How to Buy Out a Business Partner

If you own your business with someone else, and the company isn’t incorporated or a limited liability company, it qualifies as a partnership, and your co-owner is your partner.

But sometimes, you may wish to buy your partner’s stake in the venture, removing them as a partner and assuming full control of the business.

Here’s the best way to proceed.

Why Do You Want to Buy Out Your Business Partner?

Partnerships are an opportunity to share the workload of running a business and a way to bring in more expertise.

However, they do come with difficulties, and there will come a time when you may want to remove your business partner by buying their share of the business from them. You may want greater autonomy in how the company is run or to take the company in a different direction.

Or it may be the case that your partner approaches you, wanting to sell their stake in the partnership. Your partner may wish to retire or have a new opportunity that they would be foolish to pass up.

Sometimes, the relationship between you has soured. It’s unfortunate, but that’s how life is.

Be sure you know your reasons for a buyout, as this allows you to identify what you will compromise on versus things that are absolute non-negotiables.

Have an Operating Agreement

A partnership should have an operating agreement/partnership agreement, shareholder agreement, or company bylaws that stipulates, among other things, how to buy out a business partner.

Review it together to identify the rights and responsibilities of each partner. Just as businesses entering a joint venture should have an exit strategy that benefits both parties and protects customers, so should a business partnership involving individuals.

But how to buy out a business partner when no such provision exists? In this case, you may have to enlist the services of an experienced business or acquisitions attorney.

It is in all partners’ interests to avoid a court case – the only parties who benefit from legal action are the lawyers.

It can also be helpful to look at how other companies have set up their operating agreements and learn how to buy out a business partner through knowledge-sharing.

Consider also what will happen to the partnership if either of you dies, falls seriously ill, becomes disabled, goes bankrupt, or wishes to retire.

Why You Should Have an Acquisitions Attorney

Hiring an acquisitions attorney is a good idea anyway because they help ensure that everyone understands the provisos of the partnership agreement the same way. They also ensure that you abide by local and state laws governing companies.

A buyout is often the most favored option for all parties and can be carried out quickly. In an ideal world, you’ll have a well-written operating agreement that clearly states how to buy out a business partner.

Failing that, the partners must negotiate to determine the procedures and price for buying the share from the erstwhile partner.

In these cases, you effectively generate a buyout agreement detailing:

• How they will transfer ownership
• What happens to intellectual property
• How payment is structured
• The sum you will pay them
• Any other necessary details

If your breakup is less than amicable, do not be drawn into any conflict that could leave you legally liable: keep things civil and professional, even if they aren’t friendly.

The Process

Communicate with your partner. It’s only fair to tell them what you want to do and why. You can discuss these points and record how you agree and differ. Such written or electronically-captured records help document what is involved with your buyout process.

If they want to reduce their stake and contribution rather than sell their entire company ownership, discuss how to buy out a business partner in such a case.

Ask the acquisitions attorney you have engaged for assistance with:

• Gathering the appropriate paperwork
• Creating a fair buy-and-sell agreement for both partners
• Identifying any legal issues that may arise in your jurisdiction

You may not yet know how to buy out a business partner, but with the help of an acquisitions attorney and an expert knowledge-sharing community, you’ll find it’s often more straightforward than expected.

Why You Should Have Your Business Valued

Hire an independent business evaluation specialist. They can value the business in various ways:

• Discounting cash flow to the moment of buyout to determine fair value.
• Subtracting all business liabilities from all assets, i.e., determining book value. Although it is more challenging to determine book value than market value, it gives a fair assessment of the company’s worth.
• Using multiples of earnings, which looks at the company’s share price, how much it earns per share, and how many years of earnings it would take to realize that share price, expressed as the multiple.
• Using the number of outstanding shares multiplied by the value of a share to determine capitalization of earnings (or market value of equity). This number is unambiguous.
• Comparing share price to sales, earnings, and return on investment (ROI) to determine market value. Because there are many ways of calculating market value, it can differ substantially from the capitalization of earnings.
• Comparing it to competitors (similarly-sized companies in the same industry) and their selling prices.

