The Finances Behind Breaking Up with a Business Co-Owner
May 27, 2020
Starting a business on your own isn’t a simple proposition. Even if you know what you’re doing, the workload is enough to drive you crazy. Burnout is a real thing, and it’s enough to sink a new CEO and their business along with them. That’s why most entrepreneurs choose a good business partner to help share the load.
But not all business partners are good business partners, and it’s not easy to tell a bad fit from a good one until you’re already invested. In fact, 80 percent of business partnerships eventually fail, according to a study by Forbes. If you want to be one of the 20 percent that make it, you’ll need to be able to identify the warning signs.
What a Bad Partnership Looks Like
A bad partnership is surprisingly common, despite people’s best efforts, and the consequences can be dire. What’s the worst-case scenario? How about in 1999, when NASA teamed with Lockheed Martin on a Mars orbiter satellite. The organizations didn’t communicate well, so they missed the fact that while NASA uses the metric system, Lockheed uses imperial. Their coordinates didn’t line up, so when they tried to send the orbiter to Mars, they just missed. Your business partnerships may have lower stakes than a $125 million Mars mission, but a bad partnership is still a real problem.
There are a few red flags to look for in a business partner. First, look for uneven contribution. You and your business partner should have diverse but overlapping skills — maybe you know the financial side while your partner is a product designer. But when one partner doesn’t bring enough to the table, you need to find someone who does.
You should also have a partner that shares your values — and “wanting the business to succeed” isn’t good enough. You need to agree on what the company stands for, how it does business, what kind of people it hires, what kind of clients it works with, and so on.
You need a partner with whom you can solve problems in a civil and productive way. You need a partner who’s honest and doesn’t have major conflicts of interest between the success of your business and anything else they might have going on. You need a partner you like.
Finally, you need someone you can trust. No doubt you’re a very capable business owner, but that doesn’t mean you can do everything forever. If your partner isn’t someone to whom you can hand off the reins when you’re not around, you don’t have a partner — you have another employee to manage.
Is Removing a Partner the Best Option?
The first step is making sure that getting rid of your current partner is the right step. Cutting a partner out of your business is a big step — potentially an expensive and ugly one — so make sure it’s the right call. Can you restructure the way the business is run? Or maybe you’d be willing to sell out your own stake in the company? If you’re nearing retirement age or just stressed out by business ownership, now might be a good time to cut your losses.
Check the Operating Agreement
We’ll cut right to the chase — the partnership agreement is king when it comes to separating an existing partnership. If you’re thinking of starting a business or buying into one, a strong partnership agreement should be your number one priority. This is why.
If your operating agreement covers how one partner can force out or buy out another, then the discussion is over. Just follow protocol and your partner will have to sell out their stake whether they want to or not. In that case, the sticking point might be valuation. Your operating agreement should have a valuation clause that helps you determine what your partner’s share is worth — valuation can be contentious, so if you can put it on paper to avoid the argument, all the better. If you don’t have an operating agreement that covers valuation in the event that you part ways with your partner, you’ll have to negotiate.
Forms of Valuation
Hopefully, you and your partner aren’t at each other’s throats and can come to an amicable solution for valuing each person’s shares and deciding how the business will operate going forward. If things are a little more testy between you, you’ll have to pursue legal action or mediation.
In that case, the judge or mediator might enforce a “Russian roulette” buyout — a fairly drastic solution for when other ideas haven’t worked. Remember when you were little and had to split a treat with your sibling? One person cut the cake and the other person got to pick their piece? This is basically the same principle.
Partner A chooses a number — let’s say $5 million for half the business. If Partner B thinks the company is only worth $7 million, they can sell their stake for the $5 million and make a tidy profit.
If they think the company is worth $15 million, they can buy Partner A’s stake instead for $5 million — a relative steal. The idea is to incentivize Partner A to make a fair offer since they don’t know whether they’ll be buying or selling.
A “Texas shootout” is another aggressive option that a judge or mediator might force you into. In this case, each of you submits a sealed bid stating the price at which they’d be willing to buy the other partner’s shares. Whoever submits the highest bid wins, and the lower bidder is forced to sell.
After the Split
The biggest thing to remember after splitting with a business partner is that your business debt doesn’t go away. A lot of small business loans are based on your personal assets as collateral, so when your partnership is severed, the terms of your loan are likely to change pretty dramatically.
In some cases, the bank will even demand that you pay a significant chunk of your remaining principal immediately, so you’ll need to have the cash on hand for that when the partnership is officially over.
There might also be political blowback from splitting with a partner. Maybe your partner will found a competing company or start bad-mouthing you to the clients they signed, costing you business. Maybe investors will see your split as a sign that your business isn’t doing well and be hesitant to keep funding you. In either case, honesty is the best policy. Tell your shareholders, your investors, and your customers what happened and why. Get ahead of the story.
Is It Worth It?
Buying out a partner, whether they want to be bought out or not, can be a complicated process. What you need to decide is whether it’s worth it. If your business is going in a different direction, you don’t see eye-to-eye on the future of the company, or you simply need a better helping hand, a buyout might be the best way to go.