I saw a recent article in the NY Times where owners were lamenting their inability to buy out their partners. As one who has dealt with entrepreneurs for many years, I really empathized with some of these cases. It was particularly disappointing to hear of Partners who really could not work with each other but neither could afford to buy the other out. Perhaps the worst was the owner who gave substantial ownership to two Partners for some advice and connections in the early going. Now years later, while their contribution was a distant memory, their ownership remained. To me, this was not really a buyout problem but an unfortunate use of equity. I have probably blogged on this subject more than any other and it is painful to address it.
So, as your business grows, it is difficult to finance what I call the Big Three; namely increasing working capital needs, acquisitions and shareholder retirement. In fact of the three, financing sources despise the last item. In the first two, the money is hopefully acquiring something of value; not just going out the door to previous owners. In addition, the related accounting is usually just as bad; reducing the book value of the business. Talk about a double whammy.
Many (as this article did) suggest bringing in private equity and I have been involved in dozens of these transactions. It certainly is an alternative but it is naïve to think it does not come at an economic and times emotional cost. In many cases, dealing with your “new” partner is a lot different from dealing with the partner you are buying out. Please do not think of this in any way as an easy alternative. So what to do?
The best place to start is at the beginning with the old adage “don’t get into a deal unless you know how you are going to get out.” Think of the exit before you sign the deal and along with it succession. What happens under various scenarios? Start with the worst first; what happens if a partner dies; do you want to be in business with that partner’s heirs? Life insurance and non – voting stock are options that can be used to ameliorate this risk.
What about disability and who covers what that partner does? Again insurances and appropriate provisions can protect the company going forward. Pure liquidity for a partner who leaves remains as the issue. I am not a fan of providing liquidity and you can finance the buyout with a long term note (I have seen 10 -15 years) but there always has to be the provision that note payments cannot kill” the goose that laid the golden egg.” Selling basically becomes the other option and we are seeing that option in more agreements if terms of a purchase cannot be worked out. Price is also an issue and you can define it all you like; the only thing that works on basically all fronts is fair value.
So, this NY Times article would have had a much different tone had the owners considered their liquidity alternatives at formation. For the rest of you, the time has come today to address this before it is too late.