Buying Out a Partner or Selling to Your Co-Owner

Start with the agreement you already signed

Pull out the operating agreement, shareholder agreement or partnership agreement before you say anything to your partner. Most of these documents say what happens when an owner wants to leave. They may give the other owner a right of first refusal, which means a seller has to offer the share to the partner before offering it to anyone else. They may set a formula for the price, require an appraisal, limit how the buyer can pay, or put a waiting period on the whole process.

Some agreements contain a buy-sell clause that works like a forced bidding contest. One owner names a price, and the other must either buy at that price or sell at that price. Those clauses are fast and have a reputation for fairness, though they favor whichever owner has easier access to money. A partner with a bank line and a patient family can use one to squeeze out a partner who cannot raise the cash.

If there is no agreement, or the agreement is silent, the default rules of the state where you are organized apply, and those vary. Your attorney should read the document, tell you what it requires, and flag any part that conflicts with what you and your partner understand. It is common to find that the agreement has been amended informally, by conversations and habits, in ways that do not match the paper. Settle that before you negotiate.

Also look at who signed what. Banks, landlords and major customers often have personal guarantees or consent rights that tie to the current owners. Those documents decide how easy it will be to change the ownership, and we will come back to them below.

Agreeing on what the business is worth

Valuation is the center of nearly every partner buyout, and it is where the relationship takes the most damage. Each owner has a view of what the company is worth, and each view is shaped by which side of the deal they are on. The leaving partner hears the number as a verdict on years of work. The staying partner hears it as the price of continuing alone.

The cleanest way through is to hire one independent appraiser both sides accept, and to agree before the work starts that the number is binding or at least the starting point. If each side hires its own, you will often get two numbers far apart and an argument about method. Some agreements handle this by averaging two appraisals or bringing in a third to resolve a gap. Our post on what a business is worth covers how valuations are built and why different methods give different results.

Pay attention to the earnings being valued. In a partnership both owners often draw compensation, expenses run through the company, and some benefits are paid for family members. The valuation will adjust for these, and the staying owner and the leaving owner may disagree on which adjustments are fair. Read our guide on add-backs before you sit down together, so you share the same vocabulary.

Think about how the value splits when one partner contributes more than the other. If one owner brings the customers and the other runs operations, the departure of the rainmaker may change the value of the company, and the price of that share may reflect the risk. Discounts for a minority interest, or a premium for control, are debated in these valuations and your appraiser will explain how they work for your company.

Paying for a share nobody can afford in cash

A partner buyout often fails at the financing step. The business is worth a lot, but the staying owner does not have that kind of money, and the company cannot pay out the cash without hurting its own operations. Several approaches are common.

The most common is a note from the buyer to the leaving partner, paid over a period of years with interest. This lets the company fund the payments from future profit. The leaving partner should ask for security, such as a pledge of the purchased shares, and for information rights while the note is outstanding. The staying partner should confirm that the payments can be made in a slow year.

Another approach is to bring in a lender. A bank or an SBA loan can fund part of a buyout, because the transaction increases the staying owner's ownership of a company with a proven earnings history. The lender will want to see the historical financials, the agreement, the valuation and a plan for the business after the departure. Our guide to SBA loans in business acquisitions is useful even for an insider purchase.

A third option is for the company itself to redeem the departing owner's shares, using its cash or borrowing. That changes the company's balance sheet and may have different tax effects than a purchase by the other owner personally. An accountant should compare the two before you commit, because the difference can be large and it depends on how the company is organized.

Some partners structure part of the price as a payment tied to future results. If the departing owner leaves behind customers or a pipeline of work, the price may depend on whether those customers stay. Keep the formula plain, define the period, and agree on how the numbers will be reported.

When the partnership is already damaged

Owners who no longer trust each other face a harder version of the same process. If you can barely talk, the temptation is to rush a deal that ends the relationship quickly. That may cost you money. A rushed valuation, a vague agreement and a short payment schedule are the usual ingredients of a lawsuit a year later.

Bring in a neutral person. This might be a mediator, an advisor who works for both sides on the sale, or a mutual friend whom both of you respect. Have your attorneys talk to each other so you do not have to. Keep the business functioning in the meantime, because customers and staff notice when two owners stop speaking, and the value you are fighting over can slip while you argue.

Be careful about what gets said to employees. If one owner tells a few staff members that the other is leaving and the other has not agreed, you can lose people before the deal is signed. Decide together what the staff are told and when. Our post on when to tell employees applies here, too.

If the two of you disagree about whether to sell to each other at all, consider the third option of selling the whole company to an outside buyer. A sale of the entire business sometimes brings a higher price than either owner could pay, and it gives both of you the same exit. It requires both partners to cooperate for the length of a sale process, which can run many months, and our post on how long it takes to sell a business sets reasonable expectations.

Guarantees, leases and the bank

The least discussed part of a partner buyout is the paper that ties the departing owner to the company after the sale. If you signed a personal guarantee on a bank loan, an equipment lease or the building lease, your signature stays on those documents until the lender or landlord releases you. The buyout agreement between you and your partner does not bind them.

Ask for releases as part of the deal. The staying owner may need to refinance the debt in the company's name or in their own, or offer the lender other security. Landlords and banks do not always agree, and they sometimes want a fee. If a release cannot be obtained, the departing owner should ask for an indemnity from the buyer and for security behind it, such as the right to take back the shares if payments stop.

The company may also need to remove the departing owner from bank accounts, insurance policies, licenses, vendor accounts and credit cards. A license that is held in one owner's name may need to be changed or reissued before the other can operate. Rules vary by state and by trade, and your attorney confirms what applies.

Make sure there is a clear cutoff for who is responsible for what. Debts and liabilities that arise before the closing date, including unpaid taxes, should be allocated in the agreement. If an audit or a claim arrives a year later, both sides should know who pays.

What the departing owner should do next

Finally, ask what the departing partner will do afterward. Will they compete? Will they hire away staff or customers? A non-compete and a non-solicit agreement are standard in partner buyouts and should be written to be fair and enforceable where you operate. Our guide to non-compete agreements in a business sale walks through what is typical.

Now, this week, read the agreement, list the guarantees you have signed, and write down the number you would accept and the number you would pay. If those two numbers are far apart, get an independent valuation. If they are close, a good attorney and a clean agreement may be all you need. And if the discussion shows that neither of you wants to buy the other, Business Advisors of America can help you sell the whole company on terms that work for both owners.

This article shares our opinion and general information. It is not legal or tax advice. Always speak with a licensed attorney for legal advice, and a qualified tax professional for tax questions, before you act.