When the time comes to buy into a business, there is a lot for the partner—and the company—to be aware of, from coordination to compensation.
By: Brad Nakase, Attorney
When the time has come for an entrepreneur to buy into an existing partnership, the excitement is palpable. After all, a move like this can be potentially profitable and can even define one’s business career. On the flip side, for the company, selling a stake to a new and interested partner can also be exhilarating. However, these strategic business moves are based on difficult and complex decisions. Therefore, buying into an existing business should never be attempted without careful discussions and serious deliberation, even if the individual is familiar with the company or vice-versa. Since this is such an important decision, neither party can afford to rush it.
Here, we are focusing specifically on business partnerships, which can include a few different options. Partnerships can be professional businesses, such as doctors, lawyers, or accountant’s offices. They can be private corporations that have only a small number of shareholders, or partnerships can consist of two or more individuals and be registered with the state. As one can see, the only company that you really cannot call a partnership is a business that only has one owner, such as a sole proprietorship.
When a new partnership is formed under any circumstances, new opportunities are suddenly placed at one’s fingertips. Whether the goal is to attract new investments and opportunities, increase the number of valuable contacts and colleagues within a specific industry, increase revenue and capital, or expand the business in other ways, new partners and new company partnerships can bring a lot to the table. Sometimes, a new partner can transform a business in new and unforeseen ways.
However, established business owners must also be aware of the fact that new partnerships can also create an element of risk. While business owners and partners are used to taking risks, let’s focus on why buying into a new business is sometimes considered a tenuous move and how some of that uncertainty can be alleviated. The most significant risk is this: sometimes, the people who already work at the company, and are established there, do not fit with the new partner. Excellent businesses derive some of their success from the coordination and communication between the partners; for example, they should have similar visions for the company. It also helps if partners have a shared work ethic and skills that compliment each other’s talents.
When a partner rushes into a business partnership or an existing business quickly adds a new partner, this can be a cause of trouble. Most businesses are based on a reasonably delicate balance, and one new person who does not share the vision or aesthetic that has already been established can throw the balance into chaos. In order to prevent this, individuals should be certain to discuss their plans with future colleagues readily and voice any concerns they may have. Taking a look at the company’s record of growth and profits and the prospective partner’s track record is also a good idea. The key here is to take one’s time with this decision instead of leaping into something the business partners may regret in the future. One of the keys to an effective and profitable company is maintaining clear lines of communication, so why not start this trend early? Prospective business partners should communicate their concerns as well as their goals to the already-established members of the business, and the company partners should do the same. Instead of a rushed process, make buying into an existing business a calm, measured step—it will pay dividends.
It is helpful for the company to know that two main processes are involved in compensating a new business partner. The key is to achieve a balance between these two essential aspects. First, it will need to be proven that the revenue from the company is distributed evenly among all of the partners. Second, the company has to certify that it creates enough profit in order to meet its expected long-term goals.
For most companies, usually, compensation consists of a salary as well as a bonus. For business partners, bonuses can be awarded in two ways: they can be a percentage of the collected receivables or a collection of the gross income. Now, there are multiple factors to consider when weighing company compensation. Companies and their business partners must decide:
Equity is a concept that can prove difficult to pin down when a partner buys into a business since it holds different importance for different parties. Some partners value equity very highly because they see it as a way to have some control over the business. Other partners do not concern themselves with equity and focus on other things.
One of the reasons for this conjecture and uncertainty is that an equity stake that is considered “minority” is not worth much until the company is sold. Therefore, if a business is attempting to bring in a new partner and attract them with the prospect of a minority equity stake, they might not have much success. At the same time, sometimes, providing a company partner with even a minority equity stake is enough to make them feel as though they are a part of the business. When partners feel as though they have a beneficial interest in the company, they care more about the business’s welfare and will usually work harder for the company.
You may be curious about how liabilities function in situations where a partner buys into the business. Prior to a new partner buying in, the existing partners are usually expected to be already liable for some of the business’s debts. Therefore, before the new partner buys in, it should be made clear whether or not the new business partner will also be responsible for a portion of the company’s liabilities. This is an important matter that should be discussed, returning to our theme of clear communication, and its inherent value in the business world.
