GARY PALMER: How to deal with collapsing business partnerships

Choosing the right business partner is a critical decision that significantly influences a venture’s success and dynamics.

Unfortunately, partnerships can unravel for various reasons, including divorce, informal financial arrangements with family and friends, unexpected deaths, shifts in circumstances such as disagreements about how to run the business, emigration or the need for liquidity, as well as the classic scenario where one partner handles operations and the other acts as financier.

A primary catalyst for shareholder disputes often lies in a misalignment of expectations. Many partnerships begin optimistically, with one partner contributing the idea and labour while the other brings capital. However, the absence of upfront discussions about expectations can lead to eventual breakdowns. The operational partner may feel unappreciated over time if the funding shareholder appears to contribute little value operationally, or the financial partner may wish to be more operational, which can lead to conflict.

Some partners would have signed a personal guarantee, so whatever the reason for the split, if any funding is involved, the bank or lender wouldn’t just give back that suretyship or guarantee, they would want a new guarantee in place. This needs to be considered in a business partnership split.

The ideal scenario is to select a partner who not only brings in financial support but also contributes strategically and aids in sales efforts. Fostering fairness and generosity between parties is crucial, and both should be prepared for a situation where either could leave slightly aggrieved. Seeking independent advice becomes imperative, as emotions and ego can often hinder the path to an amicable resolution.

The starting point in addressing the transition of a departing partner is to scrutinise the shareholders’ agreement and its provisions on existing shareholders. Establishing a mutual agreement on values and goals is crucial, as well as the valuation of the exiting partner’s shareholding, but this demands a dose of realism from the departing partner. Additionally, for a formal valuation and to secure funding in splitting the partnership, it is imperative to ensure the financials and management accounts are current and up to date.

When it comes to valuation, a property company is comparatively more straightforward to assess than a shareholding in an operational business. Valuing an operating business often encounters disparities in the expectations of buyers and sellers. A strategic approach to bridging this gap lies in structuring the payment for the shares.

One viable method involves the seller leaving a portion of the purchase price as a vendor loan, repayable over time from the business’ profits. However, this approach introduces complexities, particularly concerning the need for security for the loan.

Injecting debt into the business

There are various ways to use debt for a partner buyout. Debt is a cost-effective financing option for partner buyouts, but it comes with the trade-off of giving up security and signing surety. Repurchasing shares through a share buyback using debt in the business is a cost-effective borrowing method. But it entails risks related to monthly serviceability and personal guarantees. If existing debt already involves surety from all shareholders, collaboration with the funder becomes essential to release the surety from the departing partner.

Discussions on expectations and potential risks become critical when dealing with debt, which may involve securing assets, including personal ones. Lenders closely monitor businesses under debt, imposing strict covenants such as interest service cover ratios and debt-to-equity ratios. Entrepreneurs are cautioned against overcommitting to debt in a high-interest rate market, considering potential risks associated with financial leverage.

Borrowing against external assets

Another avenue involves securing a loan against assets outside the business and using the funds to acquire the shares. As mentioned above, a vendor loan remains a viable option, with repayments structured over time. In instances where obtaining a loan for a partner buyout proves challenging, entrepreneurs can consider alternatives such as mezzanine funding, selling the entire business, winding down or restarting.

Finding a new equity partner

Exploring the introduction of a new equity partner who purchases the shares provides an alternative avenue for resolving the exit. Careful consideration about the associated risks and benefits is paramount in determining the most suitable approach tailored to the specific circumstances of the business and its partners.

The concept of partnerships having defined terms and an expiry date akin to a lease would be a great step forward. This approach can minimise legal and financial complexities when partnerships come to an end and address business valuations, among other benefits.

Key expectations that must be addressed include remuneration for the operational partner, a clear dividend policy, growth plans and contingencies for changes in circumstances.

Before rushing to close a deal, ensure you and your potential partner share common values and align on the vision and direction of the business. Misalignment on these fundamental aspects is a recipe for eventual failure, regardless of the deal’s nature.

Put everything in writing to prevent misunderstandings. A comprehensive shareholders’ agreement should cover minority protections, capital raising, specially protected matters, death and pre-emptive rights.

Numerous deals have crumbled because partners neglected to sign a shareholders’ agreement, leaving them with nothing to fall back on in times of disagreement.

• Palmer is CEO of Paragon Lending Solutions.