I had a call the other day with a fellow entrepreneur who needed some advice about how to move forward with her relationship with her business partner, or if she should move forward at all.
For some background, she and her partner have worked together on their business for a couple years, and were 50/50 equal partners. In the last year or so, the roles and responsibilities had seemingly fallen almost entirely on my client, even though they are still equal partners. After dealing with the imbalance for months, my client decided she wanted to either dissolve the company or buy her partner out. So she called me for advice on what direction to pursue, and how to handle that process.
The first question to answer was, do they want to break up entirely or simply redistribute the equity? Just because things aren’t going well as 50/50 partners, doesn’t mean that maybe 80/20 wouldn’t work better and be more equitable. She decided it would probably be best to split entirely (aka 100/0) to keep things fair and simple. That made sense to me, so then we had to ask the next question. Should she buy her partner out, be bought out by her partner, or dissolve the business entirely?
There are pros and cons to each of these paths. The simplest pros of dissolving the business are that there is no more legal entanglement between the partners, and the assets (if any) of the business can be divided evenly. The biggest con would be the loss of any value created by the existing business (brand name recognition, website URL/SEO, social pages, etc) as well as the time and expenses associated with setting up a new entity should either party want to continue operating a business in their space.
We talked and decided that since she wanted to continue to operate a business similar to the one they run together now, it would likely be best not to dissolve. So with that decision made, the question becomes how do you buy out your partner?
There are a lot of factors that go into deciding what a business as a whole is worth, and thus what a fractional share of that business is worth. You can use standard and relatively objective valuation processes to come up with a number that is “fair” to both parties. For example, a really common way to value a business is either a multiple of revenue or a multiple of profits. If your business makes $250k a year in revenue, and $50k a year in profits, it might be that the business is worth 1X revenue ($250,000 x 1 = $250,000) and/or 5x profits ($50,000 x 5 = $250,000). In this basic example, both valuation models yield the same result, and thus, this is likely a “fair” valuation.
The hard part, the subjective part, is which valuation methodology do you use? Every industry is different. Every business is different. Software businesses tend to be worth more than retail businesses, even with identical financial performance. Lifestyle businesses, like the one my client and her partner run, don’t tend to have much value outside of the time and efforts of their owners, because if the owners go away, the clients/customers go away. So they tend to sell for little to nothing. And like all things in life, something is only truly worth what someone else is willing to pay for it. Nothing is ever truly “fair”, and so the only way for the deal to be fair is for both parties to agree on how to move forward.
So with all that in mind, I suggested that she offer to buy her partner out, using a simple financial multiple of either profits or sales (profits tend to be better representation of value/more fair), but with the caveat that if her partner agrees to a number, that number has to be an amount which the partner would buy my client out for. Why would we do this? Because it’s only reasonable that the partner is going to want the largest buy out number possible, regardless of how fair it is, especially since the split is somewhat contentious. By forcing the partner to “put their money where their mouth is” they have to be willing to accept an offer that values the business at a price they are willing to pay for the business. If I want $10,000 for my half, but wouldn’t pay $10,000 for you half, then the business is not really worth $20,000, is it? Doing this exercise might lead them down the path to realize that the business itself isn’t really that valuable at all without either of them working on it, and therefore, the best split may literally just be half of the cash in the bank account.
She also asked me about valuing their inventory. While the inventory may have some intrinsic value, unless it’s something you could liquidate or sell in a single transaction to another buyer/competitor without a ton of time or effort, it only really has value if the business is going to continue to be operated by one of the partners, and that future value is already being captured by the sales/profit multiple. Otherwise, it’s likely worthless. I also suggested that they could literally split the inventory and raw materials 50/50 if it made sense. But, I wouldn’t suggest that she pay her partner any additional money for the inventory.
The last thing we discussed was the piece I felt was ultimately most important: their relationship. While she and her partner aren’t family or even best friends, they are friends, they have mutual friends, and they live in the same town together. Breakups are hard whether they’re business or personal. The more amicable, honest, and supportive both parties can be during their breakup, the better off both of them will be. I advised her to truly understand her partner’s perspective on this situation, and think of ways for them to collaborate so that they both can save face and keep their relationship healthy. If they see this situation as a failure, as a fight, as messy, or as negative, so too will other people, which will make their social and professional lives harder. I may be an outlier on this, but I would rather lose money and/or be taken advantage of than be seen as a snake, an opportunist, a liar, or an asshole. My reputation and relationships are worth more to me than money, and I do what it takes to protect those, even if I get “screwed over” on a business deal.
We ended the call with a recap of how to possibly value the transaction, and most importantly, how to keep value in their relationship. Like any advice, I know that it’s easier said than done, and that she’s about to have some hard conversations. But she and I agreed that in the long run, they will all be better off for it, and once it’s settled, she can get back to focusing on doing what she loves: serving her customers.
If you or someone you know has a business problem you’re stuck on, grab some time on my calendar and hopefully I can help you too get unstuck.