A buy-in price should be set if the choice is made to provide the incoming partner business equity. Commonly, existing partners desire a relatively high buy-in price for the incoming partner since this can help to increase the company’s cash reserves and be set aside to pay the outgoing partner or partners. However, this does not always occur because some partners know that a low buy-in price allows for there to be a low buy-out price. In addition, for some partners, the ability to change things more easily if the new partner does not work out supersedes the idea of adding to cash reserves.
The value of any business can be figured out by adding accounts receivable, assets, and goodwill together and multiplying them by the appropriate figure.
How does a new business partner pay for equity? A company partner who has just joined the business can pay this off in a variety of ways. One way is through salary reduction: the new partner usually accepts a salary reduction that lasts from 3-8 years. Another method for the new partner to pay their share is through vesting, in which the individual purchases equity over time. Some businesses prefer for their partners to use a combination of
One of the most important tasks to complete before a new partner joins the ranks is deciding upon exit strategies. Usually, exit strategies consist of a buyback of a partner’s business equity and termination of their employment. However, in the case of professional partnerships, the exit strategy and loss of one’s license implies terminating the partnership, too.
Typically included in the buy/sell agreement, what is known as a “shotgun clause” helps to deal with disputes among partners. If a disagreement occurs, the shotgun clause allows that the partnership is terminated immediately, through one partner offering to buy out the other. The other business partner is able to accept the offer of a buy-out or turn around and buy out the other partner for the exact figure.
It is also important to be familiar with what is known as a buy/sell agreement. A buy/sell agreement focuses on events that will create a buyback, such as an employee’s disability, death, or termination. Although unfortunate, it is essential to have these events covered and the terms specified before something happens. For example, if one partner were to pass away, a buy/sell agreement can dictate that the surviving partners are able to buy back equity from the deceased partner’s estate. Depending on the circumstances and the specific agreement, the agreement could also allow the partner’s family to keep their company share. The point here is that the business and its partners will be covered and ready for anything.
When a company really begins to produce revenue and thrive, it is usually because the partners are all focused on similar goals, communicating with each other, and looking toward the future. While diverse partners can complement each other’s talents and skills in helpful ways, it usually helps if business partners have similar goals for the company. There is sometimes not enough clear communication, direct questions, and listening in today’s business world. The most successful companies are built on a collective sense of values, goals, and ambitions.
Many find that a marriage is an apt metaphor for a business partnership. Still, while marriages usually rely on a courtship phase and an engagement, many business partners leap too quickly into an uncertain financial future alongside partners they are not truly familiar with yet. We all know that marriages do not end up well when romantic partners’ goals and desires differ too drastically, and it is the same with business unions.
When business partners’ objectives and ideas do not line up, it can cause a problem. We are not saying that business owners must mimic each other, be carbon copies of each other, or even read the same newspapers, but they should share common goals. For example, if a business owner’s goal is to completely dominate the market and even become a household name, he or she is set on staying with the business for the long haul. However, suppose that a business partner finds out that his or her partner only wants to run the company for two years before selling it and heading out traveling with the family. What we have is a significant divergence of goals. Finding this out before the business partnership is formed is not a big deal, but when these truths are revealed too later, it can lead to problems with chemistry and even earning profits.
Here are a few questions that might help prospective business partners decide if they are on the same page and in good shape to head into business together.
These questions hopefully will provide the start to some in-depth thought and reflection and some helpful and constructive dialogue with your partner. Remember, instead of jumping into a business partnership without any preparation, take the time to ask yourself and your prospective partners some questions. Then, proceed confidently but carefully, conduct your research, communicate, and be honest with your colleagues and yourself. If you are able to do these things, you will have a long, successful career ahead of you.
Please contact our attorney for legal questions about buying into an existing business. Our California business lawyers are skilled, licensed professionals who can provide advice and counsel to existing or prospective partners. With our help, you will be ready to form a new, promising business partnership and achieve greater success. Good luck in all of your business pursuits.
