Want to Buy Out a Partner? The Good, the Bad & the Ugly

Maybe your business partner has reached normal retirement age and wants out. Maybe your business partner simply desires to do other things in life. Maybe your partner has a different vision of where to take the company. Maybe your partner spends money differently than you would prefer. Maybe your partner runs the business differently than you prefer. Maybe your partner works less hard than you.

Most relationships between business partners don’t last as long as the business. No two or more business co-owners will be in perfect agreement on every and all issues; on many occasions those co-owners will develop different ideas about where they want to go with the company, and how they want to get there.

While the term business “partner” is commonly used, sometimes it is important to be precise about what type of legal structure you have. If you share ownership of a partnership, you are partners. If you share ownership in a corporation, you are shareholders. If you share ownership in an LLC, you are members. Thus, we use the term “co-owners” as a term that covers all of these legal forms.

The question ultimately becomes do the co-owners work through those issues together, presumably because they believe keeping the ownership team intact is a better path to success, or does one or more co-owner(s) desire to buy out another co-owner, presumably because somebody believes the best path for success is to part ways.

Once one or more co-owner begin to contemplate personal exit goals, differences between co-owners become even more apparent. One co-owner may want to exit sooner; another wants to exit later. One wants to sell the business; another wants to pass it down to his or her children. One needs more money at exit to be happy; another needs less. One wants a quick exit; another wants to stay with the company for the longer term. Sometimes the different exit goals are only partially or marginally conflicting. In many situations however, the co-owners different exit goals are incompatible, meaning the pursuit and fulfillment of one co-owner’s goals will undermine or block another co-owner from achieving his goals. Sometimes the best way to resolve these exit-related differences is to consider buying out one or more co-owners before the others.

Buying out a co-owner is rarely easy, and never fun. Sometimes the process is amiable from start to finish. Sometimes, the process brings out the worst in people. Most small to mid-sized companies will only go through this event once or a limited number of times, with each situation being different. Whether you are the potential buyer, or potential seller, in this transaction, you likely have a lot on the line. At best, a clumsily executed buy-out is distracting, expensive, and disruptive. At worst, a poorly handled buy-out can put everything at risk: other employees, customers, profitability, and even business survival. There’s a good reason why going through a co-owner buy-out is often called getting a “partner-ectomy”—it is comparable to major surgery, with all of the commensurate risks!

If considering buying out a co-owner, it is advisable to investigate the following steps and practices:

• Review with a knowledgeable attorney your buy-sell agreement and other co-owner governance documents. Often, these existing legal documents will include guidance and provisions that determine how to handle a buy-out. You may like what those provisions say. Or, you may not. Best to have that discussion with your attorney early in the process, to understand your options and your obligations. Make sure the attorney you work with can represent you alone, and does not represent the company and thus all of the co-owners.
• Work with a professional exit planner or other mediators, even if the co-owners get along well. An experienced, third-party professional can guide all the co-owners through difficult discussions and issues, and be the objective voice. By definition, every co-owner is personally impacted during a buy-out—even if that co-owner is not one of the buyers or sellers. Only an outside advisor can bring independent perspective and ideas to the process, arbitrate key issues, and be the bad-copy or fall-guy if needed.
• Consult your tax advisors early and often. Unless planned differently, buy-outs are structured using after-tax dollars, which makes them expensive and a cash-flow challenge. Consider strategies that can reduce taxes on the transaction and concurrently minimize the cash-flow burden.
• Research your options for funding a buy-out, especially if you are the potential buyer. Many small to mid-size companies prefer to carry little to no debt, and are unfamiliar with options to structure a buy-out other than seller financing. If the company and/or buying co-owners can bring cash to the deal, that can motivate sellers to act, and perhaps take a lower price too.
• Get a business valuation—but only if you need to. Too many business co-owners make an assumption that on the possibility of buying out a co-owner, they should have the company formally appraised. Don’t rush to do this. Your buy-sell agreement may stipulate a method for setting the company price without getting a valuation. Also, you might want the valuation to be either in the high range, or the low range, depending on your tax and legal advisor’s recommendations—you will not know this until you have consulted with them. If you need a valuation, consider coordinating with your attorney such that the valuation is covered under attorney-client privilege, in case the findings are disadvantageous to you.
• Have a communication plan. Develop a strategy for managing communications during any buy-out process, and then after the buy-out. While both buyers and sellers often want to keep buy-out negotiations confidential, you will have some people who intentionally or accidentally learn about the issue. Know how you will handle this. Once a buy-out is complete, have an agreed-upon strategy for communicating the news, especially with key customers, suppliers, and employees.
• Keep your emotions in check. Emotions can quickly run hot and high during co-owner buy-outs. Rarely will strong emotions help create mutual wins. Rely on your advisors, loved ones, and friends to help you stay calm through the process. Resist temptations to send angry emails, or say things you may later regret. Keep the end in mind, which is a bright business future (if you are the buyer), or a new chapter in life (if you are the seller.)

If you and your co-owner(s) have reached a point where a buy-out may be necessary, don’t wait to address the issue. If you leave yourself with less time to work with, you will leave yourself with fewer options to create positive outcomes. Start by discussing your situation with expert advisors, experienced in these matters, and then lay out the best course of action.