Funding to Buy Out a Business Partner

Start with the agreement, not the financing

Check your partnership or operating agreement first, because it may already set the price formula, the payment terms and who has the right to buy.

Many owners sign a buy-sell clause years ago and forget it. It may specify how the business is valued, whether the remaining owner can buy first, how quickly payment is due, and what happens in a death, disability or dispute. Following it avoids lawsuits.

If there is no agreement, you are negotiating from scratch. Hire an attorney before you discuss price, since the paperwork will define taxes, liability for old debts, non-compete terms and what happens to the partner's personal guarantees. An accountant should weigh in on tax consequences, which can vary a great deal by entity type. This page covers financing only and is not legal or tax advice.

How to value the share you are buying

Common valuation approaches use a multiple of earnings, asset value or both, and a neutral appraiser can settle disagreements.

The price drives everything else. Small business valuations commonly look at annual owner earnings multiplied by a factor that varies by industry, plus the value of equipment and inventory, minus debt. The multiple is where owners disagree.

Example, illustrative: a business earns $240,000 a year for the owners before owner pay is adjusted. Suppose you and your partner agree on a multiple of 2.5 times earnings, giving a business value of $600,000. A 40% share is $240,000. That is the figure to finance, pay in installments, or some combination.

If the two of you cannot agree, a third-party valuation costs money but avoids guessing. Get it in writing, and make sure both sides accept the method before the numbers are known.

Five ways to pay for a buyout

Buyouts are usually paid through seller financing, company cash, outside financing, a mix, or a staged purchase over time.

1. Seller financing. Your partner accepts payments over years, with interest. Often the cheapest, and it keeps their interest aligned with the company's success.
2. Company cash. The business redeems the shares from its own cash flow. Only works if cash is plentiful.
3. Outside financing. A bank acquisition loan or an SBA loan may be an option, though it takes longer.
4. Blended. A down payment from financing, the rest from seller notes.
5. Staged. Buy 20% a year over several years to keep payments small.

ROI Funder does not place acquisition loans. Where a buyout is part of the picture, we can discuss term loans or working capital for the business itself, but the file must qualify on the business's own revenue and use. Read our guide to acquisition loans for how those loans work.

Can the business afford the new payment?

Check that owner earnings, after the buyout payments, still cover your own pay and a safety margin.

Continue the example. A $240,000 buyout financed over five years at a total repayment of $290,000 is about $4,830 a month. The company earned $240,000 a year for both owners, so $20,000 a month. After buying the partner out, you take home the full $20,000 minus the $4,830 payment, or $15,170. Before the buyout, you shared $20,000 and took $10,000. So you are better off even after payments, assuming earnings hold.

That assumption is the risk. Partners sometimes bring clients, skills or relationships that leave with them. If your partner generates a large part of revenue, earnings may fall after they go. Stress test with earnings down 20%. Use the stress-test guide for the steps.

Lender-side issues to expect

Funders will ask about the ownership change, personal guarantees and whether the departing partner's debts or obligations stay with the company.

Expect questions on:

• Who signs. A departing partner's personal guarantees on existing debt may need to be released, and lenders may or may not agree.
• Bank accounts and signers. Update them as soon as ownership changes.
• Existing financing. Some agreements treat a change in ownership as a default trigger. Read them.
• Cash flow. Bank statements before and after the change help show stability.

ROI Funder considers 500+ FICO, 6+ months in business and $20,000+ in monthly revenue, with funding from $5,000 to $5,000,000. The application is online with a soft credit pull and no obligation.

Protect yourself in the paperwork

Put the price, payment schedule, security, non-compete and release of liabilities in a signed agreement reviewed by your attorney.

Points worth negotiating in writing:

• What happens if you miss a payment, including any cure period.
• Whether the seller keeps any security interest in the shares or assets.
• A non-compete and non-solicitation for a reasonable time and area.
• Release from existing obligations and a division of any known liabilities.
• How customer and vendor introductions will be handled.

A clean exit is worth paying a lawyer for. Disputes after a buyout cost far more than the legal fees.

Finally, plan how you will tell employees, customers and vendors. A buyout that is handled quietly and clearly protects relationships; one that leaks creates rumors about the business closing. Agree on a joint announcement and a transition schedule before the paperwork is signed, and make sure the bank signers, domain names, licenses and insurance policies are all updated on the closing date.