Process agreements are buy-sell agreements involving the use of one or more business appraisers in processes specified for determining value. If appraisers are to determine price, they need a definition of the assignment. Five elements must be defined in order for the appraiser(s) to provide the type of valuation sought pursuant to the agreement. A sixth element is so important from a business perspective that we include it as an additional defining element.

• Standard of value. The standard of value is the identification of the type of value being used in a specific business valuation. The proper identification of the standard of value is the cornerstone of every business valuation. The parties to the agreement must select that standard of value. Will value be based on “fair market value” or “fair value” or some other standard? These words can result in dramatically different interpretations from a valuation perspective.
• Level of value. Will the value be based on a pro rata share of the value of the business or will it be based on the value of an interest in the business? The differences bring minority interest and marketability discounts into play which may cause wide differences in the conclusion of value.
• The “as of” date for the valuation. Every business valuation is grounded at a point in time. That time, referred to as the “valuation date” or “effective date” or the “as of” date, provides the perspective, whether current or historical, from which the appraisal is prepared. Because value changes over time, it is essential that the “as of” date be specified.
• Qualifications of appraisers. Some buy-sell agreements provide a list of firms that the parties agree are mutually acceptable. In other cases, the specific, individual qualifications of appraisers are spelled out (e.g., credentials from a major credentialing organization, experience in appraisal, experience with the industry, etc.). Unfortunately, many buy-sell agreements are silent on this issue. Absent clear specification of the appraiser qualifications, there is no assurance that appraisers considered for buy-sell agreement valuations will be qualified to provide the required services.
• Appraisal standards to be followed. Some buy-sell agreements go so far as to name the specific business appraisal standards that must be followed by the appraisers. Qualified business appraisers will understand the importance of specifying appraisal standards and be familiar with and able to follow relevant standards.

The sixth defining element relates to the funding of buy-sell agreements.

• The funding mechanisms. The funding mechanism is often considered separately from business valuation. However, there may be interrelationships between the business valuation and the funding mechanism that should be considered in your buy-sell agreement. Funding mechanisms such as life insurance and sinking funds can have a direct impact on value. This aspect aside, the funding mechanism does determine in substantial measure whether the valuation, however developed, can be implemented in future transactions. A buy-sell agreement is no better than the ability of the parties and/or the company to fund any required purchases at the agreed upon price. An agreement that is silent can be like having no buy-sell agreement at all.

What’s so hard about specifying these defining elements? Getting specific often makes people think about things they don’t want to think about. But think about them they must. Know this: if these defining elements are unclear in your clients’ buy-sell agreements, following a trigger event they may be the only thing you or your clients will be able to think about until the situation is resolved. Absent a clear agreement, this can take lots of money, lots of time, and create lots of hard feelings.