My partner wants to leave: what are my options?
Advice welcomed & appreciated:
My partner and I run a small staffing agency business. We are only 3 1/2 years old. After about a year in business, I brought on a partner to help grow the business. He invested $20,000 and took a 30% share in the company. I am the majority/final decision maker with 70% of the company, and I entered a personal investment of $46,666.
Between year 1 - year 2 our revenue increased by 150%.
Between year 2 - year 3 our revenue increased by an additional 54.8%.
And so far, between year 3 - year 4 our revenue is set to increase another 10%.
In 2016, we made $160,000 net income. We put the full $160,000 in our pocket.
In 2017, we made $310,000 net income. We put the full $310,000 in our pocket.
(Stupid I know... but we had our reasons)
...my point being we have no assets. There's next to nothing in the bank other than what we need to run (we are serviced based, so we don't need much to run). We do not own property or machinery - maybe a couple of laptops and that's it for assets. Other than rent and some obvious bills, we have no debt or major liability.
My partner wants out, and wants top-dollar! No major disagreement, just bored and wants to move on to something else. He is looking for a big offer on his 30%. He has no interest in maintaining the 30% - he wants cash. He actually asked for $100,000.
Our partnership agreement contains no formula for calculating a buyout. New business owner mistake on my part! So we simply need to come to an agreement. I feel we cannot afford anywhere near $100K.
Neither of us wants to put any money into lawyers or analysts if we don't have to. So here I am...
How do we do it?
How much do I owe him?
Given the short 2 years he's been a part of the business, can I simply offer him his $20K investment back + his share of the income for this year?
Is his investment actually a part of his equity in the business? Are partners entitled to that back, or does it no longer apply?
Have we made enough growth as a company in less than 4 years to really have value? Should this be based on a business valuation or should it be based on his equity?
If we can't agree, and I decide to 'not' buy his 30% share - can he sue me? Can I be forced by the courts to buy that back? Or can I make an offer and if he refuses it, just let him keep his 30% and tell him he'll get a check on any profit at the end of the year? Would he have to be content with that if he refused my offer?
Thanks everyone for your help. I'm really enthusiastic to see your responses and appreciate you giving up your time.
- Marc
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Jun 21, 2018
Hi Marc,
I see your quandary. You have no retained earnings to set a value on your company as you took out your profits annually. You have no assets to add in for a company valuation. Sales in a company should increase by an appreciable component, min. 15-18% or be considered stagnant and the start of a decline. Customer turnover averages 15% annually in most industries. The first 5 years make or break the continuity in whether a company is viable and having any future beyond the 5 year demarcation period. This could be why your partner wants out?
As the sales are set to decline at only a10% increase in sales from your previous levels of levels of 150% followed by 54.8%? Then it could be argued that your business is losing value despite past take home money.
Both partners have made their money back and received their investment in cash.
Therefore you are left with the age-old value of goodwill, which is most often less than zero for a company less than 10-15 years. Loyalty in customers is transient in general.
An exception would be long-term contracts held in good standing by the company which could hold value. The equation would work out this way - if 50% of your business is with less than 10 companies then the loss of those contracts for whatever reason could kill your business and any future of the company - a negative factor. Assume a 30-40% loss on your big contracts and 20% on lesser contracts per year (which you individually have to replace at twice the work). Now, what is the value of the company revenue over the next 5 years? One approach is to take lowered/ corrected revenue (as above) then calculate 30%/2 ( only 1 partner to work for the company) and assess the net value of established contracts from that. Only the presently held contracts have value in this negotiation. New contracts are yours alone.
Assume you will lose your top three revenue contracts then ask yourself how you can replace that income, if you can, and who you will hire to replace them and at what cost. Now you should have a working value of the company and present contracts if you decide to retain the company.
Another solution is to start another company scooping up your good contracts to reestablish. At 4 years it's your good name, not the company that holds value. And there is always a 50/50 possibility your partner is planning this despite any non-competition clauses in your contract. Contracts are costly and ineffective to enforce if it is enforceable at all. 30% of the pie may not be enough for your partner.
Whatever number you come up with for his 30%, be prepared to sell 20% (so you at 50/50 partners) or 70% (your portion) at the same rate. Be fair.
