Any time you find yourself in a business partnership that has become untenable, a buyout can be the optimal path forward. Understanding how to proceed can make the difference between a buyout that helps all parties and one that just compounds the problems that arose in the first place.
One issue has to do with the best price to offer. Some shareholder agreements contain valuation formulas for buyout purposes, but many do not. At this point, it can be worth getting an expert opinion from outside the company to help you. The offer doesn’t just have to do with value, but also with structure (cash up front as opposed to payments made down the road).
In most cases, companies get their valuation on the basis of expected cash flow in the future. The way that you come up with this number is to look at the performance the company has posted in the past. A lot of times you’ll hear about this valuation in terms of a multiple of current yearly cash flow or EBITDA (earnings before interest, taxes, depreciation and amortization).
This is where your outside expert can help. They look at the financial performance of the company and consider what other companies in the industry have gone for recently. They also consider financing options and the expectations of the partner who is about to be bought out. Remember that if you take on a deal that saddles your company with debt, your growth down the road could suffer.
Once you’ve come up with an offer, it’s time to figure out how to finance the transaction. Sit down with your current banker, because you have the relationship there, and they are likely to support the buyout, unless they look at the partner who is headed out the door as crucial to the success of the business. If the buyout will cost more than what the bank will lend you, then you can look at some other possible sources, such as subordinated debt, payments after closing, private equity or other sources of cash.
Subordinated debt, also known as mezzanine debt, is a loan without any tangible assets backing it up. Instead, lenders extend it simply because of the likelihood that the company will continue to pull in strong cash flows. This debt comes after the bank’s claim on any assets and cash flows, which is why it is called “subordinated.” This can run with interest rates as high as 18% and are frequently tax deductible.
If you pay your partner after closing, you can put together such creative vehicles as royalty payments, payments connected to performance or a vendor note. You can also adjust the equity interest that the partner will hold. This can be a way to meet the gap between what you think your partner’s portion of the company is worth and your partner’s opinion.
Private equity can have a number of sources: Crown corporations, private individuals or private equity funds. These investors come in as your partners but generally want a way out within five years and an internal rate of return of at least 30%. You’ll want to do careful due diligence on any of these sources.
There will be cases where your bank will not support your buyout. After all, your original financing from your lender came from an application that you and your partner both submitted, likely with the two of you on top of the masthead as far as operations would go. However, some banks will see the departure of a partner as a significant form of risk.
If your shareholder agreement does not address a partner buyout, prepare for a difficult conversation – your partner may even offer to buy you out instead. This means that you should be able to enter the conversation knowing what kind of deal you want – which is why talking to an outside party to get a sense of valuation is important. The discussions you have with outside advisors can help keep things from becoming uncomfortable – which means that the deal can go more smoothly. Also (and perhaps most importantly) having that outside advice could indicate to you whether the buyout is the best idea in the first place.
Keys for Buying Out a Business Partner
So, the business that you and your partner has gone through good times and bad, and now the two of you disagree fundamentally on the next steps. You’ve decided that you want to buy your partner out – but this is a process that can become as contentious as stressful as a divorce if you don’t approach it carefully. Here are some tips for you to consider as you move into the process.
Did you agree on an exit plan when you signed the agreement?
Few people think that their business partnership will split when they get things underway, but laying this foundation from the beginning is one of the best ways to keep things smooth when the partnership does dissolve. So if your partnership agreement contains terms for severance (or for how disagreements are supposed to be handled), then start there. The terms might not address your precise situation, but they should give you a starting point for your negotiations.
Generosity now saves legal fees and stress later
If you and your partner cannot agree on terms, the partnership can end up in court, and a separation that could have taken a couple months can take years in the court system. Your costs in the legal system will likely spiral well beyond what you would have spent with a little generosity in your terms of separation. Even if you are angry at your partner, you don’t want that anger to tie you up in court and cause you to pay lawyers tens of thousands of dollars.
Pride adds nothing to your bottom line
Even if you have come to the conclusion that your partner is clueless and corrupt (or both), find a happy medium between pride and reason. Don’t let stubbornness now keep you from a resolution to the question of buyout that any third party would consider reasonable. Remember, you’re acting in your company’s best interests, not the interests of your own emotions.
Communicate early in the process
Once you are certain you want to proceed to a buyout, sit down with your partner and have a reasonable discussion about outcomes that you both want after the business breaks up. Having that combination, and operating with both of your desired outcomes in mind, is one of the best ways to ensure an amicable resolution.
Bring in an attorney – and share the fees
Are you worried that dissolving the partnership will cause too many emotional firestorms? Then hire a lawyer to oversee the process. An attorney will look at the process dispassionately and come up with the best resolution for everyone. Then, at the end of the separation, all partners pay the lawyer’s fees in proportion to their ownership in the business before the breakup.
There are several benefits to buying out your partner in an amicable way. After that, all the profits will be yours – and so will all the accountability. You get absolute control over decisions, and if your partner is hurting the company’s reputation, that will come to an end. If you don’t have the cash on hand to buy your partner out, you can use a number of different financing options, such as a traditional bank loan, a private loan, a merchant cash advance or a mezzanine loan (both of which leverage your future earnings against financing today).