What a valuation clause typically prescribes
Most buy-sell and shareholder agreements contain a clause that operates when an owner dies, becomes disabled, retires, resigns or defaults. The clause sets out how the departing owner's shares will be priced and who will buy them. Its content varies widely, but the same elements recur.
The elements a valuation clause usually covers
| Element | What the clause may say | Why it matters |
|---|---|---|
| Basis of value | Market value, fair value, a defined term, or nothing | Determines the question the valuer answers |
| Valuation date | The trigger event, the last balance date, or the notice date | Fixes which evidence counts |
| Method or formula | A multiple of profit, net assets, or the valuer's judgement | May override normal practice |
| Discounts | Excluded, required, or left to the valuer | Changes the value of a minority parcel |
| Appointment of valuer | Agreed by the parties, or nominated by a third party | Governs independence and standing |
| Dispute mechanism | Expert determination, a second valuer, or averaging | Sets what happens if a party objects |
A clause that addresses each of these leaves little room for argument. One that addresses only some of them leaves gaps that the parties, their lawyers and the valuer must fill together before a figure can be produced.
Why formula clauses drift from reality
Formulas are attractive when an agreement is signed because they promise certainty. A fixed multiple of the last three years' average profit, or net tangible assets plus an agreed goodwill amount, is easy to write down and easy to calculate. The difficulty is that the business and its market keep moving while the formula stays still.
A multiple that suited a small, owner-run business may be well below or well above what the market would now pay for a larger, professionally managed one. Net assets ignore the value of goodwill entirely. Averaging profit over years that included a major disruption, or a period of unusually high margins, produces a figure that describes the past rather than the business as it stands at the date.
Formulas often leave the inputs undefined. Whether profit means accounting profit, tax profit or a normalised figure after adjusting owner remuneration is often the real dispute. Where a formula produces a result that neither party believes, the agreement's dispute mechanism, or a fresh agreement between the shareholders, is the path forward, and that is a matter for your lawyer.
Read the clause before the valuation, not after
The valuer needs the clause at the outset. A report prepared on a market value basis is of limited use if the agreement requires fair value without discounts, and a report that applies discounts is of no use if the clause excludes them. The date, the treatment of shareholder loans and the definition of profit all need to be settled before analysis begins.
Where the clause is clear, the valuer applies it. Where it is unclear, or where the parties disagree about its meaning, the valuation should not resolve the ambiguity by choosing an interpretation. Ask your lawyer for advice on the reading to be applied, and record that instruction in the engagement so the report can state it plainly. Our guide on minority shareholdings explains why the treatment of discounts is often the decisive question.
Joint instruction or one-sided instruction
A joint instruction means both the departing and remaining shareholders engage the valuer together, share the cost, provide information through one channel and receive the same report. It suits parties who are still on speaking terms and who want a figure they can both rely on. The engagement letter should record that the valuer acts for both and takes instructions from neither alone.
A one-sided instruction is sometimes unavoidable. Where the relationship has broken down, or where one party will not participate, a single shareholder may commission a report to inform their own position. That report should say whose instructions it follows, what information the other side did not provide, and what assumptions were made as a result. It remains a proper valuation, but a reader will weigh it knowing its origins.
What to send the valuer
Send the full agreement, including the constitution and every amendment, deed of accession and side letter, rather than an extract of the valuation clause. Add the member register showing all classes on issue, at least three years of financial statements, current management accounts, a schedule of shareholder loans and dividends, and any correspondence that fixes the trigger event and its date.
If a formula applies, send the working the parties have done so far, even if it is disputed. If the shares have changed hands or been offered in recent years, provide the terms. The guide on valuing shares in a private company lists what each document contributes.
Insurance-funded buyouts in general terms
Many agreements are paired with life or disability insurance so that the remaining owners have funds to buy the departing owner's shares. In general terms, the policy provides the money and the agreement provides the price. The two are separate, and the sum insured is often set years earlier from a rough estimate of what the business was then worth.
A valuation prepared when the agreement is signed, and reviewed periodically, helps the owners and their advisers keep the cover in step with the business. Whether the structure, ownership of the policies and tax treatment are appropriate is a question for your adviser and lawyer, not for the valuer.
Getting a buy-sell valuation under way
Start by reading the clause with your lawyer and confirming the basis of value, the date and whether discounts apply. Decide whether the instruction will be joint or one-sided and tell the valuer which it is. Then assemble the documents above and ask for a scoped fee before work begins.
Valuation Group prepares shareholder exit valuations for owners and their advisers across Australia from Double Bay, Sydney. Standard signed reports start from $1,495 + GST for suitable, straightforward matters, and a draft is typically ready 5 to 7 business days after all requested information is received. The first conversation is free, so contact Jackson Wilson to discuss the clause you are working with.
Apply it to your matter
A clear scope is the next step.
Discuss the business, purpose, valuation date and intended user with Jackson Wilson. Valuation Group is based in Double Bay and takes enquiries from Sydney and Australia-wide.
General educational information. Examples are hypothetical and do not value a real business. The appropriate treatment depends on the purpose, evidence and agreed scope.