Selling a business-Need your opinion.....

Discussion in 'Growing and Managing a Business' started by BusiBusi, Sep 16, 2012.

  1. BusiBusi

    BusiBusi
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    Business hypothetical question, since there is not a textbook answer- your opinion is very valuable to me.

    Question: A small business is being bought by a large corporation for a significant sum. Senior owners wish to be fair.

    There are 4 owners. With varied status. Which are:
    a.)20 years
    b.)17 years
    c.)10 years
    d.)2.8 years, 1/5 of ownership purchase completed.

    Person d. feels that they are fully entitled to ¼ of the purchase of the business.
    Persons a.-c. feel it should be an amount that is some fraction less than the full ¼.

    EMPHASIS- We have decided not to engage in the hair splitting subjective activity of quantifying the value shareholder contributions. Their yearly contributions have been equal. Also note that A and B have decided that C contributed heavily in an IT upgrade and should be considered equal. Thus A=B=C as far as share splitting goes.

    How would you divide the buyout money?

    For example:
    The business is sold for $1,000,000. (Or 10,000,000, etc.)

    Should person d. get $250,000?

    Or 80% of $250,000
    or 75%
    50%
    30%
    etc.


    Realizing that there are many other subjective variables in partnerships, I have left this question VERY plain. Be frank.

    Anyone have an opinion?
    Or any information on where I could research precedents for this situation?


    Thanks
    for any advice.
    Busi
     
  2. MarkTaylor

    MarkTaylor
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    Hmmm.... interesting case!

    In the absence of an agreement to the contrary, I would say the purchase price should be allocated in proportion to the ownership of shares, not the real or perceived contribution to the business.

    M.
     
  3. Fergal

    Fergal
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    Welcome to Business Advice Forum BusiBusi.

    Can you please clarify that, do you mean that d has purchased one fifth of the business?
     
  4. BusiBusi

    BusiBusi
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    D. has finished 1/5 of the purchase of one share. 1/5 of a 1/4 share.
    Good question, sorry if that was not clear. So I guess you could say D. has paid for 5% of the business.
     
  5. Business Attorney

    Business Attorney
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    "Fair" is very subjective. Depending on what your agreement was with regard to the incomplete purchase, I think D should get either 25% of the sale price (less any unpaid purchase price he owes) or the amount he has already purchased.

    You say that he as purchased 5% but depending on who he was buying from - the corporation or the other shareholders - your math may not be correct. For example, lets say A, B and C each own 100 shares and D agreed to buy 100 shares from the company so he will eventually own the same amount. If he has paid for 20 shares (1/5 of 100), then he owns 20 shares of 320 shares issued and outstanding, not 20 shares of the 400 which will eventually be outstanding. In that case, he owns 6.25% of the outstanding shares.

    If, on the other hand, he is in the process of buying 25 shares from each of the existing shareholders and has already purchased 5 shares from each, then he owns 15 shares of 300 outstanding, or 5%.

    Hopefully the agreement you have is clear as to whether he owns all of the shares he is in the process of purchasing or if he only owns the ones he has paid for. If that question has no clear answer, then I think it is very difficult to answer what portion of the sale price he is entitled to receive.
     
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  6. Fergal

    Fergal
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    I agree fully with Business Attorney's point on this. If the agreement is not clear on this, I suppose the question to be asked is, why would D be entitled to more than a 5% share, given that he has only purchased 5% of the business?
     
  7. ArcSine

    ArcSine
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    When D came on board 2.8 years ago, all four partners placed a price tag on the value of the company as of that day. Probably not in so many words, but they all agreed that D would own ¼ of the biz upon payment of X dollars. Assuming a dollar of D's cash investment is worth a dollar, they all implicitly agreed the company, as of 2.8 years ago, was worth some amount Y such that X = ¼ times (X + Y). (note *)

    Hence one approach is the assumption that the efforts of A, B, and C account for the first Y dollars of the company's value, while the efforts of all four, over the last 2.8 years, have created all additional value since that time (i.e., the excess of the proposed sale price currently on the table, over Y).

    Divvying up the Y component is made simpler by the stated agreement that "A = B = C". In other words, the original 3 partners have agreed that Y should be shared as one-third to each. How you divide the additional value created over the most recent 2.8 years might best be a function of relative amounts of labor and expertise contributions during such time (as well as accounting for D's cash contributions). Your earlier post hints that the partners consider this to be roughly equal across all four partners.

    The fundamental idea is that an incoming partner generally shares pro-rata in all future profits and biz-value increments occurring since the date of his admission. But he's entitled to participate in realized gains of the company's existing value (occurring prior to his admission), only to the extent that he has actually paid for his share of such value. If I purchase a share of stock in an existing company---or a share of equity in a partnership---the value of the company on such purchase date is fully baked into the price I pay for that share. I'll only have a gain over my purchase price to the extent of my share of value increases occurring subsequent to my purchase.

    On a related point, if the terms of the arrangement are such that D is in fact entitled to share in some of the company's value existing as of his admission date, it's possible that his partnership interest is a so-called capital interest (as opposed to a profits interest), and it's hence possible that certain tax issues arise therefrom. Your tax advisor can spell it out in detail---if in fact it's even an issue at all---based on the particular facts at hand.

    (note * : this assumes D has been acquiring his ¼ in the form of capital contributions into the partnership. If, as Business Attorney points out, D's buy-in was structured instead as purchases of existing equity units directly from A, B, and C, the math is a bit different, but the concept still holds.)
     
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