Answering Common Questions from Clients:
I’m in a bad business partnership. How much is a fair amount to get me out?

By Terry Whitehead, CPA, ASA, ABV

 

Unfortunately, in business, like in life, sometimes bad things happen. Our clients seek our advice and financial analysis on various issues: some seemingly straight forward and others with more complex facts and circumstances. When a client is in a bad business partnership, our business valuation experts help determine how much is a fair amount to get them out.

This is a direct question. However, our answer will vary depending on the following factors.

 

What does the agreement say?

Fairness for an ownership interest in a partnership (or any other entity type) may be most appropriately determined based on what the parties agreed to at the time of the company’s formation or formalized in its governing documents (i.e., partnership agreement, articles of incorporation and bylaws, operating agreement, etc.).

Such governing documents often have a valuation or purchase price determination provision. The answer in these instances may be as simple as following the terms in the respective agreement. Still, even with such a seemingly straightforward scenario, we often find the language in the governing documents to be ambiguous and potentially untested. In other words, neither party interprets the language or meaning similarly and it becomes necessary to involve others (such as valuation experts).

Ideally, owners should have a clear and agreeable understanding of what the governing documents say in these situations. One way to accomplish that is to have a stress test of the process prior to a dispute between the partners. We are often hired to provide our expertise to:

(a) interpret the existing language in a company’s governing documents and

(b) work with partners to develop clear language to include in the drafting of the governing documents.

This provides the partners an understanding of the strengths or weaknesses of the current agreement from a valuation point of view.

Unclear language in the governing documents of a partnership may lead to a litigated battle in the event one party wants out. At that point, what is a fair amount is often determined by individuals other than the owners.

 

What are the circumstances of getting out?

There are an endless number of reasons why a partner may want out of a partnership including:

• immediate cash needs,
• strained relationship between owners,
• one party being unwillingly forced out.

Each circumstance may have a different solution (or determination of what’s fair) to get out.

For example, if one partner wants to sell, it may be a straightforward process of following the governing documents to determine the fair amount of the ownership interest. However, if a forced sale is involved, the determination of a fair amount may change to a legal issue or value interpretation. States have dissenting shareholder and shareholder oppression statues and laws. The remedy in these instances is often “fair value.” The definition of fair value, however, can be an area of contention between the parties.

The definition of Fair Value in a shareholder dispute context is dependent on state statue and case law. Not all states clearly answer the question of whether valuation discounts should apply under Fair Value. A valuation discount may apply because an ownership interest in a privately held company does not have the ready market of potential buyers like the public stock markets (i.e., NYSE and NASDAQ). Therefore, an appraiser will usually consider valuation discounts for non-controlling, non-marketable interests. The most common valuation discounts include a discount for lack of control (DLOC) and a discount for lack of marketability (DLOM).

However, many states explicitly exclude the application of valuation discounts under Fair Value. Understanding the state statute and case precedent may be key components to determine the fair amount to get out of the company in these instances.

 

Bottom Line

Like most valuation questions we receive, there is rarely a one-size-fits-all solution. It’s critical to engage with qualified business valuation experts who understand your questions and can work with your legal team to find the right solution.

Our objective is to listen to our clients’ questions and concerns and provide understandable, supported financial answers and expert opinions to help them make the best decisions.

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Terry G. Whitehead, CPA, ASA, ABV brings 30+ years of experience providing business valuations, financial analysis, and lost profits damage analysis for businesses and individuals covering a broad range of industries.

210-725-8646 |  [email protected]