Buy-Sell Provisions – What is Appraised Market Value?

LLC operating agreements, LLP partnership agreements, and corporation shareholder agreements all contain buy-sell provisions. These provisions grant options to purchase or require purchase of an ownership interest upon certain events such as termination of employment, death, disability, divorce, bankruptcy, etc. (the “triggering events”) in situations where the equity interests are closely held (i.e. not publicly traded).  The purpose of these provisions is to define the terms, such as appraised market value, upon which the parties will transfer their interests upon the events, before the event occurs.  The provisions provide certainty for the parties and hope to avoid protracted negotiations or litigation over the business and its valuation.  They usually contain provisions describing the events upon which the purchase rights are triggered, the purchase price and the payment terms.  This post discusses the appraisal method used to determine the purchase price.  For a more general discussion of succession planning for closely held business see Succession Planning.

Common Methods for Determining Purchase Price

There are three common methods to drafting the purchase price provisions – fixing the value, a formula, and by appraisal.  Each method has its own benefits and drawbacks.  Fixing the value at annual intervals gives certainty to the parties, but may fail to address dramatic increases or decreases if not adjusted frequently for a rapidly changing business.  A formula method addresses the rapidly changing business financials, but can also be difficult to define.  The appraisal method is often used as a simple solution when the value of the company is uncertain and in flux and the parties are unable to agree upon an appropriate formula.  The problem with this method is it kicks the can down the road and if there is not a recent appraisal, leaves the parties uncertain as to the value of their equity interest.  Given the uncertainty, the appraisal method can also lead to disputes as to how the appraisal is to be performed.  The appraisal could be based on earnings (often before interest, taxes, depreciation and amortization), adjusted earnings, liquidation or book value, comparable sales, or a combination of applicable components.  Even the term “market value” can be subject to much debate.  Does the definition include or exclude minority discounts?

Indiana Supreme Court Case Defines “Appraised Market Value”

An Indiana Supreme Court case recently addressed this ambiguity in Hartman v. BigInch Fabricators & Construction Holding Co., Case No. 20S-PL-618 (Indiana Supreme Court, 2021). The term at issue in the case read:

“[the purchase price] shall be the appraised market value on the last day of the year preceding the valuation, determined in accordance with generally accepted accounting principles by a third party valuation company within the twenty-four months immediately preceding the transfer of shares.”

The problem with the document was that it did not define “market value.”  A reasonable person could come to several different conclusions, all depending on how the term is defined.  For example, it could mean the price at which the equity interests would have traded in the public market if the company was publicly traded.  Or it could mean the price at which the entire company could be sold, divided by the percentage interest being transferred.  Or it could mean the price at which the company could be sold, reduced by minority (lack of control) and marketability (lack of liquidity) discounts and then divided by the percentage interest being transferred.  In other circumstances, the term could be defined as the liquidation or book value of the company. Each of these definitions could lead to a different result, thus the importance of discussing the alternatives and determining the parameters upon which the appraisal is based.

The case in Indiana was vigorously litigated.  An employee was terminated and required to sell his ownership interests at the appraised market value.  The trial court determined the term “market value” included minority and marketability discounts in 2018.  However, in 2020 the Indiana Court of Appeals reversed the decision, stating that the discounts did not apply.  Ultimately, in January of 2021, the Indiana Supreme Court reversed and held that the discounts were applicable in determining the market value of the shares.

Other Terms to Define

Regardless of the outcome, the shareholder agreement failed at its primary purposes – to provide certainty upon termination of employment.  The document could have clearly defined “market value” to include common discounts and saved a lot of time, energy and expense incurred over the three years of litigation.  And if the parties really intended “market value” to mean the company’s fair market value without regard to any discounts, the parties could have done so.  Clearly, the parties should have spent more time reviewing the purchase price terms, one of the core provisions of their shareholder agreement.  If the appraisal method is to be used, the provisions should address other issues as well.  Such as how the appraiser is selected, whether the appraiser can use interim or unaudited financial statements, whether intangible assets and insurance proceeds are included, how depreciated assets are valued (book or fair market value) and how appraisal disputes are resolved.


When the equity interests of an entity are not publicly traded, the buy-sell provisions are the most important tools to address the myriad of issues that arise on certain events such as termination of employment, death, disability, divorce and bankruptcy.   These provisions address control and provide a process by which the owners can liquidate their interests.  The purchase price is just one of the many issues these documents address.  Given their importance, they should be drafted with care and reviewed often.

If you would like to discuss or review an operating agreement, partnership agreement or shareholders agreement, please contact us to schedule an appointment.