Upfront payouts may not be possible or even recommended for either of you. Consider capital gains. and the need for lack of competition for you both. Why not offer x% of sales of your company over next 5 years (on a declining basis?), which would be equitable and encourage your partner's interest in keeping present contracts going. And this decreases the likelihood that your partner will open up a competitive business to yours.
Best of luck. Remember it is your 70% sweat equity started the business and built growth. Your partners lack of participation can be hidden but crucial. Whatever experience your partner offered in the relationship has now been compensated by your on the job experience. Do you want to keep your partner? Then sweeten the pot. If not, make it yours but be cautious with existing contracts that can always be arbitrarily canceled.
Jun 20, 2018
As a 70% owner, you are definitely in the driver's seat and without a buy/sell agreement, you have many options to buy your partner out. He is not in any position to put pressure on you.
A business valuation is based on a multiple of the net profit in the last fiscal year and the projection for future earnings. A rough estimate of the worth of your company would be at least $600,000 (2Xprofits). So his asking settlement of $100k is cheap.
At an income of $300,000+/year, you have more than enough cash flow to offer him an ample monthly payment over a period of twelve months.
If your partner insists on the full amount up-front, almost any lending institution should be willing to lend you the $100k based on your stellar revenues and cash flow. You will need to submit your financial statements and budget.
If you wish, you can easily find an investor to buy and replace your partner because you would be offering an outstanding ROI on the investment.
Jun 25, 2018
Thank you George - great insight.
In your opinion does it change anything to his $100K if I need to hire an employee in his place, to do his day job. What I did not mention is that he and I each contribute a full work week. When he leaves, I need to find someone to look after his division, something that will cost me about $60K-80K in wages per annum? That's the tough part for me because we do not have any additional cash flow.
I'm also trying to figure out if he can file for a valuation appraisal case through the courts should we not reach an agreement. But I'm not sure if that only applies when companies merge. Trying to research that currently!
Jun 20, 2018
If I had a 30% partner in a business netting $310,000 in one year and he asked me to buy him out for less than 1/2 the one year net, sounds like a reasonable ask. If you can keep it going on similarly without him - you get to keep all the net profits for years and years - and not need to share. I write business plans, so I'm not into legal aspects. Just what makes sense. Your $46,000 and his $20,000 makes nets over $310,000 - and you can have the entire thing for $100,000??? You brought him in to grow the business and grow it did. Think about it. Keep him happy.
Jun 25, 2018
Thanks Charlene, nicely put. I certainly see your point. Appreciated! He certainly did grow the business... however, he also wanted to take out all profits from day 1... this left us with no retained earnings and no growth to our capital account.
What I did not mention is that he and I each contribute a full work week. When he leaves, I need to find someone to look after his division, something that will cost me about $60K-80K in wages per annum? That's the tough part for me because we do not have any additional cash flow. Do you think that changes anything?
Jun 20, 2018
Hi Marc,
I would start with getting a valuation of your business. You can do this through an independent valuation firm, like a specialized CPA. From there, you can get an unbiased number of what the business is worth.
Buying out partners can be costly, and doesn't always make sense mathematically. I would advise that before you make this decision, explore other options like dissolving the partnership. This would allow you both to go your separate ways without the need for buying each other out.
If you are dead set on continuing the business and your partner wants out, you might want to consider a small business loan to buy out his share (once you know what their share is worth).
Jun 20, 2018
As a follow up to this, I just found this on Business.com. Maybe it will help you find a valuation. https://www.business.com/business-report/
Hi Elsa, I really appreciate you taking the time to provide this thorough response... 'thank you!' So kind of you.
You are correct; we have no retained earnings and we've taken all our profits out. Technically the business still has his $20,000 initial investment/equity in cash - although I could argue we did spend a portion of this getting his division started (desks, computers, phones, etc). The one part you mentioned that I feel holds significance is that he does work a full work week running his department. We are a small business - there is no other staff. I would say that his department does being in about 40% of our total revenue and he has two major clients/contracts. He does all the work/day job associated with those contracts. When he leaves... I will need to hire a senior-level manager to do his day job. This will cost about $60-80K per annum. Is that something I can deduct from the final buyout? Is that fair to do?