January 4, 2023
Buying out a business partner might be the only way forward if you’re stuck in a position where there isn’t a good alternative. Sometimes this can be a calm and friendly procedure, other times it’s a bit messy. As long as the reasons are sound, there’s usually a path to success, but this doesn’t often come easily.
It can take third-party help and often a substantial amount of money to get the job done, and in this piece, we’ll look at why and how that is. Before we do, here’s a bit on the incentives behind a business partner buyout.
The Common Reasons for a Business Partner Buyout, Good and Bad
There are plenty of good and bad reasons to buy a partner out. Sometimes there are collaborations that were just never meant to be, and two people simply can’t work well together. This can lead to understandable frustration and tension between parties when the working relationship is under strain. Ultimately, the business suffers and one person has to leave.
Sometimes it’s not the work ethic or behavior but the direction two people have in mind that’s mismatched. When equal partners can’t agree on the creative decisions that direct a company, there can be a time when they have to go their separate ways.
Other times, one partner is up to no good. Making behind-the-scenes dealings that could get the company into trouble, and they just need to be removed.
As with all decisions in business, there are wrong reasons to buy someone out too. Sometimes, a partner who disagrees with you is a good thing, and you can make a lot of progress by accepting constructive criticism and giving some leeway, rather than jumping to buy them out at the first sign of disagreement.
Other times, the person may be burnt out and there’s a much healthier workaround that relates to redistributing or rescheduling workloads in a manner that allows them to work more effectively and carry their share of the weight again.
Jumping to a premature buyout can be a costly and even devastating mistake, and you may not realize that until it’s all over. Still, sometimes it’s just unavoidable, and in these cases, you should hope to have the right policies in place to guide you through it.
The first thing to do to avoid all of this is to get an operating agreement before you start so that you don’t find yourself struggling with what to do during a buyout in the first place. An operating agreement will detail what should happen, should one of you want to leave, and things will be a lot smoother.
If you do have one of these, check fo relevant clauses that could help you out. However, Hindsight is 20/20, and you probably wouldn’t be here if that was a possibility, so it’s time to talk about what to do, now that you’ve found yourself in this pickle.
Before we get into the process, let’s take a look at some of the considerations to go over prior to committing to a buyout.
Pros and Cons of Buying Out a Business Partner
There’s a lot to consider when looking into how to buy out a business partner. There are benefits and drawbacks in every situation, and if you’re not entirely certain you want to go ahead, it’s a good idea to weigh these up and consider possible alternatives before moving forward.
On that note, let’s look at some of the implications, both good and bad:
It could be a quick departure – In many cases where a partner is no longer fit for purpose, buying them out is easier than persuading them to do the work. If there’s a lot of stress coming up behind this decision, the buyout could represent a nice clear end to it all and allow you to get on with your project.
You might lose some valuable assets – If your partner is in sales, for example, they might take all their leads with them. If you were leaning on their network, the company could suffer from a sudden loss of assets in this way.
It keeps the business alive – As an alternative to ending the project entirely, a buyout, again, lets you get on with things and move your business forward.
It can be an expensive process – As we’re about to discuss, the process can be lengthy and involved, with many moving parts and several stages, and that’s not even taking into account the cost of the finances involved.
If some of the drawbacks are too much, you might look into some alternatives instead. You could opt for a buyout that’s spread out over time (though this comes with its own problems as we’ll mention later) or you could try something entirely different.
It might be a simpler matter to alter the partnership agreement in a way that gives you more weight than your partner. This way, you’ll have more control and responsibility, and the partner might be more suited for their new level.
You might also be able to replace the partner with someone else. This is still similar to a buyout, but the resources involved will come from the new buyer.
Finally, you could consider dissolving the partnership as a way of releasing both parties without one having to buy out the other.
Still, if there’s no viable or preferable alternative, and you’re dead set on going ahead with a business partner buyout, the first thing you need to do is start positive. There can be a lot of tension in many contexts where a buyout is pending, but regardless of whether you’re on good terms with your partner, it’s important to tread carefully and foster an environment where everyone is acting in good faith.
Without good blood, you’ll simply convolute and muddy the process. But what exactly is this process?
How to Buy Out a Business Partner
A buyout gives a business partner a way out of the company in exchange for a fair price, offered by the remaining partner or partners. In some cases, this results in the collapse of the partnership entirely, such as when there are only two shareholders involved, and all equity is transferred to one.
In other cases, the equity can be redistributed across the remaining shareholders, a new partner can join the business to replace the old one, or, if there are more than two, to begin with, a single partner can buy the full amount from the seller, increasing their percentage share.
Usually, a partnership agreement will include a buy-sell agreement that outlines the way in which ownership will be handled in the event of one partner leaving. It might also include advice on how to assess the value of their shares when the time comes.
Buyouts, therefore, begin by reviewing this agreement to see what’s useful and what isn’t. Then, the value of the business needs to be determined, and a fair price is established from that. From there, financing agreements are set up, followed by non-compete agreements, and a partner-release agreement.
Due to all these agreements, it’s a good idea to have legal help on both sides of the equation, and some choose to involve mediators too. So, let’s look at the process in more detail from start to finish.
Step 1. Initiating a Business Partner Buyout: Clearing the Air
You might be able to skip this step entirely if you’re working through something amicable and clear-headed, but if there’s tension around, it’s important to tread carefully. Still, things can still get ugly between good-natured parties if the process is perceived as being skewed in the favor of one over the other.
If you’ve got more than one business partner, sometimes the cost of buying out the one who is leaving will be spread across the other shareholders in a way that allows everyone to keep their percentage share the same. This could simplify the process, as well as take some of the responsibility away from you, but involving more stakeholders may also add complexity to the legal side of things.
On the other hand, some of these shareholders may not have the money to contribute to the buyout, which then could complicate matters if there is a significant shift in percentages. Again, another thing that’s worth considering when trying to get everyone on board.
One of the best ways to approach all of this, regardless of how comfortably it begins, is to hire outside help.
Step 2. Get Help!
Even if you’ve set yourself up in a friendly environment and everyone is more or less on the same page, this step is highly recommended for a buyout for a number of reasons. First of all, the process can involve a highly technical negotiation process, especially if there are more people involved than just the two partners.
Secondly, having expert legal advice not only makes the process smoother during the negotiation but can also protect you afterward. For example, what happens when the sale is complete and the parties involved regret their transactions?
The buyer may decide the deal wasn’t worth the price or the seller might be dissatisfied with the amount they received. If the company gets lucky, or the direction is improved after the sale, this can also leave the seller with some remorse.
These issues can be avoided by making sure the entire process is done with transparency. The buyer and seller should have full access to the financials and material information of the company. This should include all the good and all the bad. Lawsuits, threats, opportunities, deals in the pipeline, etc.
Having an attorney represent both parties makes it a lot harder for either to later claim that they were under-informed, and ultimately protects your relationships throughout the entire process as a result.
But attorneys aren’t the only third-party help you could use. A mediator can come in tremendously handy during this process as they can offer a wealth of skills to help keep everything civil and above board. Often, a mediator would have a background as an attorney, though this wouldn’t be their role here.
A good mediator will help guide the conversations in a way that’s non-judgmental and free from emotion. This can be a great complement to hiring the attorney, as they can often work on each other’s weak points.
With all that behind you, you’ll now need to get a valuation.
Step 3. Buying out a Business Partner: Valuing the Business
There’s no set rule for establishing the value of a business. You may want to add up all the assets and factor in the cost of replacing all the things your partner will be taking with them. You could also involve all of the incomings and project that into the future to help establish a value or look at the sales price of your competitors as a benchmark. You can also mix and match various elements of these to your needs.
One thing should be important, whichever method you choose: everyone should be more or less in agreement with the result. If either party is not happy with the valuation method you may end up in a stalemate situation, in which case it may end up in court.
This is where the partnership agreement (if you have one) comes in handy. It should detail exactly what needs to be done in these situations and offer a path out of the stalemate. If it exists, everyone must stick to that agreement’s specifications to complete the buyout. If it doesn’t, the value of the partnership now needs to be established.
Before you’re able to structure a payout, you’ll need to know how much it’s going to come to. This is where many fall into litigation issues, in which partners suspect other partners of overvaluing or undervaluing the business as a way of cutting an unfair slice.
A business appraiser can help with this, though you’ll likely need to spend time picking one that everybody trusts. Some businesses pay for more than one appraisal, and others get one even if all parties agree on the value of the company, to help prevent changes in attitudes later on.
When it comes to projecting the potential income of your business during valuations, it’s important to have your financial documents in order, and accessible to all stakeholders. We have an incredible template for creating financial projections for an acquisition that you can do yourself with ease. The template is entirely customizable and comes with free support, so you’ll be able to design accurate projections that may also come in handy when it comes to getting financing for the buyout.
Step 4. Review your Financing Options
If you’re an SMB, you’re likely to have more luck approaching the US Small Business Association (SBA) than going to a bank to fund your buyout. The Federal government backs these loans, which gives you some support when it comes to attractiveness on the side of the lender.
You could consider funding the buyout yourself, too, if you have access to the funds. There are a few ways to do this. Usually, the payment will be broken up into installments, with the buyer spreading it over an agreed-upon amount of time until the seller is fully bought out. This option could be simpler than others, though the time it takes to complete may also provide opportunities for things to get messy, depending on how well you’ve designed the agreements.
Alternative lending options you might want to look into include:
- Debt Financing – This is the sale of bonds, bills, notes, or any other fixed-income products to investors.
- Equity Financing – This is the opposite of debt financing, and involves selling stock to raise capital. In this way, the money doesn’t have to be returned.
- Merchant Cash Advance – This is an advance on future sales, which is applicable in some cases.
- Mezzanine Financing – This is a source of funding that’s based on cash flows, and represents a sort of middle-ground between equity and debt financing.
If all of your papers are in order and the buyout is more or less complete, it might feel like the end of things, but there’s still quite a bit to think about.
Step 5. The Aftermath
It’s necessary to now prepare for the absence of the leaving party. All the former partner’s accounts, passwords, locks, and keys need to be accounted for and changed where necessary, and clients, vendors, and any other relevant stakeholders should be notified and updated.
The attorney's presence here can be really useful. Making sure all documents reach the right offices is an art in itself, and getting a full understanding of what’s being lost in the process are all part and parcel of the preparation phase for the leaving of the old partner.
Ultimately, everyone leaves a business one way or another. This makes it vital to have some agreement in place to manage the way that transition is handled. Still, if you don’t have one, there are ways through this.
Understanding how to buy out a business partner is about knowing how much their share is worth and finding a smooth and transparent path to paying a fair price for it. For this reason, consider bringing in lawyers at the very least, and involving a mediator too. This could save a significant headache both during the process and afterward.