Navigating business partnership separations

21 June 2024

The importance of knowing how to value a business, reasons and implications of separations and steps one can take to prepare

Just like nobody starts a marriage with the intention of getting divorced, nobody starts a business partnership with the intention of splitting. Business partnerships usually start with high hopes and enthusiasm. But like any relationship, a business can experience difficulties, which can often lead to the decision for business partners to part ways.  Understanding the reasons for separation, potential outcomes and knowing how to value a business can help prepare business owners for these potential scenarios.

The importance of business valuations

Understanding how to value a business is a crucial component during a partner or shareholder separation. It provides an objective assessment of the company’s worth, ensuring that the division of assets is fair and equitable. Usually these will be done by an expert to ensure objectivity and independence in what can sometimes be an emotionally charged time, particularly if the split is acrimonious. The following points need to be considered:

1. Objectivity and financial clarity: A thorough and independent business valuation provides a clear picture of the company’s financial health. This includes assessing cashflows, growth, revenues, owner dependence, assets, liabilities, earnings, and market position.

2. Fair distribution: An accurate valuation is necessary to ensure that each partner gets their fair share. This helps avoid disputes over the value of the business and each partner’s share.

3. Facilitates buyouts: If one partner wants to buy out the other, a valuation assists in setting the price. In the event of a separation, usually one partner is going to be selling their stake to the remaining party, and a fair valuation can streamline negotiations and make the process more straightforward.

4. Avoid surprises and plan ahead: The problem with only doing a valuation at the time of a separation is that partners may have wildly different views on what the business is worth. It becomes very difficult to “negotiate” in the middle of a fight or disputes. It is good practice to conduct a regular business valuation (ideally annually) to ensure that shareholders and partners are always aligned on the valuation range.

There are a number of reasons why even the best and most successful business partnerships may dissolve. Each of these has its unique challenges and we’ll briefly highlight some of the more common reasons:

Reasons for business partner separations

1. Differing and/or changing vision and goals: Partners may initially share a common vision, but over time, their goals and visions for the company may diverge. This can create friction and make collaboration difficult.

2. Financial disagreements: Money can do strange things to people. Disputes over financial management, profit distribution, or investment strategies can lead to irreconcilable differences. This can be the case whether the business is thriving or struggling financially.

3. Personal conflicts: Personal relationships can impact business partnerships. Misunderstandings, lack of trust, or differing work ethics can erode the partnership, and if not clearly communicated and addressed can lead to separation.

4. Unequal contribution: Disparities in the effort, time, or resources each partner invests in the business can lead to resentment and conflict. As the business evolves, so do the roles of founders and partners.   For example, one partner may be focused on making themselves “redundant” so they have more free time and ultimately make the business more valuable (by reducing owner dependency), whilst another partner may believe that “doing the hard work themselves” deserves more reward.

5. Unexpected life changes: Personal circumstances such as health issues, family obligations, or relocation can necessitate a partner’s exit. These are often not planned and can come as a surprise when the business or partner least expects it.

Implications of partner separations

Like with any separation, the separation of business partners has significant implications, not just for the partners themselves for the business too. 

The following are important things that one needs to consider:

1. Operational disruptions: The departure of one or multiple partners can disrupt daily operations, especially if the partner played a key role in the business.

2. Financial impact: The costs associated with buyouts, legal fees, and potential restructuring can strain the business financially. Usually businesses don’t set aside “reserves” to pay for these types of exits and the remaining partners may be forced to take on debt to buy-out the leaving partner, which can place pressure on the business going forward. This is made even worse if there is a dispute over the business valuation.

3. Employee morale: Employees may feel uncertain or anxious about their job security and the future of the company, affecting morale and productivity. There may be an increase in internal politics, particularly if certain employees were more aligned to one of the partners and may feel under pressure to take sides. This could also result in loss of other key staff who also decide to move on.

4. Reputation and client relations: Clients and suppliers may also be affected. They could be concerned about the stability of the business, potentially impacting relationships and contracts. As with employees, they may also chose to leave if they were closely aligned to the leaving partner.

