodwill in 2016. He concluded that the practice’s value ranged from approximately $5.6 million to $6.75 million.

On the other side, the defendants’ expert defined net worth as “assets minus liabilities as stated in the balance sheet,” which typically excludes goodwill. He adjusted the stipulated value for changes in the book value of net worth between 2000 and 2016 and concluded that the practice’s value ranged from about $2.8 million to $3.2 million. 

Net Worth Excludes Intangibles  
The Superior Court of New Jersey found that net worth should exclude goodwill. Based on the $2.4 million stipulated value and tangible assets ranging from about $590,000 to $973,000, the court stated that the plaintiff’s expert “blindly assumes that the difference between the two figures must account for intangible assets.” But the court explained that this assumption was “designed to inflate” the practice’s current value. 

Because the parties had failed to update the buyout provision, the court was forced to apply the original valuation formula from the operating agreement. However, the court awarded the retiring member to amount based on the high end of the defense expert’s range of values. 

Seek Valuation Advice
The outcome of this case might have differed if the members had periodically consulted with a valuation expert and reviewed the buyout provision. It also might have changed if the buyout provision had required a contemporaneous valuation or provided a more explicit definition of the term “net worth.” 

theKFORDgroup litigation team holds extensive knowledge and experience in expert witness engagements, forensic accounting, and business valuations. Our team is trained and experienced in business valuations and can assist your clients in updating their buyout provisions. For more information, please call us at (210)340-8351.

Additional information included in this report was provided by PDI Global/Thomson Reuters © 2019 

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