Mercer Capital’s Value Matters^® 2020-02

Executive SummaryBuy-sell agreements are a cornerstone of planning for closely held businesses and family enterprises. Advisors spend significant time addressing ownership transitions, funding mechanisms, and tax considerations. Yet despite their importance, valuation provisions in buy-sell agreements are often treated as secondary drafting issues. Too often, they are boilerplate clauses that receive far less scrutiny than they deserve. When buy-sell agreements fail, valuation provisions are often the root cause.This article is the first in a two-part series examining how buy-sell agreements function in practice and why so many fall short of their intended purpose. Part I focuses on the valuation mechanisms commonly used in buy-sell agreements – fixed price, formula pricing, and appraisal-based processes – and explains the structural weaknesses that often undermine them. Drawing on our extensive valuation experience, we offer a practical framework for designing valuation provisions that are more likely to produce fair, predictable, and workable outcomes when a triggering event occurs.Part II will address what is required for buy-sell agreement pricing to be used to fix the value for gift and estate tax matters, including the requirements of Internal Revenue Code §2703 and guidance from key court cases such as Estate of Huffman and Connelly. Together, these articles are intended to help estate planners move beyond theoretical drafting and toward buy-sell agreements that withstand both real-world and IRS scrutiny.Common Buy-Sell Valuation MechanismsMost buy-sell agreements fall into one of four categories based on how price is determined:Fixed priceFormula pricingMultiple appraiser processSingle appraiser processEach approach has perceived advantages, but each also carries structural weaknesses that estate planners should carefully evaluate.Fixed-Price AgreementsFixed-price buy-sell agreements establish a specific dollar value for the business or ownership interests based on the owners’ agreement at a point in time. Their appeal lies in simplicity. The price is clear, easily understood, and inexpensive to administer. In theory, fixed-price agreements encourage owners to revisit and reaffirm value periodically.In practice, however, fixed prices are rarely updated with sufficient frequency. As the business evolves, the fixed price may become materially understated, overstated, or – by coincidence – approximately correct. The fundamental problem is not the use of a fixed price, but the absence of a reliable and consistently followed process for updating it. When the price becomes stale, incentives become misaligned. An unrealistically low price benefits the remaining owners, while an inflated price benefits the exiting owner. These distortions undermine fairness and often surface only after a triggering event, when renegotiation is least likely to succeed.Formula Price AgreementsFormula pricing agreements determine value by applying a predefined calculation, often based on financial statement metrics such as EBITDA multiples, book value, or shareholders’ equity. These agreements are frequently viewed as more objective than fixed prices and are attractive because they appear to adjust automatically as financial results change.The perceived precision of formulas is often illusory. Over time, changes in the business model, capital structure, accounting practices, or industry conditions can render a once-reasonable formula obsolete. Even when formulas are recalculated mechanically, they may fail to reflect economic reality (book value as a formula is a prime example of this). More importantly, most formula agreements lack guidance on when or how the formula itself should be revisited. Without periodic reassessment, formula pricing can embed significant inequities into the agreement while giving shareholders a false sense of certainty of fairness. Formula price agreements also fail to account for any non-operating assets that may have accumulated on the balance sheet. Valuation Process AgreementsValuation process agreements defer the determination of price until a triggering event occurs and rely on professional appraisers to establish value at that time. These agreements generally fall into two categories: multiple appraiser processes and single appraiser processes.Multiple Appraiser ProcessUnder a multiple appraiser process, each side appoints its own appraiser to value the business following a triggering event. If the resulting valuations differ beyond a specified threshold, the agreement typically calls for the appointment of a third appraiser to resolve the difference or render a binding conclusion.While this approach is intended to ensure fairness through balanced input, it often introduces uncertainty, delay, and cost. The final price, timing, and expense of the process are unknown at the outset. In addition, even well-intentioned appraisers may be perceived as advocates for the parties who selected them, complicating negotiations and eroding confidence in the outcome. For family-owned businesses in particular, the multiple appraiser process can unintentionally escalate conflict at a sensitive moment.Single Appraiser ProcessUnder a single appraiser process, one valuation firm is designated, either in advance or at the time of a triggering event, to perform a valuation. This approach is generally more efficient and cost-effective and avoids dueling opinions. When valuations are performed periodically, it can also make outcomes more predictable well before a triggering event occurs. Its effectiveness, however, depends entirely on careful advance planning and drafting.A More Effective Framework: “Single Appraiser: Select Now, Value Now and Annually (or Periodically) Thereafter”Given the shortcomings of traditional valuation mechanisms, is it possible to design a buy-sell valuation process that reliably produces reasonable outcomes? We believe it is.Based on extensive buy-sell agreement related valuation experience, we recommend a framework built on three principles: selecting the appraiser in advance, exercising the valuation process before a triggering event, and careful drafting of the valuation language in the agreement. 