5. Potential legal challenges: Navigating the legal aspects of a separation, including dissolving or restructuring the business, can be complex and time-consuming, particularly if things get acrimonious.   Again, if there is a dispute over how to value a business, things can get particularly nasty, as the partners fight over their “fair share”

Preparing for potential separations

However, it’s not all doom and gloom and business partners can take a number of pre-emptive steps to at least plan ahead for a potential separation. It’s a bit like having a pre-nup for a marriage. Nobody likes to do it, but at least, the partners have this discussion and plan while they are on good terms, unclouded by the emotion and anger that can cloud rational though during a separation.

The following strategies can help:

1. Draft a comprehensive partnership agreement or shareholders agreement: A well-drafted partnership / shareholder agreement should outline the roles and responsibilities of each partner, decision-making processes, and conflict resolution mechanisms. It should also detail the procedure for a partner’s exit, including valuation methods and buyout terms.

2. Conduct regular business valuations: Regular business valuations are essential to keep an up-to-date record of the business’s worth. This can help in making informed decisions and ensuring readiness if a separation occurs. It prevents nasty surprises of differences in opinion down the line. Ideally, these should be conducted by an independent professional business valuer. Knowing how to value a business regularly is key to staying prepared.

3. Clear communication channels: Like with any relationship, communication is key. As shareholders and partners, it is important to have open and transparent communication to address issues before they escalate. Regular meetings to discuss the business’s direction, financial performance, and any concerns can help maintain alignment. There should be informal and formal meetings (e.g. AGM’s, board meetings, shareholder meetings) and ideally minutes or notes of the meetings and key decisions should be documented and recorded to avoid confusion or “he said she said” down the line.

4. Succession planning: Have a succession plan that outlines how the business will continue if a partner leaves is essential. This can include identifying potential successors or interim managers to ensure continuity. Usually, this will also include some form of documented plan.

5. Trusted advisors: Having a professional 3rd party perspective, even in good times can be a superpower. Working with business coaches, legal advisors, financial advisors (e.g. Fractional CFO’s), or exit planners can help to prepare for potential separations. They can provide guidance on general business strategy, drafting of agreements, conducting business valuations, and navigating and planning for both good times and potential disagreements down the line.

6. Conflict resolution mechanisms: Linked to communication, it’s important to agree in good times how future conflicts will be resolved. Having a pre-defined conflict resolution mechanism in the partnership agreement, such as mediation or arbitration, can often help avoid a separation. These can provide a structured process for resolving disputes without resorting to litigation, and even if a separation does happen, the “rules of the game” are defined.  In particular, the methodology of how to value a business is a crucial one that should be agreed upfront.

7. Ensure the business is sale ready: If a business is built to be sale ready at all times, by default, many of these items above will be dealt with. Systems and processes, documentation, removal of owner dependence, clear and accurate accounting records all need to be in place to be sale ready. Focusing on this, also create a positive sentiment and environment, which may remove a lot of the “reasons” for a separation to occur in the first place.

Case study: Separation of founders at Expert Engineering Solutions (names changed to protect identity)

Background: Expert Engineering Solutions (EES), a highly successful engineering firm, was founded 20 years ago by friends, Gunter and Hein. Over the years, EES grew from a small workshop to an established and respected firm with a diverse portfolio of engineering projects across maritime, motor and aeronautics.  They have a reputation for excellence.

Conflict: A few years ago, Gunter and Hein began to have significant disagreements with regards to the strategic direction of EES. Gunter wanted to diversify into cutting-edge technologies and new markets, while Hein preferred to consolidate the firm’s existing strengths and focus on core projects in their home market. These differing visions led to frequent and intense conflicts, disrupting the firm’s operations and affecting employee morale. In addition, a close family member of Hein’s had taken ill, and he wanted to spend more time with them.

Decision to separate: Recognizing that their ongoing disputes were harming the business, Gunter and Hein decided it was time to part ways. Fortunately, being engineers, they liked to plan ahead and had a well-drafted partnership agreement, which outlined the procedures for partner exit, including the need for a professional business valuation.

Valuation process: bizval was appointed to independently assess EES’s value. The valuation involved a comprehensive analysis of the company’s operating profits, cash flows, assets, liabilities, market position, and future earning potential. This objective and independent valuation provided a clear and fair basis for negotiation.

