Buy-Sell Agreements and the Standard of Value Trap
The agreement decides what the appraiser is measuring. When it is clear, the engagement is straightforward. When it is silent or self-contradictory, that is where the dispute lives.
The agreement governs, not the appraiser's preference
A buy-sell agreement is a contract. Where it defines the value to be determined, that definition governs the assignment, and it governs even where the appraiser would have chosen differently on the merits. The appraiser's job is to apply the definition the parties agreed to, and to say clearly what that definition produced.
This is the single most common misunderstanding among owners commissioning this work. “What is my share worth?” and “what does the agreement say my share is worth?” are different questions, and only the second one is binding on a transaction the agreement controls.
| If the agreement says | The appraiser measures |
|---|---|
| “Fair market value” | The willing-buyer, willing-seller standard — usually with discounts available unless excluded elsewhere in the document |
| “Fair value” | A different standard, and one whose meaning depends on the governing law and context. Frequently applied without minority discounts. |
| “Book value” | An accounting figure, not a valuation conclusion. It is what it is, and it is often far from any economic value. |
| A formula — a multiple of earnings or revenue | The formula, applied as written. If it produces an unreasonable result, that is a drafting problem, not an appraisal problem. |
| Nothing at all | See below. This is where the litigation is. |
What happens when the agreement is silent
Silence does not mean the appraiser chooses freely. It means a question has to be resolved before the work can start, and resolving it is generally a legal question rather than a valuation one.
| The gap | The practical consequence |
|---|---|
| No standard of value stated | Fair market value and fair value can produce materially different results on the same interest. Parties often discover this only after each has commissioned a report. |
| No treatment of discounts | Whether DLOC and DLOM apply may be the largest single variable in the outcome. See discounts. |
| No effective date mechanism | Value moves. A date tied to notice, to withdrawal, or to closing can produce different numbers in a volatile year. |
| No appraiser selection or dispute mechanism | Two reports and no tiebreaker. Some agreements provide for a third appraiser; many do not. |
| No treatment of the departing owner's role | Where the leaving party was the earnings driver, whether that is priced in or out changes everything. See professional practice valuation. |
Where the agreement is silent, the appraiser states in the report which assumption was applied and on whose instruction. That is not evasion. It is the only honest way to produce a usable number without purporting to decide a contract question that belongs to counsel and, if it comes to it, the court.
The self-contradicting agreement
Worse than silence, and more common than it should be: an agreement that says two things. A clause specifying fair market value and another clause prohibiting discounts. A formula in one section and a reference to an independent appraisal in another. A stated standard in the buy-sell and a different one in the operating agreement it sits alongside.
The appraiser cannot resolve that conflict — doing so would be construing the contract. What the appraiser can do, and should do immediately rather than at delivery, is identify the conflict in writing and ask the instructing party to resolve it. Where it cannot be resolved before the work, the report may be developed on each competing reading and present both, clearly labelled, so the decision-maker can see what turns on the construction.
| Approach when the document conflicts | When it is appropriate |
|---|---|
| Stop and seek instruction | Almost always the right first step. Cheapest at the start, most expensive after a report has been issued. |
| Develop on a stated assumption, disclosed | Where the parties accept the assumption and the report says plainly what it was and that it was instructed. |
| Develop both readings, labelled | Where the construction is genuinely contested and the decision-maker needs to see the consequence of each. |
| Pick one silently | Never. This is how a competent analysis becomes a misleading report. |
Funding, and why it changes the drafting
An agreement that fixes a value but not a way to pay it has solved half the problem. The funding mechanism affects both whether the buy-out can actually happen and, sometimes, how the interest should be valued.
| Mechanism | What it means for the valuation |
|---|---|
| Life insurance funded | Common for death triggers. Whether policy proceeds are treated as a corporate asset in the valuation is a question the agreement should answer, because it can materially change the per-share result. |
| Instalment note from the company | The departing owner becomes a creditor. Present value and security matter, and the agreement should say whether the stated price is a cash equivalent. |
| Sinking fund or accumulated reserve | Reserves held for the buy-out may be non-operating assets and are separated in the analysis. |
| Unfunded | The most common. The valuation is unaffected, but the practical outcome may be a negotiation regardless of what the agreement says. |
Where proceeds or reserves exist, whether they sit inside or outside the value is one of the larger swing factors in the whole exercise, and it is resolved by reading the agreement rather than by appraisal convention.
Who orders this work
| Who | When | What they usually need |
|---|---|---|
| Departing owner | Retirement, resignation, dispute | An independent view of what the agreement produces |
| Remaining owners or the company | Same trigger, other side | The same, developed to the same definition |
| Counsel drafting an agreement | Before there is a dispute | A view on whether the definition and mechanism will work when triggered |
| Executor or trustee | Death of an owner | The value for the buy-out, and often a separate value for estate reporting — which may not be the same number |
| Court | Where the agreement is contested | A report written to be tested by an opposing expert |
The fourth row is the one that surprises people. A buy-sell price fixed by a formula and the fair market value of the same interest for estate reporting are answers to different questions, and there is no rule that they must agree. Where they diverge, both numbers may be correct and the divergence itself needs explaining — see estate and date-of-death valuation.
Drafting gaps worth closing before they matter
This is educational, not legal advice, and drafting is counsel's work. But an appraiser sees the same five gaps repeatedly, and they are cheaper to close while everyone is still friendly.
- Name the standard of value explicitly, and say whether discounts for lack of control and marketability apply.
- Fix the effective date by reference to a defined event, not to “the date of valuation”.
- Specify the appraiser's qualifications and the selection mechanism, including what happens if the parties cannot agree.
- Say whether the appraisal is binding or advisory, and what happens if two are commissioned.
- Revisit any formula periodically. A multiple that was fair when the agreement was signed can become absurd after a decade of change in the business.
One dismissal recurs in these engagements and belongs on the record. Where the agreement excludes discounts for lack of control and marketability, those adjustments are considered and then not applied — not because the interest is liquid or carries control, but because the parties contracted for a figure that ignores those facts. A report that silently omits them looks identical to one that never thought about them, so the reason is stated.
Development of an appraisal of a business interest is governed by USPAP Standard 9 and its reporting by Standard 10. Where an agreement supplies the definition of value, that definition is stated in the report and attributed to the agreement rather than to the appraiser, so a reader can see it was applied rather than chosen. Where the engagement proceeds on an instructed assumption about a contested construction, that assumption is disclosed as an extraordinary assumption, because the conclusion moves if it is wrong.
A formula agreed in 2009 and never revisited is the most reliable source of buy-sell litigation there is, because by the time it is triggered one party is usually delighted with it and the other is not.
Where this sits
Buy-sell work sits inside business valuation and draws directly on the three approaches and discounts. Where an agreement fails and the matter becomes contested, see partner and shareholder disputes and litigation support. Counsel drafting or construing an agreement may prefer what we do for attorneys.
Jeremy C. Johnson, Arizona Certified Residential Real Estate Appraiser #21358 · AQB Certified USPAP Instructor.
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What the work actually looks like
Real assignments, client details removed — what each engagement actually turned on, rather than how it felt.
A house, a workshop of machine tools, a forty-year firearms collection and a stake in the family company — four disciplines that three appraisers had only partly covered. One engagement, one effective date, one set of assumptions.
A donation the regulations would have aggregated past the appraisal threshold, which the donor had assessed item by item. One qualified appraisal covering the group, itemized, signed inside the window the regulations allow.
An opposing report whose number was not obviously wrong — which is what made it dangerous. It failed on its own certification, and was answered section by section with an independent valuation to the correct definition of value.