How To Buy Out A Business Partner

Planning a Breakup Ahead of Time Will Save Everyone a Lot of Pain

There’s an adage that partners are great for dancing and playing bridge—but not necessarily for going into business together. Unfortunately, many entrepreneurial ventures launched by more than one founder eventually reach a point where the partnership needs to end—often with one founding partner buying out the other(s).

No matter the circumstances, buying out a business partner is rarely a smooth process. It’s emotional, it’s painful, and in many cases, it’s personal. After all, many businesses start with a strong bond—whether it’s childhood friends, college roommates, or even family members going into business together. When those relationships unravel, it’s like untangling a web of emotions and business interests that have intertwined for years. And as with any breakup, there’s a lot of room for missteps and miscommunication. However, with proper planning, you can avoid some of the pitfalls of dissolving a business partnership.

Why Partnerships End: It’s Not Always About Failure

There are several reasons business partnerships can break down, and it’s not always about the failure of the business itself. The company could be thriving in many cases, but the partnership no longer makes sense. Perhaps one partner has significantly more drive or ambition than the other, or maybe one partner has invested more time and energy into the company. In contrast, the other enjoys a more hands-off approach. It’s also possible that the business has outgrown the capabilities of one partner, and their contribution has diminished over time.

A classic example is my work with the CEO Project, where I witnessed a business founded by three partners. Two of the founders were experts in their technical fields, while the third handled the commercial aspects of the business. As the company proliferated, the technical partners struggled to keep pace with the expanding scope of the business. Their expertise, once crucial, was now limiting the company’s ability to progress. In the end, the commercial partner decided to buy them out. It wasn’t a hostile takeover but a natural evolution as the business demanded new skills and leadership. The partnership no longer aligned with the company’s future.

So, how do you navigate this tricky process? How do you prepare for the inevitable need to unwind a business partnership?

Plan For the Breakup and Business Partner Buy-Out From the Start

As unromantic as it sounds, the best way to handle a partnership breakup is to plan for it right from the beginning. Any time you start a business with someone, having a well-drafted partnership or operating agreement in place is crucial. Think of it as a business prenuptial agreement that outlines exactly how you’ll dissolve the partnership if or when the time comes. This foresight can save both parties from endless disputes, emotional turmoil, and potential legal battles.

Here are three standard methods you can use to lay the groundwork for a future buyout:

1. Market Price Valuation: One option is to agree at formation to use a neutral appraiser to value the business based on the market. The appraiser’s job is to assess the value of the business and compare it to similar companies in the industry. In some agreements, the buyout process might require three valuations: one from the buyer, one from the seller, and one from an independent third party. The final price could then be an average of these three appraisals. The upside to this method is that it provides an objective, data-driven approach to setting a fair price. However, this method can get expensive, especially when multiple appraisals are needed.
2. Earnings Multiple: Another approach is to base the buyout price on a multiple of earnings. For example, you might agree in advance that the business is worth three times its annual earnings at the time of the buyout. This method can be more straightforward and quicker than a full appraisal. But there’s a downside: the multiple may no longer reflect the business’s actual market value when the buyout happens. The market could have evolved, leaving one partner with the short end of the stick, either paying too much or receiving too little based on outdated figures.
3. The “Two Envelopes” Method: When multiple partners want to keep the business, things can get complicated. If no one is willing to sell, but everyone agrees that the partnership should end, the “two envelopes” method can come into play. Here’s how it works: each partner writes down the amount they are willing to pay to keep the business and places it in a sealed envelope. The envelopes are opened, and the highest bidder wins. This method forces each partner to put their money where their mouth is. It’s a straightforward way to get partners to agree on the business’s value without endless negotiations.

When There’s No Agreement: Navigating a Deadlock

Now, let’s talk about what happens when there’s no partnership agreement in place, and you’ve hit a deadlock. Unfortunately, this situation is far too common. It can lead to protracted disputes and even lawsuits. Without a pre-agreed process to dissolve the partnership, emotions often run high, and things can get ugly.

I’ll never forget a court case I witnessed in Denver, where two law firm partners were battling over how to divide their business assets. These two lawyers, of all people, had neglected to create a dissolution agreement when they started their firm. The case dragged on for hours as they fought over desks, filing cabinets, and paperweights. It was a stark reminder that even the most educated and experienced professionals can make the mistake of not preparing for the end of their partnership.

When partners cannot agree on how to proceed, the most common outcome is to sell the business entirely. This can be tough, primarily if both partners have invested years of hard work into building the company. But selling the business allows both parties to walk away with their share of the proceeds and start fresh.

Another potential option is to bring in an equity partner to buy a majority stake in the business, allowing both founders to remain minority owners. This solution can provide some continuity while allowing both partners to resolve their disagreements. However, this isn’t always ideal, and often, it’s simpler to cash out entirely and go your separate ways.

The Bottom Line: Avoiding Partnerships Altogether

So, what’s the best way to avoid the pain and heartache of buying out a business partner? The simple answer: don’t have one in the first place.

Of course, that’s not always realistic. Partnerships are often formed because two or more individuals bring complementary skills, resources, or ideas. But it’s worth remembering that partnerships, like marriages, require constant communication, compromise, and shared vision. And just like marriages, not all partnerships last forever.

If you do go into business with a partner, make sure you’re prepared for the possibility that things might not work out as planned. Have a well-drafted agreement from day one, outlining exactly how you will buy out your partner if or when the time comes. Think of it as planning for a rainy day, knowing you’ll be ready with your umbrella if and when the storm comes.

Ultimately, business partnerships can be rewarding and highly successful but also fraught with challenges. By preparing for the eventual end of the collaboration from the beginning, you can save yourself a lot of headaches—and possibly even salvage a friendship along the way.