1. Retain an Appraiser NowEstate planners and other attorneys who draft buy-sell agreements should encourage clients to retain a qualified business appraiser at the outset, rather than waiting for a triggering event. Conducting an initial valuation transforms abstract agreement language into a concrete report that shareholders can review, understand, and question. This process reveals ambiguities in the agreement, clarifies expectations, and allows revisions to be made when no party knows whether they will ultimately be a buyer or a seller.This “Single Appraiser: Select Now, Value Now and Annually (or Periodically) Thereafter” approach offers several advantages:The valuation process is known and observed in advanceThe appraiser’s independence is established before any economic conflict arisesValuation methodologies and assumptions are understood by all partiesThe initial valuation becomes the operative price until updated or conditions changeAmbiguities in valuation language are identified and corrected earlyFuture valuations are more efficient, consistent, and less contentious2. Update the Valuation Annually or PeriodicallyStatic valuation mechanisms do not work in a dynamic business environment. Annual or periodic valuation updates help align expectations and reduce the likelihood of surprise or dissatisfaction when a triggering event occurs. In practice, disputes are more often driven by unmet expectations than by the absolute level of value. Regular valuations promote transparency and reduce friction.3. Draft Precise Valuation LanguageEven the best valuation process can fail if the agreement lacks clarity. Attorneys drafting buy-sell agreements should ensure that the agreements address, at a minimum:Standard of value (e.g., fair market value vs. fair value)Level of value (enterprise vs. interest level; treatment of discounts)Valuation date (“as of” date)Funding mechanismAppraiser qualifications (making certain to use business appraiser qualifications. For example, a “certified appraiser” refers to a real estate appraiser, rather than a business valuation expert.) Applicable appraisal standardsAmbiguity on any of these points materially increases the risk of divergent interpretations and unsuccessful outcomes.ConclusionBuy-sell agreements fail not because valuation is inherently subjective, but because valuation provisions are often left ambiguous, untested, or static. Estate planners and other attorneys who draft buy-sell agreements play a critical role in preventing these failures. By selecting appraisers in advance, exercising valuation processes periodically, and carefully drafting valuation language, advisors can dramatically improve the likelihood that a buy-sell agreement will function as intended.When valuation mechanisms are designed with the same rigor as tax and estate plans, buy-sell agreements can become durable planning tools capable of delivering predictability, fairness, and continuity when they are needed most. And the buy-sell agreement pricing may even be able to be used to fix the value for gift and estate tax filings. We will discuss this in Part II.For advisors who want to delve deeper into valuation concepts, planning strategies, and practical applications in estate and business succession planning, we recommend Buy-Sell Agreements: Valuation Handbook for Attorneys by Z. Christopher Mercer, FASA, CFA, ABAR (American Bar Association), written by our firm’s founder and Chairman. This book offers a thorough treatment of valuation issues and provides example language for consideration by attorneys when drafting buy-sell agreements that contain language important to the valuation process.

A Guide for Estate PlannersExecutive SummaryBusiness valuations that are well-documented with support for the methodology used and how the concluded value was arrived at are at the core of effective estate tax planning. The recent decision in Estate of Rowland v. Commissioner (T.C. Memo. 2025-76) reinforces that truth by showing how incomplete valuation documentation within Form 706 can jeopardize an otherwise straightforward portability election.While Rowland involved a filing delay, the Court’s opinion makes clear that a deficient or poorly documented valuation can be just as damaging as a missed deadline. For estates holding closely held business interests, which are often significant and complex assets, the importance of thoroughly documenting the process of reaching fair market value cannot be overstated.Background: The Portability Election and Form 706Under Internal Revenue Code § 2010(c)(5)(A), a surviving spouse may use any portion of the deceased spouse’s unused estate tax exclusion (the deceased spousal unused exclusion, or “DSUE”) if the first spouse’s executor properly elects portability.That election must be made through a timely filed and complete Form 706. Even when an estate owes no estate tax, the return must contain detailed and supportable valuations of every asset, including business interests. Omitting or estimating values exposes the election to IRS challenge and potential invalidation.Facts of the CaseFay Rowland died in 2016, leaving an estate approximately $3.7 million below the filing threshold. Her executor obtained a six-month extension but filed Form 706 nearly six months after the extended deadline.The return also lacked key valuation detail: 1) schedules reflected only estimated totals, not fair market values for individual assets; and 2) the executor claimed the “relaxed reporting” exception for assets passing to a surviving spouse, yet a portion of the estate passed to grandchildren’s trusts, making the exception inapplicable.When the surviving spouse’s estate (Billy Rowland) later claimed Fay’s DSUE, the IRS denied the election, arguing the filing was neither timely nor properly prepared. The Tax Court agreed, which lead to Billy’s Estate paying approximately $1.5 million in additional taxes.The Court’s ReasoningTimeliness Was Not EnoughThe Court held the return untimely, but even if it had met the filing window, it failed the requirement of being “complete and properly prepared.” Completeness, the Court emphasized, includes providing valuation information sufficient for the IRS to verify reported amounts and compute the DSUE accurately.Valuation Documentation Is Integral to CompletenessTreas. Reg. § 20.2010-2(a)(7) requires a Form 706 filed solely to elect portability to include the same detail