Having a business partner or group of partners in a business is often foundational to the success, stability and overall wellness of the business. Co-ownership ensures accountability, shared responsibility and a sense of purpose for the partners, employees and customers.
At some point in the life of the company, business partners may ultimately reach an impasse in their going concern where a partnership buyout is on the table as a viable step forward. As this process unfolds, knowing the fair market value of the business is critical to ensuring a fair and equitable distribution to the partner who is exiting the business.
Before proceeding into business with a partner or prior to any type of partner buyout discussions, it is important the owners take a holistic and objective view at the path they are heading down. We advise partnerships to consider some of these factors:
- Review your partnership agreement and the terms agreed to in the buy-sell or partnership buyout clause. Much like a prenuptial agreement in marriage, the terms of your buyout clause(s) protect all parties and bring clarity to any subjective disagreements or differing viewpoints that could arise during this potentially stressful time.
- Bring together your group of trusted advisors to help facilitate and guide the partners to a mutually-beneficial outcome – your lawyer, accountant, banker and other trusted confidants.
- Understand how the buyout impacts the partner, their spouse and any other heirs particularly in the case of a partner’s death or a partner’s dissolution of marriage . In such situations, the outsides parties who are not intimately familiar with the innerworkings of the business may have a wildly skewed viewpoint on what they are or are not entitled to when such a life event triggers the buy-sell clauses you previously established.
- Establish the fair market value of the business. A partner buyout cannot be accurately or fairly executed without an instrument that objectively assesses the tangible and intangible assets of the company. Valuation and the subsequent distribution of equity and money can be a contentious topic that is hotly debated. Hiring an independent, qualified business valuator that the business owners jointly agree to using will greatly reduce differing opinions on value. However, if the business is complex, intangible value a large factor in the business or partners are at odds, these partners may wish to hire their own business appraisal experts to conduct separate, independent reviews. In such scenarios, the owners can then consider both conclusions of value and find a common ground for the buyout terms.
- Speaking of buyout terms, how will the owner exiting the business be paid? One lump sum or over a period of time? Ideally these payout terms were set in your buy-sell agreement but, if not, this needs to be established so that the exiting partner is fairly compensated while not punishing the other partner(s) or business financials in a detrimental way. The remaining partner(s) may seek partner buyout financing as a path forward if a lump sum or installment payments are not viable.
- Work with your attorney to draw up and execute the partner buyout agreement so that it is official and doesn’t languish over time, creating unnecessary stress to the partners and business at large. This can be compared to a marital separation that never has contractual resolution or clear deal terms – ultimately both partners carry considerable uncertainty, doubts and angst.
- Speak in further detail with your tax advisor about the implications to the exiting partner and the partnership remaining in the business. Section 736 of the Internal Revenue Code clearly lays out what can and cannot be tax deductible to the partnership and how the exiting partner must treat guaranteed payments as ordinary income.
If the partnership is unable to agree to terms or the vision for a partner buyout and/or if the business simply is not healthy, dissolving the business may be the only path forward. In such scenarios, the approach and viewpoints of all concerned will be different in an effort to maximize the liquidation value of the business and its assets. In this scenario, hiring an expert business appraiser becomes of grave importance to understand book and distressed values of assets in a liquidation or auction event relative to outstanding debts and liabilities on the company’s books. If you all agree that it’s time to end the business, bringing in professionals to help wind the business down is a worthwhile investment so that all parties walk away with the least of amount of damage and most amount of value possible.
If you need more insights to help navigate a partner buyout, below are some trusted resources: