Key Considerations for Partner Buyouts

Written By: Matt Lore, CVA and Todd Kutcher, CVA
(3 – 5 minute read)

In a partner buyout, one or more existing owners of the business purchase the shares or membership interests of the selling owners. On the surface, most partner buyouts appear to have similar structures as the remaining owner(s) will continue to operate the business, likely causing minimal changes to the business operations and the company’s financials.  However, there are numerous factors that should be considered carefully that can impact the value of the company.

The following are key considerations to assess when examining a partner buyout transaction:

What are the responsibilities of each owner?

If the departing owner(s) of the subject business are active in daily or weekly operations, then it is imperative to assess the need for replacement hires. If the subject business plans on promoting existing employees, then additional salary costs must be taken into consideration.  Additionally, there may be significant personal or professional goodwill associated with the departing owner(s) that may impact future revenue and earnings. For example, in a professional services business (CPA, doctor, dentist, lawyer, etc.), the departing owner may have long term relationships with clients and/or have specific expertise that could result in client attrition once the departing owner leaves the business. Lastly, lenders should ensure an appropriate non-compete agreement is in place for the departing owner, to reduce the risk of this person starting a competing business after the buyout has concluded. For more information concerning how owner responsibilities can impact a business’s value, please see the previous SBAValue article, Owner’s Responsibilities Have a Major Impact on Value.

Is there any shareholder-related debt outstanding?

When considering a partner buyout, it is crucial to carefully evaluate the impact of shareholder debt on the proposed transaction. Shareholder debt refers to any outstanding loans made between existing shareholders and the company or other existing shareholders. If these loans will be continuing obligations of the company post-closing, then the loan terms and global repayment ability to service all outstanding debt should be properly assessed. Furthermore, shareholder debt that will be a continuing obligation of the business will decrease the company’s value. Likewise, any shareholder loan assets (loans due to the company from the owners) should be analyzed, and repayment terms understood, as they have the potential to affect business value.

How will the proposed sale be structured?

A partner buyout is structured as a stock sale, in which the purchasing owner acquires the ownership interest of the departing owner. Typically, all operating assets and liabilities will transfer to the new owner. However, this should be confirmed – occasionally, certain items will not transfer, which can impact the value of the business. For example, a vehicle used by the departing owner (and any associated liability) may not transfer. If this vehicle was used in the company’s operations, a replacement cost for a comparable vehicle should be considered, which would reduce the company’s value. Occasionally, cash from the business will be distributed to the departing owner prior to, or concurrent with, the closing of the transaction, which would reduce the cash available to the remaining owner(s) and reduce the value of the business. Overall, an understanding of the deal structure is needed to determine an accurate value.

What about partial changes of ownership?

One change to the 7(a) loan program concerns partial changes of ownership. Previously, only complete changes of ownership were permissible to receive SBA loan funds. Starting with SOP 50 10 7 (pg. 98; pg. 128), for Standard 7(a), 7(a) Small, and SBA Express, partial changes of ownership are permitted. Loan proceeds may be used to fund the purchase of a portion of one or more owner’s interest in the business or of the business itself. Both the business and the individual owner(s) who are acquiring the ownership interest must be co-borrowers on the new loan. Additionally, the seller may stay on as an owner, officer, director, stockholder, key employee, or employee of the business. As of the publication date of this newsletter, there have been no changes to the business valuation requirements for partial changes of ownership, compared to complete changes of ownership. The factors mentioned above (owner responsibilities, shareholder debt, and deal structure) should still be carefully considered to ensure an accurate valuation.

Partner buyouts play a vital role in maintaining business continuity and growth. Departing owners may wish to leave the business for a variety of reasons – including retirement, new business opportunities, disagreements over the business direction, etc. Every potential deal must consider the departing owner’s roles and responsibilities at the company, shareholder debt, and deal structure. New SBA rules allow for partial buy-ins of outside individuals, which may provide additional opportunities for lenders. It is important that lenders and appraisers consider each of the above issues to ensure an accurate value and compliance with SBA lending guidelines.