When partners decide to go separate ways, the departing partner typically wants fair value for their ownership interest. Partner buyouts involve valuing the business, determining the departing partner's share, and structuring payment. Buyout disputes often center on valuation—each side believing the other's number is unreasonable.
Whether you're the partner being bought out or the one continuing the business, understanding valuation methods and negotiation dynamics helps you achieve a fair outcome.
When Buyouts Occur
Buyouts happen in various circumstances: a partner retires or wants to pursue other opportunities, partners have irreconcilable differences, a partner dies or becomes disabled, or one partner wants to buy out others to own the business entirely.
Partnership agreements should address buyout triggers and procedures. Well-drafted agreements specify when buyouts can occur, how value is determined, and payment terms. Without such provisions, buyouts require negotiation from scratch—often contentious negotiation.
Some agreements include mandatory buyout provisions upon certain events, while others give partners options to buy or sell. "Buy-sell" agreements establish predetermined formulas or processes for partner transitions.
Business Valuation Methods
Valuing a business is part science, part art. Common approaches include:
Asset-based valuation calculates the value of business assets minus liabilities. This may significantly understate value for profitable businesses with few hard assets. Asset approaches work best for businesses whose value lies primarily in tangible property.
Income-based valuation focuses on the business's earning capacity. Methods include capitalizing historical earnings, discounting projected future cash flows, or applying multiples to earnings. Professional service firms and other businesses dependent on owner relationships often use income approaches.
Market-based valuation looks at what similar businesses have sold for. This requires comparable transactions, which may not exist for unique businesses or industries without robust sale data.
Key Valuation Issues
Minority discounts reduce value for ownership stakes that don't control the business. If a departing partner owns 30%, their share might be discounted because they couldn't unilaterally sell the business or control its operations. Whether discounts apply depends on your agreement and negotiating position.
Marketability discounts reflect that partnership interests are harder to sell than publicly traded stock. A minority stake in a private business has limited buyers, justifying some discount from proportional value.
Goodwill—the value of the business beyond its tangible assets—often dominates professional service firm valuations. Personal goodwill attributable to individual partners versus enterprise goodwill belonging to the business is frequently contested.
Negotiating the Buyout
Each side typically starts with valuations supporting their position. The departing partner wants high value; the continuing partners want lower. Bridge this gap through negotiation, mediation, or if necessary, litigation.
Consider hiring a neutral business appraiser to provide an independent valuation. Some agreements require appraisers, sometimes with procedures for resolving disagreements between competing appraisals.
Non-valuation terms matter too. Payment timing, security for future payments, non-compete restrictions, transition assistance, and customer/client notification all affect the overall deal.
Payment Structures
Lump-sum cash payments are cleanest but often impossible—the buying partners may not have sufficient funds. Most buyouts involve installment payments over time, with interest and security provisions.
Departing partners want security for future payments—promissory notes, personal guarantees, liens on business assets, or life insurance on remaining partners. Continuing partners want payment structures they can afford without crippling the business.
Tax consequences affect both sides and may influence deal structure. The characterization of payments—ordinary income versus capital gain—matters. Consult accountants before finalizing terms.
Disputes Over Terms
If partners cannot agree on buyout terms, courts can intervene. Judicial dissolution forces sale of partnership assets and distribution of proceeds—often the worst outcome because forced sales rarely achieve full value.
Litigation over valuation involves battling expert witnesses, extensive discovery, and high costs. Courts or arbitrators ultimately make valuation determinations that neither side may find satisfactory.
Negotiated settlements almost always produce better results than litigated outcomes. Even bitter partners usually do better agreeing on terms than having courts decide.
Protecting Your Position
If you anticipate a buyout dispute, preserve evidence of business value—financial records, customer relationships, intellectual property, and goodwill you've contributed to building. Don't let the other side control all information.
Be cautious about continued involvement after initiating buyout discussions. If you're checking out while negotiations drag on, you may damage value you'll share in the buyout.
Getting Legal Help
Partner buyouts involve valuation expertise, negotiation skill, and legal knowledge. A business attorney experienced in partnership disputes helps you understand your rights under your agreement, evaluate valuation positions, negotiate fair terms, and protect yourself in the deal structure. Whether buying or selling, professional guidance helps ensure you don't leave value on the table or accept unfair terms.