This article is valuation commentary. It is not legal, tax, accounting, or investment advice. Specific engagements depend on facts and applicable professional standards.
The real question is not what the company is worth
If you’re buying out a partner, shareholder, or LLC member, the right question is rarely what the company is worth. It is what value the agreement or governing law requires, for what interest, on what date, and with what assumptions. Those are different questions, and the answers depend on facts most owners haven’t thought about until the buyout is on the table.
The IRS framework says fair market value is a facts-and-circumstances question, not a one-size-fits-all calculation. Practitioner guidance on buy-sell agreements goes further: price can change materially based on standard of value, level of value, valuation date, applicable discounts, who selects the appraiser, and how the buyout will be funded. Owners who treat the buyout as “company value times my percentage” often find themselves in disputes when the actual mechanics produce a different number.
The agreement controls the question
If a buy-sell agreement, shareholder agreement, operating agreement, or partnership agreement specifies a valuation method, that method usually controls. Common configurations include:
- Fixed-formula buyouts. The agreement specifies a formula such as book value, a multiple of EBITDA, or a multiple of revenue. It is easy to apply, and it often produces results disconnected from current fair market value if the formula was set years ago and never updated.
- Single-appraiser process. The remaining owners select an appraiser; the departing owner has limited input. Faster but contested in adversarial situations.
- Three-appraiser process. Each side picks one; those two pick a third. Slow and expensive, but produces a more independent answer.
- Negotiated buyouts with no formula. The parties agree to negotiate in good faith, sometimes with a backstop (mediation, arbitration, or formal valuation if no agreement is reached).
- First refusal / drag-along / tag-along. Triggered by an outside offer; price is the offer price, sometimes adjusted.
If the agreement is silent or ambiguous, governing-law defaults take over. State law in some jurisdictions specifies fair value rather than fair market value for dissenters or oppressed-shareholder claims, which materially affects whether discounts apply.
Standard of value: fair market value vs fair value
Why discounts get contested
For a minority interest in a closely held company, two discounts often apply under fair market value:
- Lack-of-control discount (DLOC). A minority owner cannot direct distributions, hire or fire management, sell the company, or change strategic direction. That lack of control reduces the value of the minority interest relative to a pro-rata share of the whole.
- Lack-of-marketability discount (DLOM). A minority interest in a closely held company cannot be readily sold. The owner bears the full path risk of waiting for liquidity. Empirical studies of restricted-stock transactions and pre-IPO sales support marketability discounts in the 20–35% range, depending on the specifics.
Combined, these discounts often reduce the minority-interest value by 30–45% from a pro-rata share. That is where most buyout disputes happen: the departing owner argues for a small discount or none, and the remaining owners argue for a large one. The right answer comes from analysis of the specific facts: the agreement, the governing documents, the rights of the interest, the size of the holding, and the realistic exit options.
When the company owns real estate
Property-rich operating businesses raise additional buyout questions. If the company owns its real estate, the valuation has to handle:
- Whether market-rent normalization is appropriate. Operating earnings reflect rent saved by self-occupancy. A buyer who would lease the property at market rent sees lower operating earnings.
- Whether the property could be split off. In some buyouts, the departing owner takes the real estate; the remaining owners take the operating business. That requires distinct valuations.
- Related-party rent. If rent is paid between common-controlled entities, the rent itself is contested. Above-market rent transfers value away from the operating business; below-market rent does the opposite.
What to prepare
The better the document package, the smoother the buyout valuation. Most engagements need:
- The buy-sell, shareholder, operating, or partnership agreement with all amendments
- Three to five years of financial statements and tax returns, plus year-to-date current
- Cap table showing all owners, classes of ownership, and any options or warrants
- Owner compensation history: salaries, distributions, perks, related-party payments
- Real estate inventory: what’s owned by the entity, what’s leased, related-party arrangements
- Recent transactions in the company’s ownership: prior buyouts, gifts, sales
- Any prior valuations performed for tax, financial-reporting, or transactional purposes
- Forward projections if available; if not, an explanation of expected business direction
- The trigger event documentation: notice of withdrawal, retirement, death, disability, or other event triggering the buyout
How the process typically runs
- Engagement and standard of value. The valuation firm determines, with counsel, the applicable standard of value, valuation date, and assignment scope.
- Document review. The agreement, financials, and supporting documents go through detailed review before substantive work begins.
- Site visit and management interviews. For most engagements, the analyst meets with management to understand operations, key risks, and forward outlook.
- Methodology selection. Income approach, market approach, asset approach. Most going-concern valuations use a weighted blend.
- Discount analysis. If applicable, DLOC and DLOM are supported with empirical evidence specific to the facts.
- Draft report and review. The client’s counsel reviews for accuracy of factual representations; the analyst doesn’t adjust the conclusion based on counsel feedback.
- Final report. Documented, signed, and delivered to the engaging party.