Almost everyone can relate to knowing someone, maybe a close friend or family member, who has been through a divorce. Maybe you’ve been through a tough personal breakup at some point in your own life. The experience can leave you feeling frustrated, angry, and exposed. It’s equally as difficult to separate our emotions from fact and fairness during these times. The same can be said of business partnerships where often more money is at stake. As a business valuation expert with over 20 years’ experience, I’ve worked with both types of business owners. The ones who’ve been fired from the business and considering accepting pennies on the dollar for their shares and the owners who are frustrated with their partner and contemplating offering to pay multiples higher than reasonably supported by the market and cash flows of the business.
One of my most memorable clients was Matt, an owner of an organic food distribution company. Matt started his business five years ago with his life savings. One year into the business, he offered ownership interests to three new partners in exchange for their industry experience and customer relationships. Each new partner received 20 percent interest in the business while Matt retained 40 percent. With the help of Matt and two of the new owners, the company grew quickly into a multi-million dollar business. The company earned national accounts and became recognized for its strong customer relationships. Behind the scenes, frustration was mounting as the third new owner had not once brought in a new client to the company. They ultimately decided to fire this partner and redeem his shares.
Luckily, the partnership agreement called for a valuation of a separated partner’s shares by a certified valuation professional. That’s when I received a call from Matt. He explained the situation and his hopes for redeeming the shares at an equitable price so he could move on and hopefully avoid a costly legal dispute. Matt, like many other owners, proceeded to tell me what he thought a fair price would be, which was about $1.0 to $1.5 million for 20 percent in the business. He based his valuation on a rule-of-thumb he had heard about from one of his longtime friends who also owned a business. What Matt didn’t know was that the rule-of-thumb given to him was generic and likely based on a business of a different industry with a different fact pattern. After a thorough valuation engagement, the estimate of fair market value of a 20 percent interest in the organic distribution company was $450,000. The valuation was based on long-standing and accepted valuation methodology, including the income and market approaches.
Matt was taken aback. He couldn’t believe he was close to paying over two to three times what the shares were worth to his partner. Like Matt, owners who want to separate from their partner are often willing to accept much less than what their shares are worth because they lack the right information. If you find yourself in the situation of letting a partner go or maybe you’re the partner who’s being let go, you’ll want to consider these top three tips to improve your chances of receiving an equitable valuation and payout in exchange for your shares in the business.
Top 3 Tips for Parting with Your Partner
- Read your company’s buy-sell agreement.
If your business does not have a buy-sell agreement, then you’ll be looking for a provision in another company document, such as the articles of incorporation or partnership agreement, for information regarding what happens if one partner voluntarily or involuntarily leaves the business. Other helpful information may also be included such as how redeemed shares should be valued and when will the separating partner receive the payout (i.e., over time or one lump sum). Who will conduct the valuation? As of what date will the company be valued (i.e., last fiscal year-end or quarter-end)? Whatever you do, don’t accept or offer a payout for interest in your company without knowing what the organization documents specify.
- Hire a certified business appraiser.
You don’t want to rely on a rule-of-thumb calculation to value the ownership interest to be redeemed. You’ll want to hire a certified business appraiser. Avoid hiring your CPA. You want to engage with a business appraiser who is certified in conducting business valuations and who is unbiased. Your CPA will likely not be certified in business appraisals and may be perceived as biased by the separating partner. You can find a certified valuator by visiting the National Association of Certified Valuators and Analysts’ online directory. Assuming you have an amicable relationship with your partner, you should first consider having a conversation to explain the current situation and the different options for proceeding. The most cost-effective route for many is to jointly hire a certified business appraiser to value the interests to be redeemed. This approach can avoid expensive attorney fees and court costs. It also usually facilitates the timeliest resolution for all partners. If an amicable relationship with you partner is unattainable, then consider Tip #3.
- Consult with an attorney.
Find a lawyer who is familiar with privately held businesses and share redemptions. Confirm the attorney has experience working on similar cases. Layout the facts and express your wishes, such as an equitable payout to minimize legal costs. Depending on your situation, the attorney may recommend directly engaging with a certified business appraiser to ensure attorney-client privilege or the recommendation may be for you to hire the appraiser directly.
Remember, your ownership interest in your business is likely your largest asset. Don’t settle on a rule-of-thumb calculation. Know your business worth and protect it.
About the Author
Shelia Darby is a Managing Director of BizWorth, where she leads the valuation and economic modeling practice areas. Shelia brings over 20 years of experience in valuation and financial modeling covering both domestic and international projects and companies. Prior to BizWorth, Shelia served as the Assistant Treasurer of Transocean and held various valuation and finance roles at ConocoPhillips. She is a Certified Valuation Analyst (CVA), holds an MBA from Rice University and a bachelor’s degree from Baylor University.