How to Make A Buy-Sell Clause That Works

I was on a call recently with a group of partners working through the buyout provision in their shareholder agreement.

Smart group. Good dynamic. Doing this early, which is exactly when it should happen.

And then this came up:

“In a buyout, we’ll each hire an appraiser.”

I hear some version of this all the time.

I’ve reviewed a lot of buy - sell agreements over the years, and this is one of the most common provisions I see. It almost always makes sense when it’s drafted.

The problems don’t show up until someone actually has to use it.

Why this breaks down

On its face, it feels fair. Each side hires their own appraiser and nobody feels boxed in.

In practice, it tends to create a different set of problems.

• You have assumed the parties will disagree .
  
• You have doubled the cost and the time. And
  
• You still do not have a clear path to resolution.
  

If the two appraisers come in at different values, which they almost certainly will, you are left asking the same question you started with.

Now what?

At this point, the agreement is not helping. It is part of the problem. I have been engaged to put out this fire more than once.

What I see work in the real world

Simplifying the process works best.

• One appraiser.
  
• Jointly selected.
  
• Independent.
  
• Properly credentialed, typically ASA or equivalent.
  
• The conclusion is binding.
  

That structure forces alignment upfront on who is trusted to do the work. It also keeps the process from turning into a negotiation disguised as an appraisal.

For groups that expect their owner partners to act in good faith, this structure holds up best.

If you want a backstop

If relying on a single opinion feels like too much, a second layer can be built in.

One appraiser to start. If someone disagrees, they can obtain a second appraisal at their own cost. If the two values are far enough apart, a third appraiser is brought in.

This is where I see a lot of agreements get tripped up.

I have seen two qualified appraisers land 12 to 15 percent apart and both be completely defensible. That is just the nature of valuing an operating business.

If you set the trigger at 10 percent, you are almost guaranteeing a third appraisal every time. Something closer to 15 percent is more practical.

You also need to define what the third appraiser actually does. A version that works is a ‘baseball style approach’ to business valuation. The third appraiser’s value is averaged with whichever of the first two is closer, and the outlier is effectively discarded.

That detail matters because it keeps everyone anchored to reasonable conclusions instead of extreme positions.

Do not lock in the method

Another provision I see quite a bit is language that specifies the valuation method upfront.

That is not how this should work.

A credible appraisal should consider the income, market, and asset approaches and then apply the ones that fit the facts. Locking the appraiser into a single approach can create more room for disagreement, not less.

The decision that gets deferred

One item that is often left undecided is whether discounts apply.

Lack of control. Lack of marketability.

This is not just technical language. It can move value in a meaningful way. I have seen entire disputes center on that question after the fact.

If the agreement is silent, you are leaving that decision for a future version of yourselves to work through. That conversation is rarely a collaborative one. Make sure discounts are addressed in the Buy-Sell Agreement.

Payment is part of the equation

The valuation is only part of it. How the buyout gets paid matters just as much.

In many operating businesses, the buyer will not have the liquidity to fund a lump sum outside of insurance situations.

What I typically see is straightforward. Death or disability is covered with insurance and paid quickly. Other buyouts are paid over time, often three to five years.

It is not complex, but it needs to be decided in advance.

Where this really gets tested

The irony is that everyone agrees to these provisions when relationships are good.

The clause gets tested when they are not.

Or when something happens that no one planned for.

A buy - sell agreement is one of those documents you hope never gets used. But if it is, it will likely be during one of the most stressful moments in the life of the business.

That is not the time to discover the valuation process was not clearly thought through.

Good agreements do not eliminate disagreement. They provide a clear path through it.

For more on business valuation read, Top 10 Mistakes Owners and CFOs Make When Valuing Their Company and visit Dave’s Library on CFO.University

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