I'm buying out my consulting partner. What should I offer?

Discussions
#1

Sorry for the throwaway. I want to be able to speak candidly about this…

I have been running a software consultancy with my business partner and friend for the last few years. There are only two of us and we’ve split the company 50/50. It’s an LLC that files taxes as an S-corp.

He does the technical work, I do everything else (business development, sales, marketing, project management, etc). I also do a good bit of the technical work.

Over the years, I’ve become unhappy with the work split. I’ve also become frustrated with and felt inhibited by my partner’s lack of initiative and ambition.

I’ve spoken with my partner and told him I am no longer happy with the work split. I’ve told him I would like to buy him out. He is open to that and he is interested in an amicable split.

Like most software businesses, we do not have a lot of assets. Mostly our brand and our relationships (both of which are associated with me).

We’ve both put numbers out, but we are pretty far apart.

I think this likely stems from our view of the roles we each play. I believe he thinks he’s a 50/50 partner and thus should get half of what the company is worth.

I believe he’s 50/50 by contract and not by action and I feel confident I could deliver on the company’s work solo. You can see why I have become frustrated.

I think what would help us reach consensus is a principled and fair way to reach a buyout number.

Is there a methodology or company that you’ve used in the past that you’ve been happy with?

#2

Hello Anonymouse. :slight_smile:

First off, let say I’m sorry to hear you’re in such a tight spot with your partner. I’ve been there before, a few times - it’s why I have a strict “no partners” policy these days - and it’s difficult. I don’t envy you.

Second, let me make an assumption - when you formed the LLC, you didn’t draft any kind of agreement governing how to handle dissolution and/or valuate the company for buyouts? Not many of us plan the divorce while we’re still on the honeymoon, but the folks who do have a much easier time when the moment comes.

Before I say anything else, let me say: I am not a lawyer, and this is not legal advice, it is my best understanding of how things work based on my own personal experience with similar issues in years past.

That said, here we go…

We’ve both put numbers out, but we are pretty far apart.

  1. How far apart are we talking?
  2. What rationale did he give for his numbers?
  3. What relationship to your yearly revenue are the numbers you’ve both put out?

I think this likely stems from our view of the roles we each play. I believe he thinks he’s a 50/50 partner and thus should get half of what the company is worth.

I believe he’s 50/50 by contract and not by action and I feel confident I could deliver on the company’s work solo. You can see why I have become frustrated.

If he’s 50/50 by contract, he owns 50% of the company, period, and your opinion of his actions is irrelevant unless you intend to take him to court, allege negligence of some sort, and break the contract. Now, if you can convince him that legally owning 50% of the company is somehow mitigated by him failing to live up to some standard you’re imposing, more power to you. But please don’t let your opinion blind you to the realities.

I think what would help us reach consensus is a principled and fair way to reach a buyout number.

Based on what you’ve posted so far, what each of you considers principled and fair is probably going to vary widely.

Is there a methodology or company that you’ve used in the past that you’ve been happy with?

The last time I found myself in your position, we decided to go through the same valuation process we’d go through if we were going to sell the company outright. Generally speaking, you can value the assets, value the income, or value the market.

With a consulting business that has few assets and most likely an ill-defined market, I would assume you’d be valuing the income (that’s what I ended up doing). Once we had a valuation figure, we decided that one of us would buy out the other for 50% of that figure, paid out in monthly installments over 18 months.

This seemed reasonable and looked promising until my then-partner started trying to justify more of an ownership share than he was entitled to by arguing “but I did X and you only did Y!” issues. I had my own “yeah, but I did N when you were only doing Z!” issues I could have brought up, but that seemed like it would perpetuate the conflict, and what I wanted more than anything was to end it.

Ultimately we had to bring in an arbitrator, and in the end nobody felt like they got a fair deal. I wanted “out” more than I wanted “equitable” so I did what I had to do to get out, which meant giving up money that I was absolutely entitled to. In the past 10+ years, I’ve had maybe 3 barely-civil conversations with my old partner, to this day.

Contrast that with another partner-based business that wasn’t working out. My partner and I shook hands and both walked away and that was that. There was still revenue to be had, still warm sales leads to be sold to, but we both agreed that it was getting toxic and it was time to just let it all drop, and we weren’t inclined to squabble over scraps. We remain close friends to this day.

I guess my point is, you can hire a third-party to valuate your business and go with that, you can take your partner to court to allege misconduct, you can bring in an arbitrator to help you resolve your dispute, and you can probably do a million other things - some more creative than others - to resolve this situation.

Above all else, though, try to understand that, based on what you’ve posted, this sounds very much like a situation in which you can end up being right, or you can end up being happy, but you probably can’t end up being both right and happy.

Think hard about which is more important to you, and optimize for that outcome.

Best of luck! I hope you get what you need out of the deal!

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#3

Pay him his money. You aren’t going to get anywhere with him. Stop letting this be a distraction. See if you can pay it over more time if that’s amenable to you.

1 Like
#4

You need a Shotgun Clause https://en.wikipedia.org/wiki/Shotgun_clause

If you don’t have it in the LLC operating agreement then see if you can agree on adding it, then triggering it.

#5

I entirely disagree about (most) shotgun clauses: They favor who ever happens to have more money at the time of triggering, and are biased towards the person who has more cash/has been accumulating while planning to trigger this.

