Business Valuation in Partner Separations
Almost all court cases require certified business valuations
Business partners may decide to buy out one another for any number of reasons. Your best choice may be to sell your stake in the business--either to your business partner or to a third party--and move on. Whether the buyout transaction is motivated by retirement, a life-changing opportunity or due to personal differences between partners, the valuation of the outgoing partner's interest needs to be calculated. Valuation calculations frequently incorporate discount rates, control premiums, and discounts for lack of marketability.
Get an objective opinion
A certified valuation gives an objective idea of what the business is worth and to make sure buying out your partner will be a good long-term investment. This independent valuation will offer a starting point to negotiate a fair price for your partnership buyout.
Reference the existing buy-sell agreement and valuation formula
Frequently, partnerships will enter into a buy-sell agreement well in advance of a buyout transaction. This will establish a simple formula for calculating the value of the outgoing partner's interest, often a certain multiple of net earnings or partnership revenues. These agreements are designed to prevent prolonged buyout negotiations and mitigate disputes from arising regarding valuation matters.
Establish the outgoing partner's share of cash flow
If a partnership does not already have a buy-sell agreement in place, it must arrive at a valuation agreeable to the parties. A critical element of business valuation is free cash flow to the owners. Thus, identifying net cash flow from operations after capital expenditures, depreciation, and nonrecurring revenue and expense items is key in calculating a partnership buyout.
Cost of capital discount rate to future cash flows
In calculating the value of an outgoing partnership interest, its share of future cash flows should be discounted back to present value. Thus, the appropriate discount rate is important for determining the proper valuation range. The discount rate is a complicated and rather technical subject. It typically represents the average cost of capital for the partnership, including a debt component and an equity component.
Valuation multiples of revenues and earnings
Another valuation method is applying standard industry valuation multiples to either partnership revenues or net earnings.
Look into partnership buyout alternatives
Before you move forward with buying out a partner, don't forget to consider alternative options. Particularly if the business valuation comes back lower than you expected—or if you find that your financing options for a buyout are limited—you may be better off simply dissolving the partnership and starting anew. If you're determined to continue with the current business, but your partner has lost interest, you could also consider changing the weighting in the partnership agreement. This would allow you to retain primary control of the company's decisions, finances and liabilities without the upfront cost of buying out your partner completely.
To save the partnership, the roles of the partners need to be more carefully defined, separated, and respected, and better coordination needs to be established. Part of the redefinition of roles should reduce the partners’ equality in the day-to-day management of the company. The partners may share equally in the rewards, but one partner should be persuaded to focus on an area of specialization—sales or engineering, for example—while the other takes on the responsibility of chief operating executive. It is possible to take a step to enforce the new roles. The operating-executive partner may report to an augmented “executive committee,” “board of directors,” or some such designated body that includes an outside third person. The third person should be more than a tie-breaker, however. He or she should bring skills to the overall direction of the company that will gain the respect of the partners.
Bringing in a CEO from the outside can be a good solution. Turning to a hired CEO can be appropriate, particularly if partners recognize that the complexity of their jobs exceeds their abilities. No one need be at fault for this to happen. Indeed, to have grown a partnership to a size requiring skilled, experienced management is a measure of success. Likewise, stepping aside from the management of a business you have inherited is preferable to remaining while the business crumbles around you.
Many business owners find that creating a payment plan with the partner you're buying out, similar to a loan repayment plan, is the most affordable way to achieve a buyout. In this set-up, your former partner would likely collect an additional percentage of equity, beyond the principal equity owned by them according to the partnership agreement, as interest on your private loan. In order to achieve such a mutually agreeable solution, both partners must be willing and able to dissolve the partnership amicably. If you've developed a hostile relationship your other half may not be so willing to make the buyout process easy for you, or could back you into a corner with an over the top interest rate.
Once the terms have been negotiated and all parties are on board with the new agreement, you're ready to make your buyout official. Make sure you file all necessary paperwork with federal, state, and local authorities; then transfer all business related accounts, making sure the former partner's name is removed from all accounts. Correct paperwork to release the former partner from business liability. In the best of circumstances, you'll be able to negotiate a buyout agreement that is a win on all sides. But if conflict arises or the relationship ends less than amicably, keep things civil and move your business forward from the best possible position.
Ending a partnership is not unlike a divorce, so it's natural for sensitivities to come up. But the more positively and professionally you can remain, the more quickly and easily you may be able to complete the buyout process and get back to building your business.