A business partner buyout is a pretty common thing to do. However, if you don't know how to buy out a business partner or do not have a previously outlined partnership buyout agreement, the whole process can get overwhelming and messy quickly. Before buying out a business partner, you need to have a solid understanding of buyout agreements, the legal and financial requirements that go along with the process, and more.
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The Importance of an Advisory Team in a Business Partner Buyout
A business partnership buyout is a process that is fraught with difficulty and emotion. From the moment the decision is made by one partner to buy out the other, it can be difficult to maintain a level head. It can be tough to set aside emotion and look at the facts. This is where an advisory team can be invaluable.
An advisory team can provide a wealth of information and expertise during a business partner buyout. The first and most important role is to help set the facts aside and offer a clear and unbiased evaluation of the situation. This can be a huge benefit when emotions are running high. An advisory team can also provide various other services, such as helping with partnership buyout accounting; searching for a business buyout loan; ensuring that the process follows all local, state, and federal regulations; and so much more.
If you’re considering buying out a partner in a partnership, then contact Cueto Law Group today. Our team of advisors can help guide you through the entire process and ensure it’s done by the books and benefits all parties involved.
Here’s How to Buy Out a Business Partner
Buying out a partner can be a highly complex process. It’s essential to know precisely what you are getting into. Whether you're looking for tips on how to buy out a partner in an LLC or buying out a partner in a small business, here are six crucial steps you'll want to follow:
- Consult a business attorney
- Determine the value of your partner’s equity stake
- Review your partnership agreement/partnership buyout agreement
- Understand the tax implication of buying out a business partner
- Explore all your partner buyout financing options
- Finalize the business buyout
If you're ready to learn how to buy out your business partner, then make sure to keep reading.
1. Consult a Business Attorney Before Getting Started
There are many moving parts to an organization. Each piece is crucial to your company’s success, but some elements may cause more confusion than others. When it comes to the best way to buy out a business partner, it's highly discouraged to go at it alone.
Instead, you should consider consulting with a business attorney before initiating the process. A business attorney can help you:
- Initiate the conversation with your partner(s)
- Explain partnership buyout accounting
- Understand the tax implication of buying out a business partner
- Outline your options for a partner buyout loan/financing, etc.
Working with a business attorney can also help you ease any tensions and help de-escalate any potential issues that may arise should the process become toxic for either party.
Contact the team at Cueto Law Group today to get started with buying out a business partner.
2. Determine the Value of Your Partner’s Equity Stake
Equity is an integral part of running a company. When a person invests in a company, they are investing in the potential future profits. The more equity a company has, the more valuable that company is.
Alternatively, the more money that a single partner invests into the business, the more significant share of the company that person owns. During partnership buyouts, you and your business attorney must determine the value of your partner's equity stake. The value of your partner's equity stake is the amount of money they are entitled to receive in case of a partnership buyout or the sale of the company.
To ensure that your partner is receiving their fair share during a partnership buyout, you and your business attorney should negotiate the value based on several factors, such as the company's current value and each partner’s share. The easiest way to approach this is using a partnership buyout formula.
Partnership Buyout Formula
The standard partnership buyout formula will help you and your attorney determine the fair value of your partner's equity stake in the company. The formula takes the appraised value of the business and multiplies that number by the percentage of ownership your partner has in the company.
Ex: Partner owns 45%, and the company is appraised at $1 million. That would look like: 1,000,000 x .45 = 450,000. So, their share would be $450,000.
3. Carefully Review Your Partnership Buyout Agreement
A partnership agreement is an important document that outlines the rights and responsibilities of each partner in the company. It will detail operating procedures, the amount of equity each partner owns, and outline any other important rules and regulations.
Each partnership agreement should also include a partnership buyout agreement section. This section will outline the process that should be taken when a partner wishes to buy out the other partners. A partner buyout agreement will detail the buyout terms, how to figure out the fair share owed to each party, and should outline the step-by-step process that should be followed to complete the buyout process.
Partnership buyout agreements are a crucial part of any partnership agreement because they protect each party involved and can help reduce tensions and conflicts that may arise between the partners.
4. Familiarize Yourself with the Tax Implications of Buying Out a Business Partner
When a business owner decides to buy out a co-owner, they have to be aware of the tax implications of doing so. Buying out a partner can be a taxable event for the business owner. The IRS can determine whether or not a partnership buyout is a taxable event based on the size of the business.
The IRS defines a small business as having less than $500,000 in annual gross receipts. If a business owner buys out a partner that owns a small business, then the buyout is likely not a taxable event. If a business owner buys out a partner that owns a large company, then the buyout is likely a taxable event. This means that the business owner will be responsible for paying taxes on the amount of money they received in the buyout. This is referred to as a Section 381 transaction, and because it is such a complex topic, it should be discussed with an accountant or a tax advisor.
The tax implications of buying out a business partner include, but are not limited, to the following:
- The business owner may need to pay taxes on the amount of money they received in the buyout.
- The business owner may need to pay taxes on any income generated by the business after the buyout.
- The business owner may inherit any tax liabilities the business partner had before the buyout.
If you have any questions regarding the tax implication of buying out a business partner, contact the team at Cueto Law Group. We would be happy to help you understand your options and answer any questions you may have.
5. Explore Your Partner Buyout Financing Options
With a plan of action at the ready, it's time to explore your partner buyout financing options. There are several ways to finance a partner buyout, including acquiring a loan to buy out your business partner, self-funding, and even writing out a financing plan to directly pay your partner over a specific timeframe. Whatever method you choose should be run by your business attorney to ensure that all necessary rules and regulations are met.
Self-Fund the Buyout
A self-funded buyout is when a buyer finances the buyout of a business partner on their own without the help of a third party. By self-funding the buyout, the buyer can mitigate some of the risks related to financing the buyout, such as paying interest on a loan. However, the buyout is still much more expensive than if a third party funds the partner buyout loan.
Apply for an SBA 7(a) Loan
One of the most popular ways to finance a partner buyout is through an SBA 7(a) loan, which is a loan guaranteed by the Small Business Administration. The SBA 7(a) loan is one of the most popular business buyout loan options for a partner buyout because it is designed to help small businesses, which means that the SBA 7(a) loan is more likely to approve financing for a partner buyout than a bank. An SBA 7(a) loan is usually more favorable than a bank loan because it comes with lower interest rates and easier terms.
Partner Buyout Financing
Another viable alternative to a loan to buy out a business partner is through a partner financing plan. This method is often used if the buyout is amicable and there is still significant trust between both parties.
Instead of going through a third party to finance the buyout, you and your partner set up terms to which the leaving party agrees. Depending on the terms of the contract, you may be able to pay for the buyout with installments over months or several years.
However, even a deal between friends can cause tension. So, before opting for this option, seek the advice of your business attorney from Cueto Law Group.
6. Finalize the Business Buyout
Once you have finalized the business buyout plan with your partner, it's time to have all parties agree and sign all necessary documents. In a business buyout, this usually means that a buyer and a seller have their respective lawyers finalize a buyout agreement that outlines the terms and conditions of the transaction. Both parties (and their legal representation) will then sign off on the transaction.
Our Final Thoughts on Buying a Partner Out of a Business
As a business owner, buyouts can be complicated and challenging to navigate. However, if you are looking to buy out a business partner, it is essential that you know your rights and understand your options.
Whether you need assistance with a business partner buyout or need a reliable partnership disputes lawyer, the team at Cueto Law Group is here to help.
Contact our team of skilled attorneys today, and we’ll help you along this venture.
