How To Buy Out a Business Partner?

A successful partner buyout requires all parties to remain on friendly terms. A business partnership buyout agreement is a contract between partners that details the terms and conditions of a partner leaving the partnership.

Business Partner Out, Example

Lee, Max, and Jaron are known in Pasadena, California, by their tech company’s moniker: Three Angels. The three friends and colleagues create iPhone apps and other programs and have enjoyed a decade of unprecedented success.

Lee is the programmer of the group, Max is the negotiator, and Jaron handles the finances and investments that have made the trio one of the most talked about Fortune 500 companies in California and across the country. Businesses all over strive to emulate the brains, vision, and technological savvy that Three Angels represent—and most companies fail.

As is often the case, the company is running perfectly until suddenly, it simply is not. Max and Jaron quickly identify the problem: Lee’s behavior. Always one of the more enigmatic partners, Lee seems to have lost interest in coding and programming and anything to do with the company. Lee enjoys the lavish lifestyle that the last ten years of 80-hour weeks have provided, but he has always focused on the next idea, the next app, the next example of tech wizardry. However, Lee’s passion has waned.

Jaron and Max meet privately and list Lee’s offenses. Lee is often late to work. He misses meetings and leaves early, sometimes for days at a time. Lee is still drawing the same profit from the company, but he is not dedicated anymore. Moreover, Lee is due to present a new idea at a big meeting in San Jose next month, and he now says he has no ideas and is not going.

Max and Jaron are worried about their friend, but they also agree they must do something. Lee isn’t happy, for one thing, but the business is suffering. The final straw occurs when Lee skips an important meeting with Three Angel’s largest client, Facebook, to go to Vegas with his brother.

Max and Jaron tell Lee they need to speak with him, but they are unsure what to say or do. What steps should they take, Jaron wonders, and how does the process of buying out a partner work? Max wonders if they should contact an attorney first and when they should look for a replacement. After all, even though their company is on the rocks, the business world hasn’t stopped. Their profits, contacts, and entire business future are in jeopardy because of Lee’s misguided, irresponsible actions. What should they do?

Regardless of the industry, all business partners must maintain a delicate balance. While their first goals are typically financial success and company longevity, getting along with their partners also plays an important role in the company’s balance.

man computer tech software programmer geek

Usually, business partners assign duties based on their partnership agreement. Company responsibilities usually correspond to partners’ talents and goals. For example, if Tom is a talented mathematician, he might take care of the books. On the other hand, if Tom’s partner Terry is more of a people person, he might deal with meetings and phone calls.

As business partners work hard and chase success, they must all play a part in the business’s day-to-day operations. However, sometimes one partner shirks their responsibilities or is not invested in the company.

Companies with determined, diligent partners usually succeed, while businesses with problematic partners begin to spiral downward. When one partner is not keeping up with the others, it is essential to speak with them and find out what is happening. Perhaps they are not interested in the company’s focus anymore, or they no longer want to be a partner in the business. Sometimes, business partners encounter unforeseen personal or family problems that divide their attention and interests.

If a company partner is not pulling their weight anymore, it is time to hold a formal meeting, speak to the partner, and make a vital decision. While it is important to let the errant business partner explain their actions or lack thereof, it is up to the business partners to decide what is best for the business.

Often, the company partners decide that enough is enough, and it is time to buy out one of the partners. But how can the partners accomplish this in a decisive, thorough, and straightforward way? Additionally, how can company partners keep the business on the right track while keeping their emotions at bay?

Partner buyouts must be fair, clearly outlined, and accepted by everyone. This clinical decision must be based on what is best for the partners, including the person on their way out. Instead, the partner or partners must base this decision on the business’s health.

This article will outline our top suggestions for buying out a business partner in an equitable, decisive, and compassionate manner. While we realize that buyouts are rarely easy, this article strives to provide clear instructions and relevant information regarding partner buyouts.

How do you approach buying out your partner?

This first step may seem simple, yet it rarely is. After all, communicating with a partner who may or may not know they are on the way out can be difficult. In addition, if a buyout occurs, the company may already be struggling, so stress may already be in the air. However, no matter how difficult it may be, verbally communicating with the problematic partner is in everyone’s best interests.

Set up a meeting with all the business partners depending on the situation. Do not approach the meeting casually, but bring evidence and have an established plan for how the meeting should proceed. If the partner agrees to meet with the other partners, the first step is out of the way. Here are a few additional suggestions for the buyout meeting.

