By 2030, all Baby Boomers will be 65+ and millions are already retiring every year. This movement is known as The Great Retirement or Silver Tsunami. As these business partners retire, the remaining partner(s) have the opportunity to buy out the departing partner’s share. It is essential for all partners to plan for a buyout in as much advance as possible to ease the transition.
What is partner buyout financing?
Funding from a lender used to purchase the ownership stake of another partner.
A big component of the partner buyout is financing to compensate the departing partner for their share in the company. Often, the partners have a buy-sell agreement that outlines procedures and compensation when a partner leaves the business. The intent is to repay the departing partner for the equity they initially put in the company and compensate them for the value of the business built from that equity. In other words, the partner buyout is the value that the business would earn if a third party purchased the selling partner’s percentage of the company.
What are the types of partner buyout financing?
Three common types of financing include: lump-sum, phased buyout, and earnouts.
What are the types of partner buyout financing?
There are three common types of partner buyout financing, each with pros and cons for the buying partner(s) and selling partner. It is imperative that all partners work with legal counsel to draft the agreements for partner buyout financing to ensure a smooth transition.
Lump-sum – Just as it sounds, a lump-sum is a single large payment to the selling partner for 100% of their share in the business. A lump-sum payment is uncommon and can be difficult for the remaining partner(s) to finance, particularly if the valuation of the business is high. A more common approach is for the buying partners to pay a percentage of the value up front, with the remainder of the payments to be paid as seller notes.
Phased buyout – In the phased buyout method, the selling partner sells portions of his or her ownership over a set period. This method eases the financial strain of a lump sum payment for the buying partner(s) and eases the transitionary period as the selling partner takes a decreasing role in the company.
Earnouts – If the selling partner chooses to stay with the company for a transition period, the deal may be financed by the earnout method. The selling partner often receives a percentage of their payment upfront and the rest of the value is paid out over time when certain performance metrics are met. The belief is that by requiring the departing partner to “have skin in the game,” the company is less likely to suffer financial loss from the departure.
The value of a partner's share depends on the equity contributed by the partner, the company's value at the time of the buyout, and the number of partners.
How do you calculate a partner’s share?
A partner’s buyout share depends on factors, such as the amount of equity the partner contributed to join the partnership, the company’s value at the time of the buyout, and the number of partners in the company. The Revised Uniform Partnership Act (RUPA) establishes a partner’s share as the value of their percentage of the partnership’s total property less the percentage of any partnership liabilities as of the day the selling partner leaves. This formula determines the percentage of the partnership that belongs to the selling partner, but the price the partner receives for that share varies.
How much is a typical partner buyout?
While the RUPA and many buy-sell agreements define the percentage of partner share, determining the company value at the time of sale may be challenging, even in an amicable buyout. The selling partner wants a greater payment, while the remaining partners want to reduce the payments to lower their costs. One way to determine the buyout price is for each party to present their estimate of the company’s value and choose a value in the middle. Another option that may cause less conflict is for both parties to split the cost of a third-party valuation. Once the company’s value is determined, the selling partner receives their share of the value based on the perimeters outlined in the buy-sell agreement.
Where do you get financing for a partner buyout?
Many traditional banks avoid offering partner buyout loans. From a bank’s perspective, a partner buyout can damage the company’s health and may negatively impact the company’s viability. However, specialty lenders see the value in funding a partner buyout. For example, Oak Street Funding has helped hundreds of businesses like yours with partner buyout financing. We’ll help you fulfill the transaction with a loan based on the future cash flow of your business. Loans can be structured as a one-time event or a multiple-year partner buyout. Contact us to learn more.
Disclaimer: Please note, Oak Street Funding does not provide legal or tax advice. This blog is for informational purposes only. It is not a statement of fact or recommendation, does not constitute an offer for a loan, professional or legal or tax advice or legal opinion and should not be used as a substitute for obtaining valuation services or professional, legal or tax advice.
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