In an earlier post, we discussed the third appraiser selection in multiple valuation process buy-sell agreements. In the last post, we concluded that the role of the third appraiser in multi-appraiser (usually three) valuation processes for buy-sell agreements is to bring the process to a conclusion. We talked about the four ways that this role is typically accomplished, with the third appraiser acting as Reconciler, Judge, Determiner, or Sole Determiner.
In this post, we explore the role of the third appraiser in more detail.
For a variety of reasons, including that I have been writing and speaking about buy-sell agreements from business and valuation perspectives for many years now and that I am reasonably well-known among appraisers nationally, I have been selected as the third appraiser in a number of valuation processes.
My experiences in these roles informs this discussion. I and others at Mercer Capital have learned many lessons from my third appraiser experiences, as well as from the experiences of our other professionals. When the call(s) come, the valuation processes are underway and often are in or headed for almost certain trouble for one of a number of reasons, including:
- There have already been two appraisals by the first two appraisers, and the two conclusions are more than 10%, likely widely more than 10% apart.
- There has been a failure to negotiate a price by the first two appraisers, and now the agreement calls for them to select a third appraiser to provide the binding appraisal.
- The buy-sell agreement provided no instructions regarding the qualifications of appraisers to be selected by the parties. The first two appraisers differ in terms of background, appraisal qualifications and independent valuation experience. Nevertheless, the first two appraisers must agree on the selection of a third appraiser.
- The buy-sell agreement is not clear on what party(ies) are responsible for paying the third appraiser’s fees.
- The buy-sell agreement does not specify the process to be followed by the third appraiser.
- One of the first two appraisers calls and is trying to create a short list of appraisers from which he or she and the second appraiser can agree.
- The first two appraisers are working to select a third qualified appraiser and one or both clients get involved in the process, creating additional difficulties.
- There is already fighting, or worse, litigation between the parties.
- There is a real sense of urgency to get the third appraiser selected and the valuation process underway.
- And so on…
The Call Comes to the Third Appraiser
With some or all of the above background, let’s say a call come to me. Based on our many experiences in the third appraiser role, I will interview the appraiser(s) who are on the phone. They think they are interviewing me, but in reality, I am interviewing them. For me, or for any third appraiser to be successful, several factors must come into alignment.
- The existing process must slow down enough to get the third appraiser process off to a successful start.
- Whether specified in the buy-sell agreement or not, it is essential that the kind of value, i.e., the level of value, must be specified. Will the third appraiser value an interest in the company or will the conclusion be of the value of the enterprise, with the interest being valued pro rata to its ownership?
- Will the third appraiser be provided with the appraisals of the first two appraisers?
- What timetable will the third appraiser work under?
- What process will be followed? For example, who will be present at the third appraiser’s management interviews? Will a draft appraisal be provided to the parties for review and comments prior to finalization? How will input be shared? Will all communications be joint with both of the first two appraisers being involved?
- Who will sign the engagement letter for the third appraiser and who will be responsible for fees? On what basis will the third appraiser work? Will there be an estimated fee or will the engagement be hourly? I know from experience that the third appraiser role is time-consuming and challenging. If we are retained, we want to be paid in full with no risk to the receipt of our fees and expenses. Any qualified third appraiser should insist on this assurance contractually.
When the call comes to me, I will insist on working out details like the above as a condition for involvement. What I know is this: the first two appraisers have to select a third appraiser to keep the process going. But I don’t have to accept the engagement, even if they agree on me.
The role of the third appraiser is an important role in any three appraiser valuation process. The above issues are seldom specified in buy-sell agreements, but they must be clarified.
What Kind of Value?
“What kind of value?” is an important question. I always ask to be able to read the buy-sell agreement so that I can discuss what value is to be determined. Sometimes the level of value is not specified in agreements. At other times, there can be language that is subject to different interpretations, but the kind of value is not my decision. There has to be agreement between the parties (and the appraisers) regarding the kind of value. The decision is important, as can be seen in the diagram below.
If we are retained, I insist that the parties agree, in advance and in our engagement letter, about the specific level of value that will be determined in our appraisal. There can be no surprises with unexpected or unexplained control premiums or marketability discounts if the process is to work.
The parties must agree on the standard of value, e.g., fair market value, and the level of value, e.g., financial control, as part of the engagement process.
What Process Will the Third Appraiser Follow?
Most buy-sell agreements provide little description of the process to be conducted by the third appraiser. If a third appraiser’s role is to be successful, a workable process must be specified and agreed to by the parties. I touched on this issue above, but the devil is in the details.
- If the first two appraisers have rendered opinions, I ask to see them. I can tell from the appraisals if there are different interpretations regarding the standard or the level of value. So it becomes critical that these be specified clearly for the third appraiser.
- How long will the third appraiser have to conduct the appraisal? Many agreements specify 30 days, but this is not realistic in contentious situations where the parties, hopefully through their appraisers, insert themselves into the process.
- How will communications occur between the parties. Unless the communication process is transparent, there will likely be distrust and dissatisfaction with the process.
- What information will be supplied to the third appraiser? It should include the entirety of information supplied to the first two appraisers plus any additional information requested by the third appraiser.
- How will information be provided to the third appraiser? Will it be through the company or through the appraisers?
- Who will be present at the third appraiser’s management interview? I recall one process a number of years ago where I took a senior appraiser with me. The management interview was conducted in the presence of the following: company management and the company’s appraiser, selling shareholder and the shareholder’s appraiser, counsel for both the company and the selling shareholder, and more. There were fifteen people present when I conducted my management interview. All of this was fine because it was agreed to in advance. What I know is that it is essential for the third appraiser to talk with anyone who believes they have meaningful contributions to the valuation process. Th appraiser can determine what was actually meaningful or credible, but if any parties are ignored, the potential for future problems increases.
- Will there be a draft report to be shared with the parties? I always suggest that the parties agree to this step. I also ask that our fees be brought current before issuing the draft report so that the retainer will be available to work out the finalization of the report.
- How will the third appraiser consider comments from either management or the selling shareholder(s), their appraisers, and/or their counsel? Will all communications from all parties be shared with the other parties.
- How long will be allowed for comments to be supplied?
- How long after receipt of comments does the appraiser have to render the final appraisal? When the final report is issued, I normally suggest simultaneous release by email to the pre-determined distribution list.
After all this, perhaps, the third appraiser’s role has been accomplished. The parties can do any averaging called for, or recognize that the third appraiser’s conclusion is binding if that is what the agreement calls for.
Having served as the third appraiser in numerous processes, I’ve learned the above from experience. What I know is that the third appraiser is being called in to resolve a pricing issue. In most cases, the first two appraisal conclusions are widely apart, often because of the use of different levels of value. The interests of the parties have diverged since the trigger event. So often, there is little love for the third appraiser from anyone involved in the process.
The general steps outlined above will not solve every problem with appraisals by third appraisers in multiple appraiser buy-sell agreement valuation processes. However, they will go a long way towards “fixing” processes that are otherwise broken, or badly bent.
For more about the role of third appraisers and buy-sell agreements in general, obtain one or both of the following:
Buy-Sell Agreements for Closely Held and Family Business Owners (a print book, special price of $25 – add it to your library and give it to your friends or clients)
Buy-Sell Agreements for Baby Boomer Business Owners (an Amazon Kindle book with an amazing price of only $2.99 – download it now and gift it to anyone who can benefit!)
As always, please do call to discuss any valuation-related matter in confidence. In particular, if you are involved in ownership and/or management transitions, read prior issues of this blog and give me a call (901-685-2120).
Until next time,