Have a copy of the partnership agreement on hand. It is useful even if the partnership agreement does not cover a buy-sell situation or address partner buyouts. In many cases, the partner can be reminded of how they violated the initial agreement.
Contact an attorney, especially if the situation may grow emotional or unpredictable. Having a lawyer in the room gives everyone a sense of increased responsibility and creates a more civil atmosphere.
Have a plan. This meeting is not intended for small talk, but it is also not intended for accusations or doubts. Before the meeting, the partners planning the buyout should go over their intentions and be ready to tell the buyout partner what will happen next.
Prepare for the unexpected. Individuals may have made up their minds, but sometimes, people respond in strange ways when faced with the truth. The buyout partner might lie, grow angry, or apologize and promise to do better. This is why hard proof is so helpful in this situation.
Be sure to listen. There is a strong chance that your company partner is struggling in some way and could use a compassionate ear.
Separate friendship from what is good for the company.
Be clear in telling the partner how they have violated the partnership agreement and informing them of the terms of the buyout agreement.
Consider if the partner has violated their fiduciary duty.

All buyouts are different, and there is a chance that the partner will refuse to meet with the others. However, having a productive conversation is one of the best ways to begin the process for everyone involved.

Go Over the Company’s Founding Agreements

While corporations use articles of incorporation to form and ground the business, general partnerships rely on partnership agreements when they begin.

All business partners sign partnership agreements when the company is founded. These agreements spell out the responsibilities of each partner and how they are compensated and include other requirements and provisions. Ultimately, partnership agreements guide the partners’ behavior and actions and establish how the business is run.

There are two main reasons to consult the company’s partnership agreement when a buyout is necessary. The first is that the partner being removed has breached the partnership agreement in many cases. If there is evidence that a partner’s actions violate the partnership agreement, then the partners can use that evidence in conjunction with the partnership agreement to show that the partner must be removed. With evidence and the partnership agreement “in hand,” the case becomes much more straightforward.

The second reason is that partnership agreements sometimes include provisions and clauses for buyouts. If the company’s operating agreement or partnership agreement addresses how the buyout of a partner works, then removing the chosen partner is much easier.

Some buy-sell agreements exist as clauses in the partnership document, while other buy-sell agreements are separate documents. In any case, if the partners are buying another partner out, reviewing the buy-sell agreement if it exists, is crucial. We will detail buyout agreements in the next section.

As a reminder, not all companies have operating or buyout agreements, which can make buying out or removing a company partner more changing. Without a partnership agreement, it makes sense to review some examples of agreements online to see what other businesses may do in this situation. For more assistance, we also recommend contacting a business lawyer for help with the buyout.

In the next step, we’ll focus on creating or using the buyout agreement.

Go Over or Establish a New Buyout Agreement

Let’s break down what they usually cover for individuals unfamiliar with buyout agreements. Buyout agreements usually include:

The terms for buying out a partner in the business

Instructions for how the partner who is removed can maintain their ownership interest

The price of the buyout

Let’s look at a brief example to see a buyout agreement in action.

For example, Tegan, Mike, and Ray ran a shoe store in Redondo Beach, California. So when the three fashion experts started Shoes Don’t Lose, they included a buy-sell agreement in their partnership agreement.

After five profitable fiscal years, the shoe business took a hit, and sales waned. Plus, Ray decided he wanted to focus on a new career in video game software, which was his passion before he became interested in sneakers and flats. Ray was the hardest worker at Shoes Don’t Lose, and the most passionate, and his change of heart was unexpected for all involved, including himself.

Mike and Tegan scheduled a meeting with Ray because they could tell that his heart was no longer in the business. In the meeting, Ray admitted that he wanted to move on, but he wasn’t sure how a buyout would work or if it would be worth it for him financially. Ray was nervous, he said, to lose money not only in the buyout deal but on the business he had worked so hard for.

However, since a buy-sell agreement, also known as a buyout agreement, was in place, the three partners consulted it. The agreement was well-structured and fair, and together, Tegan and Mike were able to buy Ray out in a manner he appreciated. As a result, Ray moved to San Jose to work in the video game industry, and Shoes Don’t Lose added a new partner and climbed back up the ladder to success.

Although the meeting could have easily turned contentious, all three partners were able to rely on the facts, and they parted ways as friends. While this outcome is not always the case, a buyout agreement helps to make buying a business partner easier.

What if a Buyout Agreement Does Not Exist?

While Buy-Sell agreements are an intelligent idea, they can also prove to be challenging. Even the most experienced company partners cannot predict the future, and it can be difficult to set up a business not only for success but with anticipation of possible failure. However, Buy-Sell agreements are useful, and if the business partnership agreement does not contain one, then the partners can create a separate document.

If a buyout is on the horizon, it is not too late to late up a buyout agreement with the other partners. Unfortunately, many busy companies do not anticipate that a buyout will be needed and then struggle to create one on the spot. In this case, the best thing to do is to meet with the other partners, explain the buyout issue, and create a standard yet comprehensive agreement.

What Do Buyout Agreements Typically Include?