By assessing the business value with multiple metrics, the evaluation specialist can structure a deal that everyone agrees is financially fair.

A commonly used method to resolve disputes about what the business is worth is for each party to develop their evaluation, and the average of the two values is agreed to be the business’s value. However, if the discrepancy is too large, getting a neutral third party to mediate is a good idea.

Additional Considerations

The buyout agreement goes beyond creating a monetary offer to purchase your partner’s share of the company.

Consider the possibilities that a departing former partner takes clients with them or exploits proprietary business intellectual property. A non-compete agreement is, therefore, a frequent part of buyout agreements.

Intellectual property (IP) developed by the departing partner but which you want to continue using (for example, your logo) is another potential pitfall.

You will also need a financing agreement that details how you will pay the departing partner for their stake in the company and a partnership release agreement that clarifies that the erstwhile partner is no longer liable for the business.

All of these issues are much easier to navigate if you have a good operating agreement to begin with.

When a Buyout Is Not the Best Option

In some cases, the financial outlay of acquiring your partner’s stake in the venture is not worth it because the IP, expertise, or industry contacts may contribute so significantly to the profitability of the company. In such cases, buying out a partner is not the best idea.

You may be able to buy out a portion of your partner’s stake, effectively leaving them as a minor partner so that you control most of the decisions and liabilities.

Or your partnership agreement may allow you and your partner to dissolve the partnership so that you can both move on to new ventures without the encumbrance of the partnership.

Do you not have these provisions in your operating agreement? Or does your partner not want to take a minority stake? It may even be a better option to sell in these cases – it may not be worth the hassle.

Financing a Buyout

Unless your business has substantial cash flow or you have great personal savings, you probably won’t be able to buy your partner’s share of the company outright. In such situations, you will need to look at financing options.

Bank Loans

You could get a bank loan, creating a leveraged buyout that depends on debt. However, banks tend to be reluctant to lend a businessperson money going toward something other than growing the company’s bottom line.

If the loan isn’t going to increase the business’s profitability, you aren’t going to be generating more income to pay off the loan. You may wish to approach an alternative lender specializing in finance for businesses.

When pursuing this option, thoroughly assess the company’s ability to service debt and then knock off around 15% of that figure to see how much debt you should take on.

Even with a high book value and valuable products, a large debt can impact cash flow to the point that the debt becomes unserviceable, wrecking the business.

Sell to a Third Party

You could also sell your partner’s share of the company to an outside investor, effectively exchanging your current partner for another one. Still, equity-based funding is also not going to make the business more profitable, meaning it will be difficult to convince investors to buy into it.

Buyout over Time

A buyout over time means you pay off your business partner in regular installments, totaling their share of the principal equity plus some interest as payment for what amounts to a private loan.

However, this requires maintaining a relationship with them for many years. If you’re parting on friendly terms, this is a great option.

However, if things have turned sour between you, your partner may want to make things difficult for you or demand an excessive amount of interest on the repayments.

Earn-Out

With an earn-out arrangement, the departing partner remains with the company for a transition period, earning a portion of the profits as payment for their equity stake.

If you are parting on amicable terms, such an arrangement can benefit both parties, as the company’s continued financial health means higher profits.

Finalizing the Buyout

Once you have negotiated everything from the buyout terms to the financing thereof, you will have to finalize the move.

File the required paperwork with local, state, and federal regulatory authorities. Next, transfer all bank accounts connected with the business to your name (and remove your ex-partner from all of them).

Have your acquisitions attorney draft the necessary documentation to release your former partner from any liability related to the business, whether legal, financial, or otherwise.

Tell your tax accountant about the change, as details such as your 1065 tax filing requirements or the Schedule of your 1040 tax return may have to be adapted.

Communicate with customers, suppliers, investors, and anyone else affected by the change in ownership. Keeping the ship steady is always a top priority.

Wrapping Up

If you’re looking for further information, bespoke advice, and support from a community of experienced, like-minded individuals, ETA Insider is the place to be.

Our fast-growing community of industry veterans and independent expert is here to share knowledge and advice on complex M&A topics. Newcomers and prospective entrepreneurs are always welcome: join the discussion now!