Negotiations and buyout: Using the valuation as a base, Gunter and Hein entered negotiations. Gunter did not want to bring in new partner’s and intended to buy Hein out. With the assistance of legal and financial advisors, they structured a buyout agreement that was fair and complied with legal requirements. It consisted of a 50% cash payment (from company reserves) and a deferred payment for the balance over the next 3 years.

Transition: To ensure a smooth transition, Hein agreed to be available on an adhoc  consulting basis, and they also crafted a clear communication process  with their employees, clients, and suppliers. Gunter provided reassurance of continued stability and commitment to excellence. Their long-standing head of engineering who had been with them for 10 years, was promoted to take over Hein’s responsibilities, ensuring business continuity. In addition, a business development partner was appointed to drive Gunter’s international expansion plans.

Outcome: Even though there was potential for this to be a disaster, their planning allowed EES to navigate the challenge and move ahead to pursue their new vision. This may not have happened had they not had a comprehensive partnership agreement, regular business valuations, and transparent communication in place.

In our experience, this outcome is not usually the norm, but it does provide a blueprint on how these situations can be successfully navigated.

Conclusion

Business partner separations, while challenging, can be effectively managed proper preparation and planning. Regular business valuations, clear partnership agreements, and open communication are essential to navigating these situations.

In addition, professional advisors who have seen many of these “rodeo’s” can assist and help business owners to both plan ahead and navigate these situations when they arise.

Whether due to differing visions, financial disagreements, or personal circumstances, understanding and preparing for potential separations can safeguard the future of the business.

Effectively handling partner separations lies in proactive planning, ensuring that all parties are treated fairly, and maintaining the stability and integrity of the business.

Learning how to value a business accurately and regularly and engaging relevant independent experts like bizval to assist can provide the clarity and objectivity needed during these transitions.

Written by:  Graham Stephen, CEO and Co-founder of bizval

Frequently asked questions (FAQs) on business partner separations

1. Why is it important to conduct a business valuation during a partner separation?

Answer: A business valuation is essential during a partner separation as it provides an objective assessment of the company’s value. This ensures a fair and equitable process and helps in setting a buyout price.  In addition, it is important for ensuring compliance with legal and tax requirements. An accurate valuation can prevent disputes and ensure a smoother transition for all parties involved.

2. What are the common reasons for business partner separations?

Answer: Business partner separations can occur due to various reasons, including:

  • Differing visions and goals for the company.
  • Financial disagreements regarding management, profit distribution, or investment strategies.
  • Personal conflicts and lack of trust.
  • Unequal contributions in terms of effort, time, or resources.
  • Life changes such as health issues, family obligations, or relocation.

3. What are the implications of a partner leaving the business?

Answer: The departure of a business partner can have several implications, including:

  • Operational disruptions, especially if the partner played a key role.
  • Financial strain due to buyouts, legal fees, and potential restructuring.
  • Decreased employee morale and productivity due to uncertainty.
  • Potential impact on the company’s reputation and client relations.
  • Legal challenges in dissolving or restructuring the business.

4. How can business owners prepare for potential partner separations?

Answer: Business owners can prepare for potential separations by:

  • Drafting a comprehensive partnership agreement that includes roles, responsibilities, and exit procedures.
  • Conducting regular business valuations to maintain an up-to-date record of the business’s worth.
  • Establishing clear communication channels to address issues before they escalate.
  • Developing a succession plan to ensure business continuity.
  • Working with legal and financial advisers to navigate the legal aspects of a separation.
  • Including conflict resolution mechanisms, such as mediation or arbitration, in the partnership agreement.

5. Can you provide a real-life example of how a business partner separation was handled effectively?

Answer: A practical example is the separation of Expert Engineering Solutions (EES). Founders Gunter and Hein had differing visions for the company which lead to frequent conflicts. They decided to part ways and followed their partnership agreement, which included a professional business valuation. The valuation helped in setting a fair buyout price, allowing Guner to buy Hein’s shares. They communicated openly with stakeholders to ensure a smooth transition. The separation highlighted the importance of a comprehensive partnership agreement, regular valuations, transparent communication in managing partner separations effectively, and working with trusted advisors to manage the process.