Buyout agreements feature the rules and procedures that must be followed, including but not limited to:

How payments will be made to the buyout partner
How will ownership be transferred
Additional rules and procedures that depend on the situation

Online websites such as Nolo feature standard buyout agreement templates that businesses can use as is or edit to suit them.

How Can Partners Estimate the Company’s Value?

Another challenge for business partners is estimating the company’s financial worth, especially when forecasting its future value. However, the partners must base a buy-sell agreement on the company’s price, and the partners must agree on the business value and the buyout price.

One of the simplest ways to determine the company’s price is by examining the business’ assets or past profits. These figures provide insight and inform the company’s assigned value, making it easier for partners to agree on a fair price.

Another helpful recommendation when determining company value is to get in touch with an experienced corporate attorney. A skilled business lawyer can help analyze the company’s value and examine future projections.

While there is no formula for evaluating the price of a private business, there are common steps that partners take, and we recommend them. These include:

Use methods such as book valuation, capitalization of earnings, or multiples of earnings to arrive at a fair price.
Figure out the complete value of all company assets, then subtract liabilities and debts
Compare the company to other similarly sized companies in like industries.
Do some research: what have other companies in your industry sold for?
Discount cash flow in enough time to view fair value
Consider the amount of the return on profits and investment if a new partner buys into the company, then use that number as an indicator.

Lastly, all buyout agreements should include the names of the people who will have the power to buy out a partner and the justifications for a buyout. These additions helped make the agreement official and recognized by the partners and in a court of law.

Lock Down Financing to Make the Partnership Buyout Easier

The existing partners determined the company’s value and identified how much ownership the buyout partner was giving away. Also, the partners have met and agreed to an impending buyout. They have already completed many difficult tasks, but financing needs to be secured.

Ask the partner who is leaving these questions:

How much would they prefer to be paid?
When would they like to be paid, and over what period?
Would they prefer one sum upfront or a payment schedule?

At this point, many businesses require a loan to complete the buyout. Individuals should contact lenders and banks they have used before for the best options. If these do not pan out, do some networking and find out how your fellow companies secured funding in buyout situations and if they were pleased with the process.

Sign the Agreements and Begin Making Buyout Payments

Sometimes during the last period of the buyout process, business partners lose their initiative and make silly mistakes. Do not let that happen to you. Instead, check over every document and make sure that every partner is on board. Here is a quick checklist:

Clarify every issue with the buyout partner and your lawyer
Make sure that all agreements are signed and understood
Ensure that all payment terms are understood, completed, and finalized

Make Sure All Administrative Tasks Are Completed

Lastly, there are a few more details to pin down. Partners should be sure to:

Update annual report filings to show the partnership change
Change the partnership agreement to include the new ownership structure.
Communicate the partnership changes to customers, clients, suppliers, and other organizations and people who depend on your goods or services
Let the company’s accountant know.
Let the company’s attorney know—though they already should
Decide if this buyout warrants a change in business structure.
Decide if any paperwork needs to be filed with the business formation agency in California to inform them of the change.

Continue to Speak With The Business Partner

In our last step, we return to the all-important first step and its emphasis on communication. We recommend continued communication with the buyout partner. For example, is the company aware of how involved the partner wants to be in the future?

We encourage partners working on a buyout to communicate openly about future expectations and goals. Obviously, for some, a buyout is a contentious affair full of emotion, and those partners usually desire to go their separate ways.

While some partners wish to sell their shares and move on, others still want to be a part of the company. Sometimes, a partner who is “bought out” only wants to lower their ownership percentage instead of cutting ties with the business forever.

If communication is at a standstill among partners, try using a mediator to enhance dialogue. Experienced, knowledgeable attorneys can also help to bridge the gap between partners.

How Can Nakase Wade Help Individuals Remove A Partner from a Partnership?

We hope that you have found this article illuminating and that it will help the anticipated buyout proceed smoothly.

Sometimes, buyouts occur easily. In some situations, one partner or more can buy out another partner without hassle or concern. However, buying out a company partner can also be a difficult process that causes emotional stress and even financial losses.

At Nakase Wade, our California business lawyers and corporate attorneys have successfully guided many professionals in the buyout process. We know the process can be challenging and time-consuming, not to mention stressful.

However, our attorneys willingly focus on your needs and priorities. Whether the buyout is routine and easy, volatile and demanding, or in between, we are there for you.

In our initial free consultation, our lawyers will listen to the reasons for the buyout. Then, we will examine the company’s documents and note all relevant details. Next, we will provide you with options.

Our motto is not to instruct clients on what to do. Instead, we provide choices. Every client is different, and every relationship among partners is unique. At Nakase Wade, our goal is to provide solutions and secure the buyout terms our clients seek so they can get back to what they do best.

Contact Nakase Wade today, and let’s tackle the buyout of your partner now, so you can keep your eyes on a bright future.

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