By enabling people to team up, partnerships allow small businesses to leverage the complementary skills of many entrepreneurs.
Some business partnerships need to come to an end and the reasons may be either because the partner is ready to retire or move away. Sometimes partnerships end due to a toxic relationship. Partner buyout loans can play an integral role in facilitating a clean break. However, buyout financing works a little different than other kinds of financing.
In this post, we will explain what a partner buyout is and the pros and cons that come with it.
What is Partner Buyout Financing?
Partner buyout financing is funding that one partner uses to purchase the ownership stake of another partner. You can finance a partner buyout in many ways—using a partner buyout loan, your own funds, or by selling your partner’s shares in the business to investors.
Partner buy outs are expensive and a popular option for small business owners who need to buy out their partners.
Pros of Partner Buyout Financing
Reduces impact on cash flow
You can use your own money to make a lump sum payment and buy out the partner that is leaving. However, even in a relatively small business, buying out a partner with a significant amount of ownership can be expensive.
Using your own funds for the buyout ties your free cash up for something that’s not going to be valuable in the future.
With a partner buyout loan, you can buy out your partner and retail financial flexibility. That way, your business partner gets bought out and you still have free cash to invest in your company.
Quickly get rid of a toxic business partner
A business partnership that is not doing well, can negatively impact the business. Therefore, partner buyout financing enables you to get your business back to focusing on what matters. Plus, unlike equity financing, partner buyout loans don’t erode your ownership share, which ensures you retain the freedom to control the business.
Enables you to continue running the business
Faced with the need to buy out their partner, some entrepreneurs choose to simply dissolve their partnership and start over again. This allows them to sell off their part of the business and avoid a buyout. As any entrepreneur knows, starting over can come with its challenges.
Cons of Loans to But Out Your Business Partner
Hard to qualify for
Traditional banks tend to avoid making loans for partnership payouts. This is because banks want to make loans for projects that will increase the value of a business.
With a buyout loan, buying out a partner isn’t a value-add activity. When you buy out your business partner, you lose a valuable asset to your business.
- How active your partner is
- Who will replace them
- How their absence might affect the future sales of the business
Legal and loan expenses
Regardless of where you obtain it, partner buyout financing is not free. While a longer business loan repayment period might keep your payments low, you generally end up paying more in interest. You will also need to pay attorney fees to get help financing the terms of your buyout deal.
How to Finance Partner Buyouts
It’s hard to get approved for a partner buyout loan at a traditional bank even if you have good operating history and strong credit. The good news is that online lenders recognize the need for buyout financing and are beginning to fill the gap.
Still, you may find it harder than you expected to obtain a loan to buy out your business partner, so it’s important to have alternatives. You can:
- Dissolve the partnership, sell your share of the business, and start over.
- Allow your partner to retain some ownership so the buyout is less expensive.
- Self-finance the buyout by agreeing to a payment plan with your partner.
- Use equity financing by selling your partner’s ownership shares to investors.