Owning a business with one or more other people is a delicate balance. You can divide roles and responsibilities, and bring each person’s expertise to your venture. At the same time, it’s important that everyone contributes to the success of your business and makes the most of their ownership.
When that desire to be part of the business changes, that can mean your partner no longer wants to be part of your organization. If that happens, you need a clear and straightforward way to buy out your business partner in a fair way that works for everyone.
Here’s how to buy out your partner in a way that’s straightforward and fair for everyone.
Review Your Operating Agreement and Other Documents for Buy-Out Procedures
Most businesses should have an “Operating Agreement,” “Partnership Agreement,” or similar documents or agreements in place that have been signed by all business owners and partners. If you do, then that’s your starting point. Carefully review the language in the agreement to understand what the rights, responsibilities, and processes are for buying out other owners. This will show what you need to do next to meet the terms of the agreement.
If you don’t have an operating agreement, it’s worth reviewing some examples online as they can be a useful guide to the process. If you need assistance, consult a business attorney with experience in buyouts.
Get a Buyout Agreement in Place
Whether you have a partnership agreement or not, it’s worth setting up a buyout agreement with your partner. This document covers the various rules and procedures that you will both follow when it comes to transferring ownership, making appropriate payments, and other factors.
Services like Nolo, UpCounsel, and PDFFiller all have buyout agreements you can use. Although you can use a template for a buyout agreement, we recommend consulting an attorney to ensure you’ve considered all factors.
Establish a Fair Value for the Business and Your Partner’s Stake
To buy out your partner’s ownership interest of the business, you will need to determine its value. To do so, you need to get a fair valuation of what the business is worth. There’s no single, simple way to value a private business, but some pointers you can use include:
- Comparing your business with other businesses of a similar size and in a similar industry, and what they have sold for.
- Calculating the total value of all your business assets, less your business liabilities.
- Establishing what the Return on Investment and profits would be if someone were to buy into the business and using that as a guide.
- Using your cash flow and discounting it to this point in time to establish fair value.
- Using other methods like capitalization of earnings, multiples of earnings, or book valuation.
All this to say, valuing your business can be complex. It’s important that you consult with a specialist independent business valuation expert. They can help you establish a fair value and, importantly, agree that value with any other business partners.
Decide How Involved Your Business Partner Wants to be in Future
It’s important to discuss expectations with your business partner, and understand how they will interact with business operations in future. While some partners may want a complete and clean break, selling all of their stake, others may simply want to lessen their responsibilities and lower their ownership percentage. Work with your partner, and with a third-party mediator if needed, to understand and document what your and their expectations are for their future with the business.
Once you’ve both established those expectations, you’ll need to understand what you can do to fill the gap. Will you take on more work yourself, outsource some of their responsibilities, promote other staff members, or hire a new expert? Plan for these contingencies, and you’ll be better prepared when the time comes.
Access Financing to Make the Partnership Buyout
Once you’ve agreed on the value of the business and how much of their ownership your partner is giving up, you’ll need the money to buy them out. Talk to them about how they want to be paid, over what duration, and any other factors. See if they’re happy to take regular payments out of the operating profits of the business or if they would prefer a lump sum. If you don’t have the money readily available, explore if you can take out a loan to make the buyout.
Make Payments and Get All Agreements Signed
Double-check and clarify everything with your partner and your business attorney. Ensure that all of the terms and agreements are properly understood, and arrange to make payments as you’ve previously stated. Then, get the agreements signed and the buyout process will be complete.
Complete a few other tasks as a result of a partner leaving the business
You will have some final administration to do.
- Determine if the partner leaving changes your business structure—for example from a partnership to a sole proprietorship, or from a multi-member LLC to a single-member LLC.
- Establish if you need to file any paperwork with the business formation agency in your state to notify them of the change in ownership or business structure.
- Let your accountant know about any changes in ownership, as it may change how you report your taxes and the forms you need to file—for example, changing 1065 filing requirements or moving from a Schedule K to a Schedule C on your 1040 tax return.
- If relevant, let any customers, suppliers, or partner organizations know about the change in ownership.
- Amend your partnership or operating agreement to show the new ownership of the business.
- Update your next business annual report filings to show the change in ownership.
We hope you’ve found this guide helpful and that it makes buying out your business partner and continuing to run your business fast, easy, and successful.