It is not uncommon for a business owner or director will buy out a business partner to let them go from the business. For many companies, buying out a partner is a standard practice because they may need a partner early on in the business, and once it’s up and running, they don’t need their services. However, there are other reasons too, some of which may complicate the business.
These reasons could be a dispute between partners, divorce settlements, or retirement. Buying out a company partner may be complicated and time-consuming if you aren’t prepared or haven’t drafted a partnership buyout agreement early on. In this article, we will discuss all the necessary things to know when you’re thinking of a buyout business partner so you can keep a check when drafting a buyout agreement.
Buyout of a business partner
Sometimes buyout can be simple when a buyout agreement is drafted early on in the business, or a clause is included in the partnership agreement. However, most times, there is a lot of hardship and conflict involved in buying out a business partner. When one partner decides to buy out a business partner, it may be challenging to be calm and collected. This is why you should be well-versed in buyout agreements, the law, finances, etc., before buying out a company partner. You also need to know how to properly value the buyout of a business partner. Let’s understand the basics of buyout first.
What is a buyout?
A buyout is the purchase of a significant stake in a business and is used interchangeably with an acquisition. If the company management acquires the share, it is considered a management buyout. If a substantial debt is utilized to finance the buyout, it is termed a leveraged buyout. Buyouts typically occur when a corporation is going private.
When a director buyout a business partner, it’s called a partnership buyout. In a partnership buyout, they purchase all the shares belonging to them with the intent to end the partnership agreement. By including a buyout option in the agreement of partnership, a partner’s shares may be gradually acquired, and their involvement in the firm severed over time.
What is a buyout agreement?
With the use of a buyout agreement, the remaining directors of a company may purchase the shares of a departing director/partner in the event of the director’s voluntary or involuntary departure. It’s also possible to give the option to buy out a partner without giving them a warning if that partner accepts a new position or leaves the organization. For the sake of security and to limit the number of potential buyers, a buyout agreement outlines the terms for protection.
Reasons for business partner buyout
The business director may decide to buy out a business partner ahead of time at a later date. Some of the most typical causes of a partnership buyout include the partners’ divergent views on how the company should be conducted, a major conflict between them, or monetary difficulties. Here are some reasons to happen business partner buyouts:
- Business venture – A common reason to buy out a business partner could be if the partner wants to exit the business and sell the shares voluntarily to get involved in a different venture.
- Partnership split – If there is some kind of dispute, partners could split over a discussion or negotiate for the director to buy out the business partner and end the agreement.
- Risk reduction – Say the partner of the company is involved in some kind of scandal or act of crime. The business cannot risk its reputation due to its association with the partner. In this case, there will be a buyout to cut ties in the interest of the remaining shareholders.
- Sole ownership – If the director of the business partners with someone for the sake of funding or reducing risk, they may agree to join for shares in the venture. In future, the director may decide to become a sole owner with an agreement to buy out the business partner.
- Financial difficulty – When a business is at a financial risk, the partners may agree to put their shares up for sale within the company. This may provide the necessary cash flow for the business to run.
- Retirement – Partnership buyout does not necessarily have to be negative. It can be for the benefit of the partner too. At the end of their long-term, partners may decide to retire with cash in return for their shares in the company.
Factors to consider in a business partner Buyout
At some time in the life of a partnership business, co-owners may decide that a partnership buyout is necessary to ensure the company’s continued success. All the partners must take a step back and look at the big picture before engaging in partner buyout talks. Here are some factors to consider before anyone decides to buy out a business partner.
- Review partnership agreement – Your partnership agreement may have a buyout clause that you agreed upon. It serves a similar purpose as a marriage’s prenuptial agreement because it safeguards all parties involved and makes it easier to resolve any conflicts or divergent opinions that may occur during the transition. Make sure to review them before deciding on anything.
- Gather trusted advisors – Gather your team of close associates, including your lawyer, accountant, and other company partners, to assist in coordinating and steering the partnerships to a win-win solution.
