Frequently Asked Questions About Partner Buyouts
How do I figure out what price to offer?
Unless a valuation formula is spelled out in your Shareholders Agreement, you may want to get outside professional help with this. It’s not just a question of what’s the company worth – it’s also a question of how the buyout is to be structured, that is to say, how much cash does your partner get upfront and what is the amount, and the nature, of payments made to your partner afterwards, if any.
Typically, companies are valued based on their expected future cash flows. A company’s historical performance is used as an indicator of future performance. So you’ll often hear that a company was valued at, say, a 4 or 5 times multiple – meaning it was valued at 4 to 5 times the company’s current annual cash flows or EBITDA (earnings before Interest, Taxes, Depreciation and Amortization).
Your advisor will help you come up with a valuation and a structure based on (1) the company’s financial performance, (2) a comparison of what other companies in your industry have recently sold for, (3) what the partner’s expectations are, and (4) what are the various financing options that are available to you to fund this buyout.
But beware of catching “deal fever”. The final deal you negotiate must not jeopardize the company with excessive debt that will hinder your ability to grow the company in the future.
How do I raise the financing?
Your first discussions should be with your existing banker. They know you the best and will likely be the most supportive of your buyout, presuming that the bank does not see your exiting partner as being critical to the business.
If the cost of your partner's buyback is greater than your bank is willing to finance, then you will need to raise the shortfall from a combination of the following sources:
- Subordinated debt
- Payments to your partner post-closing
- Private Equity
- Additional cash from you or your employees
Subordinated debt: Subordinated debt, sometimes called mezzanine debt, is a loan that has no tangible asset security and relies solely on the strength of the company’s future cash flows. It ranks behind the bank, so is “subordinated” to the bank’s first claim on the assets and cash flows of the company. Interest rates range as high as 18% and are often tax deductible. This may appear to be very expensive debt but should be looked at as cheap equity.
Payments to your partner post-closing: This is where creativity comes into play when structuring the deal. These payments bridge the gap between what your partner thinks their portion of the business is worth and what you can actually pay them at closing. Partner payments can come in the form of a vendor note (VTB), royalty payments, performance related payments, or retaining a smaller equity interest in your company.
Private Equity: Private equity (PE) can come from PE Funds, Crown Corporations, and private individuals. These investors are you “partners”, not your bankers. And they each have their unique cultures and methods of dealing with you. They typically look at exiting their investments within 5 years and look for Internal Rates of Return of 30%+.
Regardless of who your financial partners are, you need to do your “due diligence” on them. These will be your “partners” for a long time so getting the right fit – working with people who you like and respect and who are experienced in helping private companies grow – is very important for your future success.
Will my bank support my partner buyout?
Not always. This is a tougher question than you may like to believe and requires you having an open and honest conversation with your banker before you start this process. When you originally obtained your bank financing it was with you partner and you were possibly both presented to the bank’s credit department as the team that drove the business.
Most of the times the bank will support this type of transaction because your company’s infrastructure has hopefully mitigated the risk of a loss of any one partner, but don’t automatically presume that the bank sees you as the critical partner capable of assuming the responsibilities of your departing partner with no new additional risk to the company.
What if a partner buyout is not dealt with in the Shareholders’ Agreement?
While each situation is unique, discussions on partner’s buyouts are often emotionally charged. Be prepared to have the tables turned on you, with him/her offering to buy you out instead. If you can lower the emotional aspects of these discussions, you’ll have a higher likelihood of a successful transaction. And one of the best ways to do this is to have both you and your partner receive professional advice and guidance throughout this process.
Prior to entering into a discussion with your partner on a potential buyout, you should have a fairly good idea of the type of deal that you want to offer and how you will finance it. This will involve discussions with outside parties – advisors, bankers, and other potential sources of financing. Be very careful not to disclose too much confidential information. Seek out the advice of an experienced, well respected professional who can evaluate your proposal while at the same time guarding your confidentiality.
In Their Words
The MBO Group seems to have a unique ability to uncover interesting and worthwhile opportunities in the Canadian private company market. I have had the benefit of working with them in a variety of situations. They have always been able to capture the essence of what makes a project assignment or deal work in a very strategic way that others can embrace. With a rare ability to communicate clarity they are able to efficiently bring individuals as well as groups to understand what it takes to achieve success.
FCA, Former CEO & President, Marsulex Inc.