As an advisor for companies, I regularly encounter the situation of a minority owner wanting to buy out a controlling partner. This scenario, if handled poorly, can end in significant value destruction to the company. Owners should have a buy-sell agreement in place defining the actions that need to occur for one partner to buy out the other. Depending on the buy-sell agreement, there are a number of things a minority owner can do to make a smooth transition. Remember, this is not a situation where you’re trying to discount the value of the company. Fairness to your partner should be your first thought.
Number one, agree in advance how you both are going to measure the value of the company. What is the fair market value, should be assessed constantly? Number two, how will you and the company be able to pay for the buyout? This is an interesting dilemma for the business. This is not a situation where you’re borrowing funds to improve the company by adding equipment or funding a growth initiative. This is capital to be exchanged for equity. Banks don’t like situations that aren’t accretive. Is the company buying out the stock of the controlling shareholder or is the individual buying the stock?
A common solution to handle this situation is to have the company buy back the shares from the controlling partner in some form of structured payout, usually cash, a long term note, and occasionally, a performance upside. Another solution is to look at private equity to fund the buyout. Done with the right people, this can be a very attractive alternative because PE groups often have access to additional capital, providing financial stability, and they usually initiate growth strategies to accelerate company value.
Finally, the third, keep the conversation civil and positive. Strive to make the situation a win-win. Change is difficult for all parties in a negotiation. A poor attitude and arrogance can be very destructive to the company and to the current relationship. In closing, this is a situation where I advise using a third party negotiator such as your investment banker to facilitate the process especially if both principals trust the intermediary.
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George Walden is a Managing Director and Principal in Corporate Finance Associates’ Houston office with twenty-five years experience as a middle-market investment banker. George is a member of CFA’s equipment industry practice group and an expert in the precision machining industry with special emphasis on manual machining, CNC precision machining, and gun drilling services and has been responsible for several industry-leading transactions. You can learn more about George HERE.