Having a business partnership is often foundational to the long-term success, stability and overall wellness of most businesses. Running a business alongside a business partner helps to ensure accountability, shared responsibility and a sense of purpose for the partners, their employees and company’s customers.
During the course of company ownership, business owners may reach a point where a partnership buyout is an important step for the health of their business. As this process unfolds, you will need to determine the value of your business to ensure a fair and equitable distribution to the business partner who is leaving the business. Before proceeding into business with a future 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 buying out a business owner protects all parties and brings clarity to any 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 – attorney, accountant, banker and other business owner confidants.
- Understand how the partner buyout impacts the relationship with the owners, their spouses and any other heirs particularly in the case of a partner’s death or a partner’s divorce. In such situations, the outsides parties who are not intimately familiar with the innerworkings of the business may have a wildly inflated view into what they are entitled. The partner buyout agreement provides the necessary paperwork to define equity value and what is fair in buyout negotiations.
- Establishing the fair market value of the business is a key starting point. A partner buyout cannot be accurately or fairly executed without an instrument that objectively assesses the tangible and intangible assets of the company. An independent business valuation and the subsequent distribution of equity to the selling partner can be a contentious topic that is hotly debated. Hiring a qualified business appraiser that the business owners jointly agree to using will greatly reduce differing opinions on value and keep things objective in the buyout negotiations. However, if the business is complex or if intangible value is a large factor in the business or if partners are at odds, the owners 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 partnership buyout terms.
- Determine how the business partner existing the business will be financially compensated. 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 cash flows in a detrimental way. The remaining partner(s) may seek partner buyout financing options as a path forward if a lump sum or installment payments are not viable.
- Work with an acquisition attorney or small business arbitrator 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 legally binding 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 business partners are unable to agree to buyout terms 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 order to maximize the liquidation value of the business and its assets. 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.
Common Questions Business Owners Have Regarding a Partner Buyout
How do I buy out my business partner?
The most appropriate step is adhering to the terms of the partnership agreement you and your partner(s) signed when starting the business. In this situation, it’s a matter of distributing the capital to the mutual benefit of the owners which can be facilitated through owner an owner finance such as a lump sum payment or ongoing financial distributions. Other financial buyout options include equity financing from an outside investor, a bank loan, SBA financing or a collateralized bridge loan. An independent valuation and the advice of your attorney are key before any financial arrangements are agreed upon, even if all owners are amicably parting ways. If, however, no partnership agreement exists, it is strongly advised to bring an attorney, appraiser, banker and tax advisor into the discussions to prevent tensions and ensure a fair outcome to all owners involved that do not do irreparable damage to the company’s health.
How do you value a company for a partner buyout?
An expert, independent business appraiser is the best solution as they will use a combination of Asset based, Income based and Market based approaches with the goal of determining fair market value. Once a company’s value has been determined, you would simply calculate each owner’s percentage of ownership relative to the value of the business. Bringing in a business valuator helps to minimize the threat of partner disputes and financial pressure on a company’s health if a partner is seeking a buyout.
Can I force a 50/50 partner out of my company?
For starters, this is the last resort. When a business partnership ends – for personal, financial, retirement or deep-rooted differences – it is critical that the business be protected and the relationship between the owners be respected. If one partner wants the other out, the easiest path is making an offer to buy them out at fair market value. This likely requires a business valuation to support the deal terms. If the relationship is completely strained, the next path is to present clear evidence that the partner you want forced out is in strict violation of your partnership agreement. If no agreements have been broken and if the partners cannot reach a fair settlement, the next best path is appointing a neutral third party to arbitrate the matters, legally. If arbitration is off the table, then you will need to hire business law attorneys to help settle the matter.
If you need more insights to help navigate buying out a business partner, below are some additional resources: