Your Business Partner Buyout Guide
To understand the buyout of a business partner, the circumstances surrounding it must first be discussed. When purchasing a business partner’s interest, both parties must agree to the sale price to the business for the transaction to be a success. The entity most likely to assist in valuing the business is the accountant. The accountant knows the most about the business and has access to all the documents, which should include not only tax returns but the entire financial history.
Many factors influence how much a business is worth. The location of the business and the proximity to the local competition must also be factored in as well as the value of each employee, which includes assessing the departure of key employees.
Assessing the tangible assets of a business is often the easier part of the valuation process. The business must have a list of its tangible assets, which includes computers, desks, furniture and anything else that will not be used by the business after the transaction. Other possible tangible assets could include office equipment, copy machines, printers and telephones. Additionally, it is recommended that the business consider creating its own property classification list prior to the valuation. The list should include the year in which the item was purchased, the cost and the replacement cost.
Additionally , intangible assets must also be identified. This will include the goodwill the business has accrued with its clientele base and may also include the corporate name. Intangible assets are often the greatest asset a business has, and the business partner seeking to purchase the company must come ready to pay an adequate amount for these assets.
The business may also have contractual or business arrangement fees that the business partner must consider. A business partner may be bound by a non-competition agreement or to make payments to a third party or supplier. The agreement may also include a guarantee to the lender for the business. The business must also take into account any legal or shareholder disputes with other partners. Lingering legal issues often have a way of rearing their head in the future.
Last but not least to this step of the process is the tax consequences that may become effective outside of the deal. The business partner seeking to purchase the company may have these consequences associated with the purchase. The business may also be liable for any tax implications as well.
When the deciding the best way to purchase the company, the business partner also needs to take into account the mechanics of how the transaction will be financed. Some options available for financing a partnership buyout include a tax-free business incorporation, buying the business from through a buyout agreement, funding the buyout through equity sales and loans, borrowing money through a loan, financing the buyout through stock, loans or seller guarantees.
Valuation of a Business
Assessing the value of the business effectively requires a comprehensive understanding of various business aspects. For starters, it is essential to review the business’s financial statements and the extent to which the company is profitable. If it is a recent startup, the primary focus will be on the current market demand and the business plan’s central focus.
Standard practice typically involves a series of steps to assess the business’s worth accurately. An analysis of assets and liabilities is crucial, including both tangible and intangible assets. The overall profitability of the business and any anticipated changes in the near future are also critical factors relevant to valuing a business. For example, if the company intends to merge with another or create a new branch in a different geographical area, these are important details. If the company has recently suffered a downturn in sales or profit, this must also be factored into the valuation.
If the evaluation process becomes complicated or if there are numerous conflicts between the partners, it may be necessary to enlist the services of a third party business valuator. One of the most common methods of business valuation is calculating seller discretionary earnings, which is effectively the amount of money that the company can make. It factors into account compensation and the costs involved with operating the business. This includes things such as compensation for the owner, perks associated with being the president, and accounting fees for a business owned by a person with accounting experience. Financial statements, tax returns, and accounting records are the typical considerations of the valuation process. Obviously, a lot of time can be spent attempting to calculate earnings based on these criteria.
Terms of the Business Partner Buyout
Once you have reached an agreement in principle, the next step is to agree on the purchase price and terms of payment with the selling partner. Keep in mind that the selling partner is about to lose up to half their investment and may not have an opportunity to access their investment funds for some time. Depending on their age, they may never have the chance to re-invest in a new business. Do you really think that they will just walk away with a business partner who has practiced negotiating by bluffing them into selling even if they do not want to do so?
Depending on your relationship with the other partner, negotiating the price and terms may be more of an art than a science. While they may have no choice but to sell at some point, the without an amicable deal they may leave all of their powers of negotiation at the front door, even if they do not have to. In order to keep the negotiations on track, you will need to consider the following factors:
1. If the business is well-structured, there may be a well-defined market for the business. If your business has made profits in the past, it may be traded at a multiple of those profits. If that is the case, you will find a market price for your business and it becomes a numbers’ game – your profits times your multiple. Your lawyer may refer you to a qualified business appraiser, whose opinion will then become the basis for the purchase agreement.
2. There may be certain discounts from market value that should be considered in the price. Those discounts include:
(a) the illiquidity discount, meaning that it will be hard to sell the business.
(b) The control change discount, meaning that the buyer will need to exert some leverage over the business. Costs and problems associated with that will be factored into the price.
(c) The discount if the shareholder is removed for cause, such as a breach of fiduciary obligations.
(d) The estate freeze discount, meaning the selling shareholder may need to pay immediate tax as a result of Other partner’s decision to freeze the business.
- Courts will consider the "fair value" of the company when deciding whether to allow minority shareholders to sell their shares at a price above market value. Fair value factors in the company’s fair working conditions, the employee relationships, and the business’s future growth potential. If your business is fairly profitable, you can argue that valuation should take into consideration your future growth potential and your stellar management team.
- If you have received interest from other parties to buy out the business, that may be used as a market price for the business.
- If your partnership agreement allows for lock-step purchases, meaning the selling partner has to sell all of their shares all at once, this will be more difficult to negotiate. If there is no time pressure to sell, your partner may be able to hold out for the highest dollar figure and you may need to find financing to get that price.
- Consider if you will need to borrow money. By using locked-in funds from the bank, you may be able to pay a higher purchase price as you will not be using your own money to buy the business. Be warned that the bank will take a dim view of your attempts to buy a business if you have not budgeted in advance for the investment.
- Is there an established rate for interest on the deferred balance? If there is a potential increase in the goodwill value of the company, consider how you might build in a small percentage of the increase in future dividends, so that you can both share in the company’s continued success.
- Consider personal tax impacts for both you and your partner.
Business Partner Buyout Financing
When it comes to the actual payment of the buyout amount, seller and buyer may be stuck for choice. In many cases, the business will not have the cash flow to fund a lump sum buyout with available cash. There are many other ways of funding a buyout, though.
Lending may be a source of financing a buyer into a company with a non-active owner. The lender might get a personal guarantee from the owner. The lender could lend on the business assets, as well.
Private investments might provide an alternative to financing a buyout. An incoming partner may bring in cash to fund a buyout.
Stretching out the buyout payment can also be a wise move. Making payments over time may help to avoid the type of cash crunch that could result from a sudden lump sum buyout.
Legal Forms to Use When Buying Out a Business Partner
When buying out a business partner, legal considerations are of the utmost importance. Many businesses are formed as sole proprietorships, partnerships or corporations. Each entity type has unique operating agreements and procedures that govern ownership transfer. If a partnership dissolution agreement is not available, state general partnership dissolution statutes may outline how buyouts must occur. Alternatively, articles of incorporation or bylaws (when a corporation is involved) could contain language that permits the buyout of a business partner when certain events occur. Examples of triggering events include the retirement or death of a business partner, a business partner leaving voluntarily, or if one partner becomes disabled and can no longer perform his or her duties . If there is a buy-sell agreement in place, it will likely dictate how to buy out a business partner (if the partner is alive) or his or her estate (if deceased). It may reflect partner value and payments, as well as terms of a buyout. An attorney should review the agreement to determine the best way to act in accordance with provisions of the buyout agreement. A buy-sell agreement should contain terms that allow for the transfer of businesses interest when the buyout is triggered, how and when the buyout is to be paid, whether life insurance benefits will be paid to the surviving business partner in the event of the death of a partner, and other details unique to the relationship.
Business Partner Buyout Process
Once terms have been agreed upon, you should memorialize them in a written buyout agreement that is reviewed and signed by both partners. This agreement can be incorporated into your original operating agreement, or it may be a stand-alone document that amends your operating agreement. It should go without saying that you must each obtain independent legal review of the agreement, even if you are the sole owners of the business. Remember that what seemed like a win-win solution in the negotiating process may feel very differently to you when it has been captured in writing, and your lawyer has reviewed it. You should not sign any agreement that does not feel right to you after taking time to consider it and discuss it with your lawyer. Non-advice on my part, but you really can’t hurry this process along! I would not recommend your signing an agreement until at least two days have passed from the point that you first saw it. Two to three days is typical.
In addition to the buyout agreement, you should update your company’s records with the ownership changes (for example, including a resolution reflecting the change in membership). If you have an LLC, you will also want to update your LLC operating agreement with the buyout and/or any other changes to the LLC.
If you have a company bank account, you will need to update your company signature card and ensure that the new ownership is reflected in your company banking signature card. The company’s books should be updated as well until you have fulfilled all of the requirements in your buyout agreement (i.e., in case you need to effectuate a loan during this period, etc.). You will want to record the member’s buyout in your books as a loan payable to that member if the purchase price is being paid over time, or as a withdrawal of capital if the amount to be paid out is for the member’s capital account in full.
Finally, in order to achieve the result you seek in cutting the departing member out of the company, you will want to notify your clients and/or any government entities about the buyout in accordance with the terms of the buyout agreement.
After the Business Partner Buyout
The steps that follow the buyout of a business partner are as important as the buyout itself. There is usually a period during which the selling partner may continue to perform some duties for the business and must also assist in the transfer of business relationships to the continuing partner. The extent of this involvement should be carefully defined and should take into account the time that it will take the selling partner to complete this transition. If it is not carefully defined, a business can suffer to the extent that there is a lack of clarity in the ongoing responsibilities of the selling partner.
Furthermore, any ongoing obligations or continuing assistance from the selling partner should be clearly identified. There should be a corresponding right of compensation for the selling partner with respect to future income, profit-sharing or commission where appropriate.
Where an ongoing period of assistance has not been provided for, the sale transaction provides the general business advice that the legal obligations of the continuing partner to the selling partner terminate on closing. Leave them no doubt that they are no longer a partner!
By the same token, if certain goodwill value depends partly on the reputation of the selling partner, there may be a period where ongoing assistance may be useful for both parties . If clients or customers are moving from the selling partner to the business where the other business partner has agreed to act in the short term, that should be dealt with in the buyout agreement and provision for transition.
It is important with these buyouts to separate business valuations, payments for shares and the ongoing benefit of operational concentration or expansion. It is also important that where there is going to be a rapid transition to a point where the continuing partner can proceed without the ongoing assistance of the selling partner, that the transition is smooth and that as the selling partner moves on, all reasonable efforts are made to advise the clients or customers of the transition.
There may be a period when not only have business partners decided to split up, but some of the staff may decide to move on as well. If the value of the business is geographically based, for example, a retail store, it may make more sense to include a closing date recognizing the time period over which the transition will occur. This satisfies the concern of the client or customer base that this business is continuing at the location at which it is currently located.