Basic Training: Capital vs. Sweat Equity: What’s a Fair Buyout?
By Nina Kaufman, Esq.Q: I’m in a situation where one owner is an active “sweat equity” owner; the other is inactive but provides financial capital. I’m the sweat-equity owner who has put in the hours and grown the business, while the other has been gone for months at a time. I am now in the process of trying to buy out my business partner. He put $20,000 into the business and I am trying to figure out where to start on coming up with a fair number to buy him out. He seems to think $32,000 is the number, although we are just barely starting to turn a profit. Any suggestions?
A: Whether $32,000 is a fair number depends on a number of factors:
- Whether you have a partnership agreement that sets out the method for valuing a partner’s interest upon exit (If so, follow that.)
- How businesses in your industry tend to be valued–$32,000 may be fair for a product-based business if you’re on the upswing and your partner relinquishes all rights to develop similar products, but not fair in a service-based business where he’ll walk away with a fair amount of the goodwill. Your accountant may be able to provide you with guidelines of how to value the business at this stage.
- The cost of litigating the dispute. If you don’t have a written partnership agreement and can’t reach an amicable agreement, your only recourse is to go to court to have a judge figure it out–and he/she will probably expect you to hire your own valuation experts to provide guidance on the financial terms, etc. The likelihood is that you could spend more than $32,000 and then still have to pay him something. Best to consult with an attorney in your area to get a sense of the costs involved.
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