Most entrepreneurs form partnerships when running their businesses mainly to act as leverage in the long-term thriving of the business.
A partnership allows them to share profits, liabilities, and management operations. However, in due time, these partnerships may likely run their course due to the need to venture on sole business ownership, financial constraints, or a partner may move away or is ready to retire.
That said, most turn to partner buyout financing after doing some networking and research to ensure business continuity and success.
Keep reading the article to understand the meaning behind partner buyout financing and learn more about partner buyout financing pros and cons and other alternatives.
What Is Partner Buyout Financing?
In business terms, partner buyout financing is the capital or money a business partner requires to buy their other partner’s ownership stake in the enterprise.
Please note that for a partnership buyout to occur, the buyout clause should be incorporated in the initial partnership agreement with clear rules that define the process. The clause allows the partners to exercise their buyout interests without restrictions.
For example, here are a few reasons behind the partnership buyout:
- Sole ownership. A partner may decide to own the business fully. Thus, with the buyout clause in motion and a mutual agreement in place, integrating a partnership may help one of the directors or partners become the sole owner of the enterprise.
- Mutual split. Sometimes a partnership may not work out well for both parties. So, following a peaceful discussion or a dispute, a business partner may end the partnership by selling their shares to the other.
- Retirement. Suppose you are in a partnership with an old business partner about to retire. They can sell their shares to you in preparation for retirement.
Irrespective of other buyout reasons, a business’s changeover and continued achievement likely depend on the partners’ mutual agreement to proceed with the process.
Understanding the partner buyout financing pros and cons is important. The decision for one partner to retain the business partnership can be challenging as it requires finances to ensure the optimal operation of the business.
That said, despite the process becoming very expensive, the good news is the partner can turn to partnership loans, personal reserves, or sell their partner’s shares to investors to ensure the partnership buyout is a success.
Pros of Partner Buyout Financing
The following are a few pros of partner buyout financing:
Allows You To Continue Running the Business as an Owner
As an entrepreneur, starting over a new business after the dissolution of another can be quite challenging. Thus, knowing what is at stake and if you have the passion for continuing with the current business venture, buying out your partner can prove beneficial.
With the available funds, you can retain and run the business as you see fit and avoid a buyout or a total business dissolution.
Allows You To Buy Out a Damaging Business Partner
Sometimes, business partnerships grow sour. For instance, partnerships may fail because not all partners share the same vision and reasons for existing in the business. Some may lean more toward making money than prioritizing quality and business collaborations, while others resent their business partner for slacking.
Such emotions and feelings towards each other can undermine the business. However, the good news is the partner buyout financing option enables owners who value quality and customer satisfaction over quantity to get back the business that matters to them.
Allows You To Retain Financial Flexibility
There are many options you can use as an entrepreneur, including taking out partnership loans and using self-funds to make the buyout.
However, the cash flow reduction is the main disadvantage of considering self-funding for your partner buyout. The buyout may likely be expensive, necessitating you to use a lot of your money, hence reducing your financial flexibility to manage your business.
However, with a partner buyout loan, you can still have the chance to buy out your partner. It also allows you to use your reserves to make valuable investments in the company and increase your creditworthiness with the loan lenders, ultimately retaining your financial flexibility.
Cons of Partner Buyout Loans
Below are the main disadvantages of partner buyout financing.
Expensive Loan Interests
Partner buyout financing, especially partner buyout loans, is quite expensive. Regardless of the lender you choose, having a long repayment period often means the loan interest rates will be high.
Thus, you are likely to pay more to the lenders, a lot more than you bargained for when buying out a partner.
Lack of sufficient collateral for small business enterprises may exclude you from obtaining financing.
For instance, in the case of partnership buyouts, you may lose valuable assets to the business. Though your business may survive in the long run, your partner’s absence may likely affect the business’s future sales.
Such reasons may make it hard to qualify for bank loans because they are unprepared to deal with businesses with no collateral.
Other Options to Finance Partner Buyouts
Now that we’ve gone over the partner buyout financing pros and cons, you may be looking for other options.
To make a partnership buyout, your partner hopes to walk away with the equivalent capital to their half of the business. Thus, you are required to make up for the difference.
Although it may seem like a simple process, in hindsight, it can be an expensive and challenging endeavor.
That said, there are other ways to finance partner buyouts. They include:
- Equity financing. You can send your partner’s shares to investors to raise the capital needed for a buyout.
- Self-funding. You can use your savings and funds to buy out your partner.
- Debt funding. You can take out additional loans, such as the SBA 7(a) loans, and accrue more debt but get the funding needed to make the buyout possible.
- Merchant cash advance. The option allows the borrower to receive a lump sum, repayable with a percentage of the business profits. Though expensive, it can finance your partnership buyout.
Businesses facing a partner buyout do so for many reasons. Going with the partnership buyout route can prove beneficial and challenging regardless of the situation. However, no one said it would be impossible.
With the varying options and alternatives to finance partner buyouts, you do not have to worry about your bank denying your loan application. Instead, your decision to make the partner buyout solely depends on your drive to see through the process and the money to back it up.
An Outsourced CEO and expert witness, Jim Thomas is the founder and president of Fitness Management USA Inc., a management consulting, turnaround, financing and brokerage firm specializing in the gym and sports industry. With more than 25 years of experience owning, operating and managing clubs of all sizes, Thomas lectures and delivers seminars, webinars and workshops across the globe on the practical skills required to successfully overcome obscurity, improve sales, build teamwork and market fitness programs and products. Visit his Web site at: www.fmconsulting.net or www.youtube.com/gymconsultant.