The Pros and Cons of Partner Buyout Financing
However, for one reason or another, some business partnerships must come to an end. Sometimes it’s a benign reason—one partner is ready to retire or move away. Other times buyouts are necessary to end a toxic relationship.
Whatever the case may be, partner buyout loans can play an integral role in facilitating a clean break. However, given their specific, unique purpose, buyout financing is a little different than other kinds of financing.
To help you navigate this process, this post will explain what partner buyout financing is, as well as what its benefits and drawbacks are.
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.
Because partner buyouts are often expensive, partner buyout loans are a popular option for small business owners who need to buy out their partner(s).
The Pros and Cons of Partner Buyout Loans
The Pros of Loans to Buy Out Your Business Partner
1. Reduces impact on cash flow
As mentioned, you could use your own money to make a lump sum payment and buy out the exiting partner. However, even in a relatively small business, buying out a partner with a significant amount of ownership can be expensive.
Plus, using your own funds for the buyout ties your free cash up in something that’s not going to add value for the foreseeable future.
With a partner buyout loan, though, you can quickly buy out your partner and retain financial flexibility. That way, your business partner gets bought out and you still have free cash to invest in your company.
2. Quickly get rid of a toxic business partner
A business partnership is a lot like a marriage. Invariably, there are good and bad times in a business partnership. Yet just like a marriage, business partnerships can—and often do—go sour.
If your partnership has gone sour, it’s going to 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.
3. 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 again. This allows them to sell off their portion of the business and avoid a buyout. However, as any entrepreneur knows, starting from scratch comes with its own challenges.
Partner buyout financing makes it possible to keep your business even if you can’t afford to buy your partner out by yourself.
The Cons of Loans to Buy Out Your Business Partner
1. Difficult to qualify for
Traditional banks tend to avoid making loans for partnership buyouts. 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. In fact, a partner buyout can damage a company’s financial health.
2. Negative impact on future business
Presumably, your business partner provides value to your business through expertise or personnel connections. When you buy out your business partner, you lose a valuable asset to your business. Of course, this depends on:
- How active your partner is
- Who will replace them
- How their absence might affect future sales
3. Legal and loan expenses
Regardless of where you obtain it, partner buyout financing isn’t free. Also, while a longer business loan repayment period may keep your payments low, you’ll generally end up paying more in interest. In addition to interest, you’ll have various fees to pay on your loan. Finally, you’ll also need to pay attorney fees to get help finalizing the terms of your buyout deal.
Other Ways to Finance Partner Buyouts
As mentioned above, it’s challenging to get approved for a partner buyout loan at a traditional bank, even if you have a solid operating history and strong credit score.
The good news is, online lenders recognize the need for buyout financing and are beginning to fill this 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.
Whichever route you choose, make sure you’re open and upfront with your partner. Failure to communicate during the buyout process often leads to an expensive breakup and tense transition period.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.