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Getting a loan to buy your business partner out
Buying out a business partner can be a simple and inexpensive process if both partners are amicable, or a complex and expensive process if one partner disputes the buyout arrangement.
As much of their own finance may be tied up in their share of the business, owners will often seek business finance to cover the cost of the purchase. The options available and the process are generally quite similar to getting finance to buy a separate business.
Let's take a look...
What is a business partner buyout?
A business buyout refers to the process of buying or selling shares owned by a partner or shareholder of a business. Most shareholder or partner agreements will disclose the mechanics of how a buy out should work and also how the business is to be valued in the event of a buyout.
Business partner buyouts may happen for various reasons. Most commonly, buyouts occur when one business partner is retiring or looking to start a new business or in disputes.
Other reasons for partner buyouts include...
- The business’s partnership agreement expires
- A partner can no longer legally own the business
- A partner declares bankruptcy
- A partner passes away
- The business applies for bankruptcy or insolvency
- Majority shareholders want to remove minority shareholders from the business
Shaun McGowan, Money's loans expert
These situations can be amicable or hostile, and understanding the process around a partner buyout can limit the financial strain and personal stress while the partnership is dissolved. Having the buyout structure included in the shareholder agreement (SHA) will help keep emotion out of buyout, particularly if there are areas of dispute.
Shaun McGowan, Money's loans expert
How to finance a partner buyout
Before initiating the buyout process, it's important to understand how you will finance the purchase.
There are two common ways to fund a business partner buyout:
Secured business loans
To apply for a secured business loan, you’ll need an asset to use as collateral. This could be a personal asset, such as your own home, or a business asset.
Secured business finance has a number of benefits, including lower interest rates than secured loans. However, there is a degree of risk as you could lose the asset if you cannot repay the loan.
Unsecured business loans
You could also use an unsecured business loan to finance the buyout. You won’t need an asset to secure the loan and the funds can be used with fewer restrictions compared to secured finance.
Instead of an asset, an unsecured business loan is assessed and granted based on business revenue. In other words, you'll need to be able to demonstrate to the lender that the business can sustain sufficient cash flow to support the loan repayments.
Other options for financing a business purchase
- Vendor finance: With vendor finance, you only pay part of the sale price up front and then pay the rest to your partner (plus interest) in instalments. Essentially your former business partner is financing part of the sale.
- Lump sum payments: Alternatively, an agreement may be reached where the partner exiting the business stays on as an employee for an agreed period of time, with conditional lump-sum payments made periodically until the buyout of the shares is completed.
- Invoice finance: If your business is owed money by customers, you may be able to borrow against the value of the outstanding invoices to finance part of the buyout. This is called invoice finance.
How to qualify for a loan to buy out a business partner
You can apply for finance to buyout a business partner from a bank, credit union, online lender or peer-to-peer lender. The exact eligibility criteria will depend on the finance option you choose and the specific provider.
The lender will assess your eligibility based on information about you and your business.
What information will you need to provide?
The lender will ask you to demonstrate that:
- You are an Australian citizen or permanent resident
- You do not have any issues in your credit history (if you do, some lenders offer bad credit business loans)
- Your personal income, assets and liabilities demonstrate your capacity to borrow (there are low doc business loans available for borrowers who cannot provide standard documents as proof)
- The lender may also want to know how much of your own money you have invested into the business
The lender will also ask for detailed information about your business. It will want to establish that:
- Your business has been in operation for at least six months
- It has sufficient regular revenue to service the finance
- It is in a strong financial position based on its balance sheet
- Overall the outlook is good for the industry you operate in
Buying out your business partner
Once you have determined your eligibility for finance, the next step is to consult your partnership agreement. This should provide direction for the business and how it will operate, and also contain a buyout clause, which sets out the process for buying and selling shares within the business.
Ideally, your buyout clause should detail:
1
When a partner can sell their shares in the business
2
Who is eligible to purchase a partner’s shares
3
The valuation process for determining the sale price of shares
The buyout clause may also specify options for buying out the departing partner, including:
Full buyout
Where a partner is exiting the business and all shares will be sold to the remaining partner
Part buyout
Where one partner sells a number of shares to another partner to allow majority control of the business
Including details about the buyout process in your partnership agreement will ensure that, regardless of how the partnership ends, both the departing and remaining partners will be protected and a fair price for shares can be mutually agreed upon.
