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What to know before buying out a business partner


What to know before buying out a business partner

Updated: March 27th, 2020

What to know before buying out a business partner

Most business partnerships end for one of two reasons: Either one partner wants to retire, move, or accept a new job, and therefore won’t be able to contribute to the business the same way, or one or both partners decide they can no longer work together.

Whatever the reason, if you and your business partner choose to terminate your working relationship, and you still want to retain control of the business, you’ll need to consider a partner buyout.

Here are seven things to keep in mind as you go forward.

1. The better terms you leave on, the easier the process.

The key to a successful partner buyout is to “remain on friendly, congenial ground,” said Jim Angleton, president of AEGIS FinServ Corp, a financial consulting company. As an expert in partner buyouts and someone who’s bought out a business partner, he said it’s important not to let drama or emotion enter the picture.

It’s normal to feel resentful or angry when splitting up, but airing these feelings isn’t productive. Approach your partner calmly and rationally, and focus on finding a win-win solution, Angleton suggested. “What is good for you should be mutually good for your partner,” he said.

2. Talking with your partner first can help minimize confusion and competition.

The more details you can square away with your partner one-on-one, the better off you’ll be when you invite outside parties into the conversation.

Try to find common ground first, said Angleton. He suggested creating a joint Memo of Understanding to give to your representatives, wherein you both agree on a solution and write what you want going forward. “This will lower your professional invoices,” Angleton said, “and make your partner buyout work smoother.”

Sometimes, though, there may be too much tension or animosity between you and your partner to have a productive conversation on your own. If that’s the case, consider bringing in a mediator to help guide the discussion.

3. Seeking professional help is a crucial part of the buyout process.

Orchestrating a successful partner buyout requires the help of several different people. Contact your accountant, banker, and attorney before you make any major decisions, said Ken Stalcup, a CPA and senior director at Houlihan Valuation Advisors, a company that provides business valuation services.

Your accountant can help you prepare tax returns and other financial statements necessary to determine the value of the seller’s equity interest, Stalcup said. “The accountant can also discuss some of the tax considerations in buying and selling,” he explained, “and help structure the transaction to minimize the tax bite.”

Your banker can help you discuss options to finance the buyout and manage your funds throughout the process. “The bank may also be involved in the funding of the purchase of the exiting party’s stock or equity interest,” said Stalcup.

Your attorney, on the other hand, will inform you of your state’s laws regarding partner buyouts, and advise you in creating the terms of a buy and sell agreement. This might include details around the price, the pay-out method, and potential non-compete clauses.

4. An independent valuation helps you create a fairer agreement.

Consider hiring an independent financial expert to assess whether the business is in a good position for a buyout. When business owners contact Stalcup for help, he develops a financial profile of the business to calculate “the fair market value of the exiting owner’s interest.”

He does this by examining the balance sheet, expected profits, and future cash flow of the business. “Three things that drive value are growth, cash flows, and risks,” he explained.

Information from a third party can help you and your business partner view the buyout more objectively. From there, you can come up with buyout terms that feel fair and mutually beneficial.

5. Try to solve problems before they happen.

Any time you make a big move in business, there will be risks — and you need to be prepared to handle them. Take some time to identify the greatest risk to your business if your partner sells.

“Suppose the exiting owner is the key saleswoman for the business,” Stalcup said. “She has all the contacts and all the relationships. If she leaves, can the business continue to operate? Will all your customers follow her to her next job?”

It’s critical to anticipate and understand the consequences of a buyout before you go through with it. That way, you can brainstorm solutions ahead of time, like instating a non-compete agreement, to either prevent or reduce the probability of certain problems cropping up.

6. Make the buyout terms as clear as possible.  

It’s important to keep accurate records of everything you discuss throughout the buyout process. The documents will serve as the basis for your buy and sell agreement, and can help limit potential problems and lawsuits later on.

Not only do you need to set clear terms of ownership in your agreement, but you also need to define each partner’s role, responsibilities, and business influence going forward. Be thoughtful about the tone of the agreement, too, Angleton said, as an aggressive or malicious tone can easily negate the goodwill both partners cultivated. “The verbiage of the buy/sell agreement is what makes lawsuits come alive,” he explained.

7. You may need to look into financing.

Depending on your financial situation and the state of your business, you may not be able to pay for a buyout with cash on hand. There are a few different ways to fund a partner buyout, however.

You can self-finance it, which means you treat the departing partner like a lender and pay that person gradually over a certain amount of time. This strategy works well when you have a healthy relationship with your business partner and clearly defined legal terms surrounding the payment plan. If the partnership is toxic, though, dragging out your time together by paying a little bit at a time may not be the best decision.

Another option is to apply for a business loan. This allows you to buy your partner out at once, while still paying off the amount in smaller chunks.

A successful partner buyout can pave the way for new growth in your business. Of course, negotiating the terms of the buyout can be tricky, but with the right attitude and approach it’s completely doable.

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