How is a business valued when an owner dies?

By whatever method the agreement specifies. Where it specifies none, by negotiation between a grieving family and the surviving owners.

By whatever method the agreement specifies. Where it specifies none — and a great many say only that the parties will agree a value at the time — the answer is by negotiation, conducted between a grieving family and the surviving owners, each of whom now has an obvious and opposite interest in the number.

A number will be chosen either way. It may as well be one everybody agreed to in advance, before anyone knew which side of the table they would be sitting on.

The methods, and what each is good for

• A fixed price, reviewed annually. Simple and clear. Fails quietly the moment the review stops happening, which is usually after the second year.
• A formula. A multiple of earnings, or of revenue, or book value with adjustments. Predictable and cheap to apply. Can drift a long way from economic reality if the business changes shape.
• An appraisal at the time. Most likely to produce a defensible number. Slowest and most expensive, and only as good as the appointment mechanism.

Many agreements combine them: a stated price the owners may update, defaulting to an appraisal if it has gone stale.

Specify how the appraiser is appointed

This is the provision that decides whether an appraisal clause works. Who selects? What qualifications are required? What happens if the two sides each appoint one and the results are far apart — a third appraiser, an average, or the closest of the two to a midpoint? Left open, the valuation clause becomes a second dispute rather than the resolution of the first.

Discounts, and being able to support them

Minority and marketability discounts are ordinary features of valuing a closely held interest. They are also closely examined where the same interest is being reported for estate tax purposes, and a discount claimed without support behind it is a weak position.

Consistency matters here. A price fixed by an agreement is not automatically the value for tax purposes; it holds up where the agreement was a genuine business arrangement, binding during life as well as at death, and comparable to what unrelated parties would have agreed.

Why we call this the cheapest thing to fix

Amending a valuation clause is an afternoon. Not having one costs a family the difference between two numbers, and frequently costs them the relationship with the people their parent spent thirty years in business with.