Breaking up is hard to do

• Stephen Craft
• 19 August 2008
• Page 1 of 2 : single page

What happens when a business partner wants to move on? It’s the business equivalent of a divorce, and it can be just as ugly.

Many of the issues are surprisingly similar. Who gets the kids (your employees)? How do you divvy up the house, car and furniture (your business assets)? And who keeps the mutual friends you made while you were together (your customers)?

There’s also the other scenario, which no one likes to think about. What happens to the business if your business partner becomes seriously ill or even dies? Could you keep the business running without their skills and knowledge? And could you keep paying their salary during a long convalescence, especially when you’re one person down?

Hope for the best, plan for the worst

If you don’t find these questions worrying, you’re either a sole trader or you’ve already thought out the answers and put a plan in place. The rest of us need to start thinking about it, now.

The first step is to think about the contingencies you need to protect yourself. I call them the four Ds: disagreement, departure, death and disability.

Disagreement

Partners inevitably have different views on the direction and operations of their business. Occasionally those disagreements can become serious. It happened to two friends of mine. They’d been in business together for awhile when their interests started to diverge. She was focused on servicing the bread-and-butter clients who made up the bulk of their income. He was busy pursuing new opportunities that had the potential to grow their sales significantly – but hadn’t paid off just yet.

Eventually their contrasting approaches grew from a source of creative tension to the cause of arguments. They were effectively running two different businesses, and they decided it was better for them to do it separately.

That situation was relatively straightforward. Because they were focusing on separate parts of the business, they were able to divide it without too much rancour.

But what happens when two partners want to continue working in the same industry and the same area? When business partners become competitors, there are many things to decide.

• Who keeps the trading name?
• Who keeps the current phone number, website, domain name and other contact details?
• Who keeps the current client base, and what protections are put in place to stop the other partner from marketing to them?
• Who keeps the current staff, and what protections are put in place to stop the other partner from making job offers to them?
• How much are these intangibles worth and how much should the other partner be paid for them?

Departure

Business partnerships, unlike marriages, are not entered into with a promise of fidelity until death do us part. Eventually one of the partners will decide to move on or retire, at which point they will want to convert their share of the business into cash.

However amicable their departure, this situation also raises some important issues:

• How do you value your partner’s share in the business? Valuation is not always simple, and often involves some subjective judgements about the value of things, such as intangible assets or goodwill.
• Who will take over the leaving partner’s share of the business and how will you transfer ownership?
  
• Can the departing partner require the remaining partners to buy out his or her share – even if the partners keeping the business don’t have the cash on hand?
• If the departing partner wants to sell his or her share to an outsider, does this require the approval of the existing partners?
• If the other partners do buy the departing partner out, how do they fund the purchase?
  

Death or disability

This is potentially the most disastrous of the four Ds, because it is the most unexpected.

Without a formal agreement in place, the unforeseen death of a partner can put the surviving partners in the awkward position of negotiating with bereaved family members who have inherited his or her share of the business. And as we all know, your life partner and your business partner don’t always see eye to eye.

If you can’t agree on a valuation, you could be left running the business hand in hand with someone who has no real interest in it or no background in the industry. Or they might take too active an interest. Either way, it’s a difficult situation.

A prolonged illness can be even more devastating. Naturally you’d want to support your business partner in their time of need. But how long could you continue to pay them an income when they’re not in the office helping to keep things running? And if they needed to leave the business, would you be able to buy them out?

Be prepared

As always, the answer is to plan ahead. You need to create a written business succession agreement well in advance, before any of these problems arise.

A comprehensive buy-sell agreement will cover all of the issues described above. It can also include:

• A call option, giving each partner the right to buy out the other in specified circumstances.
• A put option, giving each partner the right to force the other partner to buy them out in specified circumstances.
• An agreed price or valuation method for the buy out. If the agreement specifies a price, it’s usually updated annually to reflect the changing value of the business.
  

Your solicitor can help you draw up an agreement tailored to your needs. The Commonwealth Bank also has a legal team, eCommLegal, which can draw up an agreement for as little as $495. That means we can offer you a complete package, with a buy-sell agreement and insurance cover – helping to answer the inevitable question of where the money’s coming from?

Where’s the money coming from?

Your buy-sell agreement is only one half of the puzzle. Having decided the circumstances in which partners can buy one another’s shares in the business, you need to decide how to fund those purchases.

In the case of a disagreement or departure, the answer is usually a business loan. However, if a partner dies or becomes disabled, then key person insurance is an absolute must.

Typically you will need an insurance package that includes life cover, total and permanent disability insurance and trauma insurance.

An insurance payout can cover the cost of buying out the injured partner, or give you the extra money you need to pay their salary while they recover from a long illness.

That means the insured amounts should be calculated carefully so there is enough to cover each partner’s share, plus their part in any joint business borrowings.