Save Money and Pain by Planning the Business Partner Breakup Ahead of Time
An old adage says that partners are great for dancing and playing bridge—but not for going into business. Unfortunately, in many entrepreneurial ventures, the day arrives when the partnership needs to end. Typically, this business partner break-up means one founding partner buys out the other(s).
Any time that happens, it’s an emotional and painful experience. It’s often very personal. Someone may have started a business with a childhood best friend, college roommate, or family member. So, it can be extremely difficult to unwind when the partnership runs its course. However, the process can be far smoother with proper planning and strategies.
Key Takeaways
- Create a partnership agreement from the start to outline clear terms for a buyout.
- Use proven methods like market price valuations, earnings multiples, or the two-envelopes method to determine fair value.
- Avoid unnecessary conflicts by planning ahead and consulting professionals.
Breaking up a partnership doesn’t have to mean breaking the bank—or burning bridges. By planning for the end at the beginning, you can ensure a smoother transition and preserve your business’s future.
Common Reasons for Business Partner Breakup
Business partnerships can dissolve for various reasons:
- One partner is contributing significantly more than the other.
- Partners have differing visions or goals for the company.
- One partner is unable to scale their skills as the business grows.
Another example I saw firsthand in my work with the CEO Project was when a business was started by three partners: two of the founders in technical roles, and the third ran the commercial side of the business. As the business proliferated over time, the technical partners failed to elevate their thinking, and their ability to contribute to the business faltered. The result was that the commercial partner decided to buy out the other two founders. Their partnership didn’t make sense anymore.
But that begs the question: how do you break up a business partnership?
Steps to Plan a Business Partner Buyout
Ideally, any time you start a business with someone else, you have a partnership or operating agreement that maps out exactly how you can unwind the partnership—explicitly laying out how one partner can buy the other(s) out. Think of it like a business prenup.
Here are three common methods to determine the buyout value:
- Market Price Valuation
Hire a professional appraiser to assign a value to the business based on market trends and similar transactions. For fairness, some agreements may require valuations from:
- The buyer
- The seller
- An independent third-party
The final selling price is often the average of the three values. While accurate, this process can be costly as formal appraisals aren’t cheap.
- Earnings Multiple
A second way to set the selling price for the business is to decide ahead of time on a multiple of earnings. In other words, you might say the price will be three times earnings. The downside of this approach is that the price could be too high or too low based on how the market has evolved since the agreement was signed. Someone might end up with the short end of the stick.
- The Two-Envelopes Method
Things can get tricky in unwinding the partnership if multiple partners want to keep the business. In other words, no one is willing to sell, even as everyone recognizes that the partnership is ending.
One way to address this scenario is to use the “two envelopes” method. As the name implies, each partner in the business writes down the number they are willing to pay for the business and places it in a sealed envelope. When the envelopes are opened, the highest bidder wins.
This approach is often an effective way to get every partner to put their money where their mouth is to state what they think the business is truly worth.
What Happens Without a Partnership Agreement?
Breaking up a business partnership can become messy and expensive without a formal agreement. Disputes can even escalate to court battles over assets like office equipment or intellectual property.
I remember visiting Denver with my son, where we spent a few hours watching a court case involving two partners in a law firm fight over how they should divide the assets of the law firm they started together. They were arguing over who got the desks and filing cabinets. It wasn’t pleasant. Can you appreciate the irony that two lawyers of all people neglected to establish an agreement when they started their business?
The most common scenario that results when two partners don’t have a prenup and also can’t agree on who gets to keep ownership of the firm is that they sell the business altogether.
I have also seen situations where companies have brought in equity partners willing to buy a majority stake in the business, which could allow the founding partners to remain minority owners. But it’s often more straightforward for everyone to cash out and go their separate ways.
That’s why the best advice about buying out a business partner might be to not have one in the first place.
