Buy/Sell Agreements and the Valuation Clause

Posted by Ralph Sklar @ 11:15am on July 8, 2015

A common problem with buy/sell agreements is that people don't always understand the valuation clause. Frequently partnership agreements give survivors the right to buy their deceased partner's business or real estate interests at fair market value. What they don't always understand is that the fair market value of say 1/3 of an entity is usually less than 1/3 of the value of the entity because valuation experts apply discounts for minority interest, lack of marketability, and lack of control. This is neither good nor bad. After all, the buyer often has to go into debt to buyout her deceased partner's share of the business, and she may not want to increase her exposure to a single risky asset. Recently, in calculating a client's need for life insurance we realized that his heirs would only receive about 60% of the value of his real estate. While at first he was upset, on further consideration he was happy because given his partner's advanced age, my client was pretty sure that he would be a buyer and not a seller. What does your Partnership Agreement say?