How to Set up Buy-Sell Agreements

Recommended Valuation Process for Buy-Sell Agreements: Single Appraiser

Chris Mercer tells how to set up a Buy-Sell Agreement for closely held and family businesses. He identifies three key procedures: Owners should select an appraiser for their business when they create the Buy-Sell, that appraiser should offer an initial baseline valuation for the Buy-Sell, and the named appraiser should continue to value the practice each year or two thereafter. Here’s why.

The Single Appraiser, Select Now and Value Now buy-sell agreement valuation process is the one I recommend for most successful closely held and family businesses.

I prefer this single appraiser process as the best available alternative for fixed-price, formula, and multiple appraiser agreements.

• Select now. I have long recommended that parties creating buy-sell agreements name the appraiser at the time of agreement. This way, all parties have a voice and can sign off on the selection of the appraiser no matter how difficult the process of reaching agreement. 
• Value now. Once selected, the chosen appraiser provides a baseline appraisal for purposes of the agreement. I suggest that the appraisal be rendered in draft form to all parties to the agreement, and that everyone has a reasonable period of time to provide comments for consideration before the report is finalized.  

• Value each year (or two) thereafter.  Ideally, the selected appraiser will provide annual revaluations for buy-sell agreement purposes.    

• The structure and process, in addition to being defined in the agreement, will be known to all parties to the agreement in advance.
• The selected appraiser will be viewed as independent with respect to the process; otherwise, he or she would not have been named. At the very least, the suspicion of bias is minimized.
• The appraiser’s valuation approaches and methodologies are seen first hand by the parties before any triggering event occurs.
• The appraiser’s valuation conclusion is known at the outset of the agreement by all parties and becomes the agreement’s price until the next appraisal, or until a trigger event between recurring appraisals occurs.
• The process is observed at the outset; therefore, all parties know what will happen when a trigger event happens.
• The appraiser must interpret the valuation terms of the agreement in conducting the initial appraisal. Any lack of clarity in the valuation-defining terms (“the words on the pages”) will be revealed and can be corrected to the parties’ mutual satisfaction.
• Having provided an initial valuation opinion, the appraiser must maintain independence with respect to the process and render future valuations consistent with the instructions in the agreement. 
• Because the appraisal process is exercised at least once, or on a recurring basis, it should go smoothly when employed at trigger events and be less time-consuming and less expensive than other alternatives.

• The parties will tend to gain confidence in the process. The selected appraisal firm should provide valuations that are generally consistent with prior opinions, taking into account relevant changes in the company, the industry, the economy, and other relevant factors. Subsequent appraisals should be reconciled with prior appraisals so that all parties understand why value has changed.
• The parties will know the most current value for the buy-sell agreement. This can be beneficial for a company’s planning purposes, for example, facilitating the maintenance of adequate life insurance on the lives of appropriate shareholders. The periodic appraisal will also be helpful for the planning purposes of shareholders.
• The Single Appraiser, Select Now and Value Now process with annual reappraisals facilitates the estate planning objectives of the shareholders at relatively low incremental cost. If the buy-sell agreement calls for an enterprise level of value (marketable minority or financial control), the appraiser can provide a supplemental appraisal at the nonmarketable minority level for gift and estate tax purposes. This supplemental appraisal would, of course, have to consider the impact of the buy-sell agreement on the value of nonmarketable minority interests. Consult with your tax attorney to be sure that the buy-sell agreement price is determinative of value for estate tax purposes.
• Enhanced confidence for all parties. Importantly, because the appraisals are recurring in nature, the appraisal firm’s knowledge of a company’s business and industry will grow over time, which should further enhance the confidence all parties have in the process and conclusion of value.