How to value a business for partner buyout
An important part of buying out a business partner is valuing the business to determine a fair price for the sale. You can engage an independent valuation consultant to conduct an impartial valuation of the business based on its current and projected profits.
The valuation consultant will look at the existing debt and equity within the business, and consider several other factors which may affect the value, such as:
- The departing partner’s expertise, business contacts and influence
- Unpaid salaries and dividends
- Existing shareholder loans
If the departing shareholder contributes significant industry expertise to the business, or profits within the business are generated through the departing shareholder’s contacts and influence, this may affect the sale price of the shares.
In the situation above, you may choose to consider two options:
Include these factors
Agree to include these factors in the valuation and specify a non-compete clause (NCC) to prevent the departing shareholder from opening a competing business.
Exclude these factors
Agree to exclude these factors and purchase the shares at a reduced price, without restricting the departing shareholder from opening and operating a competing business.
Non-compete clauses will often be included within your partnership agreement, as will the specifics about how company shares are valued.
Without a partnership agreement, both parties (the remaining partner and the departing partner) will need to come to a mutual agreement on the process to avoid complications and prevent legal mediation.
In a best-case scenario, both the remaining and departing partner will be on amicable terms, and able to easily reach a buyout arrangement without conflict.
Dealing with disputes when buying out a business partner
If a business relationship turns hostile, there are likely to be disputes around the buyout process, such as:
The value of the shares held by the departing shareholder
The value of contributions to the business by the departing shareholder, and how these affect the total value of the business
When a departing partner leaves a business relationship, they will often try to maximise the value of their shares, just as the remaining partner will try to devalue the shares to reduce the buyout price.
Where business partners cannot mutually reach an agreement on the process:
- The partners may choose to engage in business mediation to find a solution
- If mediation is successful, it will set out terms for the buyout and valuation of shares
- If mediation is unsuccessful, partners may engage individual legal teams and present their respective cases for a fair buyout process before a court.
Ultimately, it is in everyone’s best interests to avoid mediation and legal action where possible, as the process can be incredibly time-consuming, stressful, and expensive for both partners.
After your buyout
Once an agreement has been made on the purchase price for the partner buyout, you will need to complete the purchase and update your business documents. This includes:
- Submitting updated business documents to federal, state, and local authorities
- Transferring all business-related accounts
- Removing the former partner's name from business accounts
You may also consider reviewing the partnership agreement - if there will be two or more remaining partners - and update the terms for any future buyout arrangements.
Buyout without a partnership agreement
If you do not have an established partnership agreement, the state or territory legislation relative to your business location will determine how your partnership will be dissolved. You will also need to consult your local business authority to ensure the process meets all legal requirements for the state your business operates in.
Refer to the individual state Partnership Acts below, and contact your state's government business authority for more information.
Australia State Partnership Acts and Business Authorities
State Partnership Acts | Partnership Act 1963 (ACT) |
|---|---|
State Business Authorities | Innovate Canberra (ACT) |
State Partnership Acts | Partnership Act 1892 (NSW) |
State Business Authorities | Fair Trading (NSW) |
State Partnership Acts | Partnership Act 1997 (NT) |
State Business Authorities | Business and industry (NT) |
State Partnership Acts | Partnership Act 1891 (QLD) |
State Business Authorities | Business Queensland (QLD) |
State Partnership Acts | Partnership Act 1891 (SA) |
State Business Authorities | Business and trade (SA) |
State Partnership Acts | Partnership Act 1891 (TAS) |
State Business Authorities | Business Tasmania (TAS) |
State Partnership Acts | Partnership Act 1958 (VIC) |
State Business Authorities | Business Victoria (VIC) |
State Partnership Acts | Partnership Act 1895 (WA) |
State Business Authorities | Small Business Development Corporation (WA) |
| State Partnership Acts | State Business Authorities |
|---|---|
Partnership Act 1963 (ACT) | Innovate Canberra (ACT) |
Partnership Act 1892 (NSW) | Fair Trading (NSW) |
Partnership Act 1997 (NT) | Business and industry (NT) |
Partnership Act 1891 (QLD) | Business Queensland (QLD) |
Partnership Act 1891 (SA) | Business and trade (SA) |
Partnership Act 1891 (TAS) | Business Tasmania (TAS) |
Partnership Act 1958 (VIC) | Business Victoria (VIC) |
Partnership Act 1895 (WA) | Small Business Development Corporation (WA) |
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