I don’t think the other person in this instance would favor it anyhow, so is moot for this discussion.

#6

Devils advocate

What is the “value” of the business and how have you defined it?

Its a 2 person consulting company right? Long term contracts? Relationships that can’t be shifted? Royalties/Licensing? IP?

If you (and/or your partner) have put a value on the business purely on a multiple of the income from the two of you its likely to be far far removed from what a true market value would be.

(If you’ve got a cash pile thats easy to deal with - distribute 50/50 or whatever split is defined in your initial contract / shareholding regardless of how much either of you think you brought in in the past).

So - whats stopping you (or your partner) from just quitting and setting up on their own? Sure its some hassle and therefore cost involved but < that for me is the true value of the business. Paying anything more than that to your partner seems pointless to me.

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#7

My thinking exactly.

What is the impediment for you to just walk away and form ABC Inc instead? Existing contracts?

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#8

I hope it’s contracts and not simply squabbling over who has more “right” to keep working with the existing clients. I’ve been in the middle of that, it’s miserable.

Here’s hoping OP can resolve this cleanly and as amicably as possible.

#9

@Rhino I don’t want to walk away because of the stress that would cause for clients. It wouldn’t be that hard logistically, but I think it’d turn a currently amicable breakup into a confrontational distraction for all parties.

The company has no IP. It’s all paid for work that needs to be shipped and all but signed for work that could be big. For that reason, we’d both like to avoid a fight that would poison the company and our relationship.

Finally, for all my bravado in thinking I could easily walk away, it would be hard since I believe with a few more days of dialog, my partner and I can reach a consensus that would let me keep a company that it turns out I love.

@Christopher, thank you for your thoughtful response. There is an LLC agreement that lets members leave the LLC, but it does not describe how that will work. That is a mistake that I hope others can learn from.

I hear you that 50/50 is 50/50. I can let the frustration that started this breakup go because I now have an out. It’s not worth going to court over who did what and it’s certainly not worth undoing all the things we do agree on.

We agree that there needs to be a split. We agree on the non-financial terms like a gradual wind-down, a non-compete, and payment over time. We continue to work together to deliver the paid for client work.

Where there is a gap is on the amount. We are 5X apart. My offer is based on his payout on existing work and his is based on a discounted cash flow analysis, with an adjustment downward to what felt right to him. It’s about 1.3X of average profit over the last five years.

I’ve asked my accountant to run through the numbers and do a rough valuation based on adjusted net income as a sanity check and the plan is to go from there.

My current struggle is what happens if the estimate comes in much higher than the value of the company to me. The cost of starting over is most certainly going to be lower than the value of the company…

#10

Yeah, that sounds like a pretty big difference. Best of luck, hope you guys can bridge the gap.

#11

I entirely disagree about (most) shotgun clauses: They favor who ever happens to have more money at the time of triggering, and are biased towards the person who has more cash/has been accumulating while planning to trigger this.

It’s a consultancy that relies on the founders itself so it isn’t worth much. A shotgun clause forces people both sides to cut the bullshit and commit to a number.

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#12

One concept I’ve looked at is for both to work out an offer where they buy the other out and what they’d be happy with if bought out. That puts you on both sides of the discussion.

What’s the number at which you’d walk away? If your partner thinks the DCF value is so high, maybe he pays you that and you get to start again but with an extra income source for a while. Let him consider the risks in paying out and keeping the business, and you can see what the costs (emotional, relationship etc) are in walking away from the business.

It’s quite possible that the numbers might be different. E.g. you might want to pay 50k but want 100k to walk away.

It also means that you both have a market, rather than being stuck to one side of the transaction. If he’s fixated on selling he could find all sorts of ways to explain how it’s worth more. Better for him to really consider what’s involved in taking the risk of running the whole thing. (Same for you in the opposite direction.)

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#13

My point is - the person who is willing to walk away from a negotiation has the power.

Is there anything stopping you leaving and taking some of the clients with you - you said you have the relationships? If you explain to your partner that if you can’t agree on an amicable number you will just leave (either with or without some existing clients) it should give you leverage.

Of course it could piss him off and wreck any chances so if you threaten something you have to be prepared to back it up.

Is this moral? Not really but then again there isn’t any ‘assets’ or value in a 2 person consulting company so coming up with a price based on DCF seems pretty harsh as well.

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#14

I had our CPA evaluate the value of the company based on historical profit. 50% of that amount was close to what my partner was asking for, so I’ve taken @mj_langford’s advice and will be paying that amount over time.

It’s much more than I want to pay, but paying it ensures a fast and amicable exit. I’m much happier now than I’ve been in months, and at the end of the day, that’s what matters. Thanks for everyone’s help.

3 Likes
#15

I bet the peace of mind that comes with being out of this awkward partner situation will be worth every penny over time.

Is there an agreement in place regarding non-solicitation of your clients?

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#16

Hmm… how about a Shotgun clause with the option to pay out over time, so that it’s not biased to whoever has the cash?

Unless both parties can reach agreement on the value of the business (or agree to abide by someone else’s valuation (maybe an accountant, etc.) then you’re stuck with possibly an unreasonable partner.

#17

Yes, there is a one year non-solicitation and non-compete.