as a taxable return, except for assets passing entirely to a spouse or charity. The Rowland estate’s generalized estimates prevented the IRS from evaluating the DSUE computation.The Court rejected arguments of substantial compliance and equitable relief, holding that valuation documentation is not simply a procedural technicality, but rather a statutory prerequisite.Why Business Valuations MatterFor many families, closely held business interests comprise a large share of estate value. These assets require specialized valuation under Revenue Ruling 59-60. A well-supported valuation not only establishes compliance but also enhances the credibility of the entire filing.A defensible business valuation requires:Identifying the rights and benefits of the interest being valued (control, transfer restrictions, etc.).Using relevant market evidence, including public comparables and transaction data.Applying sound financial analysis that addresses expected cash flows, risk, and growth prospects.Reporting clearly and effectively to the IRS and other readers.Documentation: The Bridge Between Valuation and ComplianceThe Rowland decision underscores that a valuation unsupported by documentation is no valuation at all. A properly prepared Form 706 should therefore include:Narrative descriptions of each business interest, outlining ownership, structure, and rights.Detailed valuation schedules explaining how conclusions were reached.Supporting exhibits, such as financial statements and methodology summaries.Explicit reference to appraisal standards that demonstrate compliance with USPAP and Treasury requirements.Without these elements, a return fails the “complete and properly prepared” standard which is exactly what happened in Rowland.Practical Guidance for Estate PlannersEngage Qualified Appraisers Early. Business interests should be appraised by professionals experienced in federal transfer tax matters and IRS examinations.Coordinate Across Disciplines. Attorneys, accountants, and appraisers should align on ownership structures and entity specifics to ensure consistent reporting.Avoid Estimates or Prior-Year Values. Fair market value is determined as of the date of death; using approximations risks inconsistency with IRS standards.Explain Discounts and Assumptions. Clearly document the rationale for any discount for lack of control or marketability.Maintain Comprehensive Records. Preserve valuation reports, source data, and correspondence to support the filing if later reviewed or aud.ConclusionThe Estate of Rowland v. Commissioner decision delivers a clear message: Form 706 filings must contain credible, well-documented fair market value determinations for all assets, particularly business interests, or risk invalidation. Portability hinges not only on timeliness but on the completeness and substantiation of reported values. The strength of the filing lies in the quality of its appraisals and the documentation supporting them.At Mercer Capital, we integrate these principles into every estate and gift tax engagement, ensuring our valuation opinions are technically sound, clearly presented, and defensible which positions clients for successful outcomes under IRS scrutiny.Valuations are a critical element of successful tax planning strategies and objective third-party valuation opinions are vital. Since 1982, Mercer Capital has provided objective valuations for estate, gift, and income tax matters across virtually every industry sector. To discuss your valuation needs in confidence, please contact one of our professionals .

Executive SummaryEstate planning for business owners is rarely straightforward, and it becomes significantly more complex when a potential sale of the business in question enters the picture. Timing matters and so does understanding how valuation interacts with both estate planning goals and the expectations of the IRS.In Mercer Capital’s new 75-minute webinar, Valuing a Business Amid a Potential Sale: What Estate Planners Must Know, Nicholas J. Heinz, ASA and Thomas C. Insalaco, CFA, ASA, explain how to navigate valuation in such an uncertain environment.When Estate Planning and M&A OverlapA liquidity event can be transformative for a family, but it raises complex valuation questions. How do you determine fair market value for gift or estate tax purposes when an M&A process is underway but incomplete? This webinar offers insight into what valuation analysts must consider when a company is “in play.” Heinz and Insalaco explain how to evaluate indications of value that emerge from deal discussions, what constitutes relevant market evidence, and how to apply weights to preliminary offers that may or may not close.What the IRS ExpectsThe presenters outline IRS guidance that provides insight into how appraisers should document assumptions and support their conclusions when a sale may occur soon after the transfer date. Estate planners will gain perspective on what information should be shared with valuation professionals and what documentation supports defensibility.Practical Scenarios and TakeawaysUsing examples drawn from real-world engagements, the webinar examines several practical scenarios:A business exploring a sale but not yet under letter of intentA transaction announced but not yet closedA sale that falls through after gift transfers are madeIn each case, Heinz and Insalaco discuss the influence of timing, negotiation progress, and third-party interest. They also highlight coordination points between the estate planner, client, and valuation expert to avoid costly missteps.Watch the RecordingThis session is designed for estate planning attorneys, tax advisors, and wealth professionals who advise business-owning families. Even if no sale is imminent, understanding how valuation shifts during an M&A process prepares planners to identify risk, manage client expectations, and anticipate IRS scrutiny. The recording is available on Mercer Capital’s YouTube channel: Watch the webinar here.For additional reading, the August 2025 issue of Value Matters® explores these same issues and offers complementary analysis.Together, these resources seek to equip estate planners with practical guidance for advising clients whose estate planning and exit planning timelines may overlap—a scenario that is increasingly common in today’s dynamic M&A environment.