- Impacts on the relationships – In the event of a partner’s divorce or demise, you should consider how the buyout may affect your connection with the partner’s husband or wife and successors. The documentation provided by the partner buyout agreement helps to establish equity worth and fairness during buyout discussions. A party from the outside who is unfamiliar with the internal functioning of the company may have an exaggerated sense of their entitlement in such a case.
- Determine the FMV of business – You will need an objective evaluation of a company’s assets through an independent appraiser to buy out a business partner. Distribution of equity can cause a commotion in the proceeding, and you must choose a valuation team approved by everyone involved. The partners may employ their own individual appraisal experts and weigh their respective valuations to agree if:
- company is complicated
- if the intangible value is a significant element in the business
- or if partners are at odds with one another.
- Fairly compensated existing partners – It might be given all at once, or the payment can be spread over time. These payment parameters should have been defined in the agreement. Still, if they weren’t, they need to be to appropriately recompense the leaving partner without penalizing the remaining partners or the cash flows of the firm.
- Have an acquisition attorney or small business arbitrator – If you want to make sure that the buyout agreement is binding and doesn’t go on for too long, causing unneeded stress for both parties, you can seek the help of an acquisition attorney or a small company arbitration.
- Consider all the tax implications – Learn more about the repercussions for both the departing partner and the partnership from your tax adviser. Any assured payments received by a leaving partner must be reported as regular income, as per Internal Revenue Code’s Section 736.
How to value the buyout of a business partner?
Planning for a potential ownership shift at the beginning of a company venture makes arranging a buyout business partner in a common partnership considerably simpler. If the departing partner has what the surviving partners see as an exaggerated sense of the company’s current value, coming to an understanding of the value of the firm after the problem has arisen may be challenging.
- Negotiate value – To buy out a business partner, you and the leaving partner must discuss terms. Often partners don’t agree on the same value. There are rules and regulations around buyouts in every state where the business operates. Most states mandate partnerships to buy out business partners at a reasonable sum that equals what his portion of the revenues could be following the dissolution or sale of the business. It’s not easy to estimate how much your business might be worth in the event of a sale or when liquidated; a business valuation can help with it.
- Determine Business Valuation – It is possible to value the buyout of a business partner by calculating how much the partners’ assets would cost per the value of all business assets. This is done with a business valuation To determine a company’s worth, you might look at its cash flow and make projections about it. You can also value the company by comparing its worth to the selling price of similar companies that have recently changed hands in the same region.
- Prepare partnership agreement – If you’ve included buyout clauses in the partnership agreement at the beginning, it’s great. These clauses outline the procedure to be followed in the event a partner wishes to withdraw, as well as the conditions the partnership may require the partner to surrender their stake back to the corporation. A method for business valuation must be included in any well-drafted buy-sell clauses.
- Break a stalemate – There are ways out of a deadlock if partners can’t settle on the value of the company to back a takeover offer. It is possible for the buy-sell terms in the partnership agreement to require the use of mediation to conduct any buyout discussions. As an alternative, the co-owners may take the matter to court, where a judge will evaluate what the company is worth and what a reasonable buyout would be.
How to calculate a business partnership buyout?
You may use the conventional partnership buyout calculation to estimate the worth of your partner’s share in the business. Your partner’s share of the firm’s worth is calculated by multiplying the business’s assessed worth by the amount of ownership of the partner.
Therefore, if your partner owns 30% of the company and a business valuation gives you the value of the business at $1 million, their share would be 30% of that value, i.e. $300,000.
Get help with your business valuation for a buyout with Eqvista!
By now, you understand the importance of getting a proper business valuation when a partnership buyout occurs in a business. Entrust the experts at Eqvista for business valuation for your partnership buyout. We have a staff of accountants, attorneys, valuation specialists, and business owners that work around the clock to improve their clients’ operations. Our trained professionals are here to assist you in determining how much your company is worth based on its assets, revenue, and other factors with a thorough and accurate business assessment. Contact us today to learn more about our valuation services.