Do you need finance to buy out a partner ?

Please note that this module does not deal with management buyouts (i.e. the purchase of an existing business). If this is what you need, please read Do you need finance to buy an existing business?

South Africa has legislation to actively promote small businesses, as well as promote the transformation of business to ensure fairer and more equitable participation in our economy. As a result, if you are a previously disadvantaged person looking to buy out a white partner’s share, then government agencies might be a good starting place to raise finance, in particular, the National Empowerment Fund.

How available is it?

Previously, the Companies Act restricted companies trying to buy back shares from shareholders, and therefore to raise finance to buy out a partner was only possible in your personal capacity. Thankfully, the New Companies Act changes this and today, buying out a partner is considered to be a normal part of business finance.

Fair value for the business

Lenders will always want to ensure that the amount they are lending is appropriate to the item(s) being purchased with the money. Therefore, they will want to see a formal evaluation of the business, together with the shareholders' agreement that shows the percentage ownership details.

If you have chosen a reputable company to perform the evaluation, they may be willing to accept the amount without further probes. However, don't be surprised if they request to do their own due diligence to double check the evaluation figure. Once they are satisfied with the company’s evaluation figure, they will know the actual value of the shares and can check that the amount you requested is in line with their estimates.

Tips to handle sour deals

It isn't always possible to keep emotions out of business, particularly when you have invested time, sweat and tears into your business. Shareholders often feel the same way you do. This can lead to an emotionally tense environment during partner buyouts for all parties. Plus, you might be in the process of buying out your partner because there have been tensions brewing for some time in the business, leading to even more conflict.

Beware of the following things that can happen during a buyout:

You overpay your partner because you are tired of talking to him/her and just want to get rid of them.
Your partner is bitter and will stop at nothing to make sure that you don’t get your way, possibly deliberately sabotaging the business.

If this is the case, it will help to have a neutral person negotiate the buyout process and ensure that the company data, processes and client base is not damaged during, or after, the buyout. Terms that protect the remaining shareholders and the company will be written into the buyout agreement. A key point to consider is that ideally, both parties must agree on the person or company that will be assisting them in the buyout.

From a psychological point of view, it can be extremely helpful to have a neutral person as the key communication point in this process. This person will be able to address issues without becoming emotionally involved and their mandate is to conclude a deal that is fair to both parties and protects the company, its properties, and data.

Lastly, it is very important that the buyout is communicated in a positive way to employees, suppliers, and clients. Even if the current relationship between shareholders is not good, it is really important to communicate the exit of a partner/shareholder in a positive light, and to advise the details of the person that will be taking over the roles of the exiting partner (this is critical if the partner played an active role with clients, suppliers or staff).

Tax

The tax implications of buying out a partner may include dividend tax on companies, as well as capital gains tax, but the final amount depends on how you structured the partnership deal. It is best to get professional help to understand the tax implications.

What are the business implications if your partner leaves?

Before you consider approaching a lender for a loan to buy out a partner, you need to do some homework. Remember that lenders always check to see whether the business will be able to pay back the loan, so they will expect you to know the following:

What skills will be lost to the business when this partner leaves?
How will the business replace these skills?
What role did this partner play in the business?
Who will take over this work?
Did this partner provide collateral for the business? If so, how is this going to be dealt with?

In short, the lender wants to be assured that if you do buy out your partner, the business will not suffer in any way and that you have put plans in place to make sure that no gaps are left.

Structuring a buyout

There are three possible ways to buy out a partner. Since all of these options involve levels of complexity, it can be useful to meet with an experienced business advisor at this point. You need to make sure that this transaction is fair, and that the business is not prejudiced in any way. Working with an independent advisor has the advantage that it removes the emotional aspect of the negotiations and conclusions.

Option 1

Do it simply as a private deal between two shareholders. This doesn't involve the raising of finance for the business but rather depends on using your own personal assets and savings. This would still involve legal documentation stating the particulars of the deal.

Option 2

You could buy back the shares from the partner who decides to leave. This would be governed by the Companies Act that states it is only legitimate if the business can pass a solvency and liquidity test after the deal. This would also need to be legally documented.

Option 3

Lastly, set up a new company, which then buys the existing stock. The new company won't include the partner who has been bought out, but might include an equity financier, who may well want to be bought out over time too.

What are your loan options?

Once again the total cost of the buyout will dictate which finance options to explore. For larger amounts, equity finance is probably the best option, followed by term loans. For smaller amounts, you can explore personal credit and term loans. Seller finance is an option for both large and small amounts, depending on the partner’s willingness to finance the deal and how the deal is structured. If the buyout involves a BBBEE deal, then visit the National Empowerment Fund to see if they would consider funding the buyout.