Auctus article originally published on Home Business Magazine
Many small business success stories begin with two or more friends teaming up to start a business. Other times it’s colleagues from a big company deciding to break away and do it on their own. Whatever the case may be, inevitably, there comes a day when one owner decides to depart before others — and owners are often unprepared for a partner buyout.
How can business owners prepare? Here are key considerations to help ensure partners are ready for a buyout.
Buy-Sell Agreement: It is surprising — even shocking — how many businesses do not have buy-sell agreements in place. In fact, nearly three out of four owners lack documented succession plans.1
The first step in partner buyout readiness is creating a buy-sell agreement. The agreement, at a minimum, is designed to protect owners and the company in the event of death or disability of an owner. Even if the time has not yet come, documented plans help outline key details up front (such as who can buy into the company and how the process will work), while providing opportunities to discuss and plan for possible scenarios — including co-owners who may agree on different terms for life-time transfers.
Valuation: How much is the business worth? It’s always a central issue, and there is never a perfect answer. Even in scenarios that begin on amicable terms, competing interests can sour the process.
Owners who have not put a realistic assessment to their company’s value could be in for a surprise when a partner decides to depart. Both company and partner metrics can influence the valuation. If the selling partner is highly valuable to the business, they could demand a higher payout. At the same time, non-controlling interests in a business are less valuable and discounts usually apply to minority interests. Maintaining a current sense of company value is important.
Payment Terms & Financing Options: Almost as important as value are payment terms. It is uncommon that a company can fund an up-front cash buyout. Whether the payout is structured as a lump-sum payment, buyout over time or an earnouts, it must meet the needs of both the departing owner and the cash flow needs of the company.
The purchasing owner should calculate a conservative assessment of the company’s ability to service debt. Leveraged companies may have difficulty financing a buyout on terms that meet the departing partner’s needs. To structure a solution that will be satisfactory for all, buyout terms and financing is a critical element where planning as far in advance as possible is necessary.
Building the Team: If the departing partner plays a key role in company operations, it is of course important to be sure the team can pick up and carry on without them. This often cannot be done on short notice. Transitioning key relationships and responsibilities may be the element of a partner departure that takes the longest time to execute.
The Second Exit: The current exit of one partner may be a daunting process, but it can’t overlook the future exit of the remaining partners, especially in the case of the two-owner firm. Partner buyout readiness is often a multiphase process. The second exit needs to be planned at the same time as the first exit, even if not expected for a period of time.
The Happy Ending: As in all undertakings, there should be a clear vision of the definition of success from the beginning: what does a happy ending for all partners look like? Once that is understood, it is a lot easier to work toward a plan that makes it happen. Whether it’s decades from now or years away, driven by ambition or necessity, careful planning and support from investment banks undoubtedly ensure the best results with fewer obstacles.
Auctus Capital Partners exists to help businesses identify opportunities and navigate their way through complex business transactions, maximize value and achieve favorable outcomes. Contact Auctus to learn more about advisory services and solutions provided to clients.
1 PWC’s 2019 US Family Business Survey