John and Mike each own 50% of a business. They sign a buy-sell agreement providing that if one of them dies, the other one will buy out the deceased owner’s share at a specified price and on specified terms. The drafting attorney or attorneys suggest that the business be valued by a qualified appraiser, but John and Mike do not want to pay for an appraisal so they set an arbitrary figure as the value. They tell the attorney(s) that they will update the figure from time to time to reflect changes in the business’s value. As years go by, John and Mike continue to ignore the issue, in part because they still do not want to pay for appraisals of the business, so the initial arbitrary figure for the business’s valuation stands.
Ten years later, John dies. Mike will either be paying too much or too little to buy John’s share. Mike will be angry if he has to pay more than John’s share is worth. John’s beneficiaries will be angry if Mike pays them less than what John’s share is worth. The two sides will be likely to go to separate attorneys, and one side may try to attack or set aside the valuation in the buy-sell agreement. The two attorneys representing the two sides will be the big winners.
What if the buy-sell agreement did not set a price? What if the buy-sell agreement provided that when one owner dies, each side will pick an appraiser, and that the two appraisers will agree on a third appraiser, and that the valuation done at that point by the third appraiser will set the buy-out price of the deceased owner’s interest?
Using this method, John and Mike still don’t have to pay for an appraisal when the agreement is drafted. Using this method, John and Mike don’t have to pay for future appraisals to periodically update the buy-out price. Using this method, when one owner dies, a fair price will be arrived at, which will lessen the possibility that the two sides will hire lawyers to fight eachother.