Partnership buyouts happen for many reasons. Sometimes a partner has a new opportunity that is too good to pass up. Maybe a partner is no longer in line with the vision of the company or there has been a personality conflict. Most often is when a business partner is looking to retire. No matter the reason, it is important to cover your bases and ensure the buyout is favorable for all the business partners as well as the company. Defining the terms of a partnership buyout helps individuals make more informed decisions and aides in a successful transition. Below are 4 steps you should take when initiating a partnership buyout.
1. Have a Buy/Sell Agreement
Ideally, you and your business partner should begin your business venture by drafting a buy/sell agreement. This document outlines how you run the business, make decisions, divide responsibilities, and plan to exit the company. A clear exit strategy from the beginning helps negotiate how to part ways in the event a partner wishes to leave.
Buying out a partner without an initial partnership agreement isn’t impossible, but having one makes things easier. The best scenario is when you have both thought of this situation ahead of time and are prepared to work through it. If you don’t currently have a buy/sell agreement in place, it is never too late to start one.
2. Obtain a Business Valuation
Agreeing upon a valuation of the company can help you make a more informed decision on how to structure the deal and finance the buyout. A buy/sell agreement should detail specific terms and conditions for buyouts. Often it contains a clause about a formula to use or valuation to be obtained. This can help mitigate risks or arguments over the terms of the buyout. Disputes about the details of the buyout can create a sour mess very quickly.
There are several outside factors that influence valuation. Both company metrics and partner metrics can influence the dollar amount. If the partner leaving is highly valuable to the company, they can demand a higher payout. However, without the value this partner adds, the business’s future cash flows will likely decrease, ultimately lowering the value of the business. Besides assets, income, and liabilities, things like “goodwill” and future growth potential also add value to the company.
A common approach is to use an independent third party to provide a valuation for the company. This will help determine a fair price for the partnership buyout and ensure the buyout is a good long term investment for both parties.
3. Formalize the Deal
Legal requirements can be very complex and vary from state to state. For instance, some states allow a 50% owner to dissolve a partnership, while others do not. In partnership buyouts, it is common to hire a lawyer who has experience in mergers and acquisitions.
There are many important documents and tasks at this stage so it is important to have this taken care of professionally by someone with expertise. Filing all necessary paperwork and transferring all business accounts to the remaining partner(s) is essential. This clears the leaving partner’s legal ownership. If not done correctly, a previous partner may still be liable.
A good lawyer will help partners not only meet legal requirements but also structure the deal in a mutually beneficial way to help prevent disputes from arising. Common agreements include finance, non-compete, and partnership release agreements. The cost of hiring a legal professional is worth more than the headaches or conflicts that may occur down the line if buyout terms were mishandled or unclear.
4. Finance the Partnership Buyout
There are many ways to structure the financing of your partnership buyout. A few options include lump-sum payments, seller financing, lender financing, buyouts over time, and earn-outs. Debt financing is more common than equity financing. With debt financing, you are removing an owner and increasing your ownership with borrowed money. With equity, you exchange one owner for another. Equity financing is useful in scenarios where the selling partner has the expertise, skills or connections the business cannot thrive without.
Each of these steps can help align the buyer and seller’s interests. Together they can support a maximum transaction price for the outgoing partner while reducing risk and creating a fair deal for the remaining partners. As a small business owner, you may need to negotiate an agreement that is unique to your situation depending on the financing capabilities and business valuation. It is important to explore all your options.