Fair value is not a mechanism

Most family shareholder agreements written more than a decade ago contain a sentence entitling a departing shareholder to fair value. Very few of them say how fair value is arrived at, who appoints the valuer, what standard the valuer applies, or over what period the money is paid.

That gap does nothing at all until the first time somebody wants out, at which point it does everything. Each side commissions a valuation. Each valuation uses a method that supports the side that commissioned it. The difference between the two can exceed a good year's operating profit, and both numbers are defensible.

What closes the gap is a method fixed in advance: a named basis of valuation, a mechanism for appointing the valuer that neither side controls, what happens if the two valuations diverge beyond a stated margin, and payment terms including how long the business has to find the money.

The mechanism also needs a cap on how much may leave in any one window, because an exit mechanism the business cannot fund is not a mechanism. Agreed while nobody wants out, all of this is a technical discussion. Agreed afterwards, none of it is.