Business partnership buyouts can occur for a number of reasons. Sometimes, a business partner is no longer aligned with the vision of the company. More commonly, a business partner is looking to retire or move onto a new venture. Whatever the scenario, it is important to cover your bases to ensure that the buyout is favorable for all business partners and the viability of the company. Once the terms are defined, you will be able to make an informed decision on how to best finance the buyout.
We expect the need for partnership buyouts will increase in coming years. In 2007, 46% of small business owners in the U.S. were between the ages of 50 and 88. Just five years later, the same age group accounted for 50.9% of all small business owners. As the baby boomers continue to retire and the new generation takes the reins, there will be an increasing need for creative financing of business partnership buyouts.
Agreeing On The Valuation of the Business
Before you can make an informed decision on the structure of the deal or how to finance the buyout, it is important for the partners to agree upon a valuation of the company. Even in scenarios in which the buyout begins on amicable terms, disputes about details of the buyout can sour the process. Ideally, the partnership agreement drafted during the formation of the partnership outlined a buy-sell agreement, with specific terms and conditions for the buyout. This can help mitigate potential risks or arguments over the terms of the buyout.
Both company metrics and partner metrics can influence the valuation of the business. If the selling business partner is highly valuable to the business, they can demand a higher payout. However, without the value this business partner adds, the business’s future cash flows will likely decrease, lowering the valuation of the business.
A common approach to valuing a business is to have each partner develop their own valuation and take the average of the values. If the numbers are too far apart or you cannot agree for other reasons, find an independent third party to provide a valuation for the company.
Formalizing The Structure Of The Deal
Even in buyouts with a partnership agreement, it is common to hire a lawyer experienced in mergers and acquisitions. Legal requirements can be complex and may vary by state. For example, some states allow a 50% business owner to dissolve a partnership, while others do not. It’s also important for all accounts and legal documents to be transferred to the purchasing partner’s name. Otherwise, the bought out business partner may not be wholly released from liabilities of the business. A good lawyer will help both partners meet legal requirements, structure the deal in a mutually beneficial way and prevent disputes from arising. Common agreements include a financing agreement, a non-compete agreement and a partnership release agreement.
Determining The Best Way To Finance The Partnership Buyout
There are several ways to structure the financing of your partnership buyout, including lump-sum payments, buyouts over time and earnouts. These all involve debt financing, which is more common than equity financing. Equity financing is primarily used in scenarios where the selling partner has a particular expertise, skill or connections that the business cannot thrive without. In essence, you’re bringing a new partner into the business with the new equity owner.
A lump-sum payment can be difficult for many small business owners, particularly if the valuation of the company is high. Buyouts over time agree that the purchasing partner will pay the bought out partner a predetermined amount over time until their ownership has been fully purchased. Similarly, an earn-out pays the partner out over time but requires the partner to stay with the company during a defined transition period. Earn-outs commonly pay out more if the financial health of the company remains strong. This can protect the purchasing partners and help smooth the company’s transition to a new management structure.
Financing The Buyout
It is critical that the purchasing business owner runs a conservative assessment on the company’s ability to service debt. No matter how healthy the company is, an unserviceable loan can sink the company.
If your business has a solid operating history, has become more profitable the last six months, and the purchasing partner has an excellent credit history, SBA loans may be the best option. However, many traditional banks avoid underwriting loans for partnership buyouts. From the bank’s perspective, buying out a business partner can damage the health of the company and is unlikely to improve the viability of the company. Many alternative and creative lenders have recognized the opportunity and are becoming better at financing partnership buyouts. With the uptick in demand for partnership buyout financing, we should continue to see lenders move into the space.
This article was written by Forbes Finance Council from Forbes.