7 Steps on How Do You Buy a Business Partner Out

When a partner’s interest in playing a part in the business changes, it may be that the partner no longer wants to participate in the organization. If this occurs, then a business owner needs to find a straightforward, simple way to buy out the partner.

Author: Brad Nakase, Attorney

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Business Partner Buy Out, Example

Luis and Dominic have been partners in the business venture Cool Threads for the past ten years. They have always gotten along well and have together made their clothing company a wild success in Los Angeles. However, recently Dominic has come to Luis with the upsetting news that he would like to leave the company. When Luis asks why, Dominic explains that he would simply like a new challenge, perhaps to pursue a project on his own. Luis understands, but he is not sure how to buy his business partner out. For instance, he is not sure how much to pay Dominic, as well as what the procedures are for handling his exit.

What To Do When a Business Partner Wants Out

It is not easy to own a business with one or more other people. In fact, managing responsibilities and personalities is a delicate balance, even when these factors are divided as carefully as possible. However well organized a company may be, it is important that everyone contributes to the business’ success and uses their ownership for the good.

When a partner’s interest in playing a part in the business changes, it may be that the partner no longer wants to participate in the organization. If this occurs, then a business owner needs to find a straightforward, simple way to buy out the partner. This method should be fair to all involved so that there is no negativity or arguments.

This article will address how a business owner can buy out a partner in a way that is simple and fair for all involved.

1. Review the Company Operating Agreement and Other Buy-Out Procedures

Most companies will have an operating agreement, a partnership agreement, or other related documents and agreements that the business’ owners and partners have all signed. If the company has one of these agreements, then a business owner pursuing a buy-out should start here. It is important to carefully study the agreement’s language in order to know the specific rights, duties, and processes involved in buying out a partner. The listed procedures should show a business owner what he or she needs to do to meet the terms stated in the agreement.

If a company does not have an operating agreement, then it would be a good idea to study some examples that may be found online. These examples can serve as a helpful guide to the buy-out process. If at any time a business partner needs help or advice, he or she should consult an experienced business attorney.

2. Have a Buyout Agreement in Place

Regardless of whether a business has a partnership agreement in place or not, it is worthwhile establishing a buyout agreement with any partners. This contract covers the procedures and rules that partners must follow when transferring ownership of the company, making the necessary and proper payments, and various other elements.

There are services such as UpCounsel, Nolo, and PDFFiller that offer buyout agreement templates. Still, although using a template is an option, it is recommended that a business owner contact an experienced business attorney to make sure that all bases are covered.

3. Decide on a Fair Value for the Business and the Partner’s Stake

A business owner will need to first determine the value of his or her business in order to buy out their partner’s ownership interest. To establish the business’ value, an owner will need to get a fair valuation of the business’ worth. Unfortunately, there is no simple way to assign a value to a private business. However, there are some pointers that one can use, including the following:

  • Compare the business with other businesses that are similar in size and within a similar industry, and what they have sold for.
  • Calculate the total value of the business’ assets.
  • Establish what the profits and Return on Investment would be if someone bought the business.
  • Use cash flow and discount it to the present point in time to establish a fair value.
  • Use other methods such as multiples of earnings, capitalization of earnings, and book valuation.

Needless to say, it can be very complicated to value a business. It is therefore important that a business owner work with a specialist independent business valuation expert. This individual can help establish a fair value and ensure that the other partners agree to that value.

4. Assess How Involved the Business Partner Wishes to Be in the Future

A business owner should be sure to discuss expectations with the partner who wishes to exit. The owner should understand how the partner will interact with the business in the future. Some partners may want a complete break with the company and will sell all their stake. Others, however, may just want to reduce their responsibilities and ownership percentage. It is therefore important that a business owner works with the partner to settle on and document what the expectations for the future are. In some cases, a third-party mediator may be needed.

When the partners have settled on expectations, it will then be necessary for the business owner to figure out how to fill the space left by the departing individual. Perhaps the owner will take on more work or divvy up duties among other people. It is crucial that the owner plan for this situation so that he or she is prepared to keep the business operating through a transitional period.

5. Get Financing to Make the Partnership Buyout

After the partners have agreed on the value of the business and how much of the ownership the leaving partner is willing to give up, money will be required to buy them out. An owner should talk to the partner about what they want to be paid, for how long, and any other relevant factors. One should see if the partner is willing to take regular payments from the business’ profits or would prefer receiving a lump sum instead. If the business owner does not have the money available, then it may be necessary to take out a loan to complete the buyout.

6. Make Payments and Get the Agreements Signed

It is important that a business owner review all documents and information with both his or her business attorney and the departing partner. The terms of all agreements should be mutually understood and the payments scheduled as fits both parties. The agreements should then be signed, making the buyout process completed.

7. Other Tasks That Must Be Completed When a Partner Leaves a Business

In addition to the steps listed above, there will be some other administrative tasks to attend to. These include the following:

  • Figure out if the exiting partner changes the business’ structure; for example, from a partnership to a sole proprietorship, or from an LLC to a corporation.
  • See if the business owner needs to file any paperwork with the state’s business formation agency in order to inform them of the change in ownership.
  • Inform the business’ accountant about changes in ownership, because this may affect how taxes are reported and filed; for instance, changing 1065 filing requirements or switching from a Schedule K to a Schedule C on the 1040 tax return.
  • Let customers, suppliers, and partner organizations know about the ownership change.
  • Update the partnership or operating agreement to reflect the change in ownership.
  • Update the business annual report filings to display the ownership change.

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