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drdoombot's avatar

Business question: When you buy into a business and become a partner, are you also buying the previous expenses/losses of the sole owner?

Asked by drdoombot (8135points) January 2nd, 2012

I have a friend who is in negotiations to buy in to a business which is now owned by a single owner. The owner quoted a price of $250k for a total buyout and $100k to become a 49% partner (the owner is insisting on this detail to have final veto power in the business). The business is currently in the red and has quite a way to go before being profitable. The owner has been paying out of pocket for these losses and even took out a loan for $125k to cover these expenses. In order to be profitable, some renovations and other expenditures need to be made so the business can accommodate more customers (and hence, more income).

While negotiating the terms of the partnership, certain questions have come up that I find baffling:

1. The owner insists on a 51% share of the ownership, but will split the profits 50–50. Is this common in partnerships?

2. After my friend expressed interested and agreed to paying 100k for a partnership agreement, both sides agreed that some additions need to be made to the business. The owner expects my friend to pay half of the costs for these additions, on top of the $100k already paid. It seems to me that my friend is buying an incomplete business and that any additional costs should be taken from the $100k, not in addition to it.

3. The owner also expects my friend to pay half of whatever remains of the $125k loan (some portion of the $100k my friend is paying for the partnership will go to pay this; what remains of the debt will be split by the two partners). My friend balked at this, thinking he was buying in to the business, not the owner’s previous expenses. The owner’s perspective is that she spent/lost money on the business already, so that’s part of the cost of buying in.

The third point is the one that strikes me as the strangest one. When you buy into a business, does that mean you are buying into all of its losses retroactively? Why is my friend responsible for lost money or loans spent by the previous owner?

I’m not having an easy time wrapping my head around something like this, so I’d like to get some perspective and fresh looks at the situation. When you pay someone to become a partner, what exactly are you buying? Should that money cover any subsequent expenses needed in the business, or are those costs shared? Should that money cover previous losses before the new partner came on?

wow, this seems more complicated now that I’ve written it out

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10 Answers

Tropical_Willie's avatar

Your friend NEEDS a lawyer. That will make due diligence a lot easier.

Judi's avatar

It’s all negotiable. If I were you friend, I would insist that the payment made go to old debt. Itherwise, the price just wen’t up by ½ the liabilities.

elbanditoroso's avatar

I hope your friend has a good lawyer. It sounds like he will need one.

#1 and #2 seem perfectly reasonable.

#3 seems sketchy. Your friend’s lawyer ought to drop this clause. Of course the reality is that the parties can agree on anything, so it’s all ‘legal’ in that sense, but why would your friend buy into someone else’s debt? Seems like a strange way to get started, especially when your friend did not incur the debt.

Put it this way – if someone came to me with the terms in #3, I would NOT sign it. Something smells.

Judi's avatar

He needs both a lawyer and an accountant. It would be silly to invest in a business without an audit of their books.

Coloma's avatar

I agree with the legal counsel, and with @elbanditoroso

Also, remember, you are partnering up with someone that has a shakey history and a lot of debt, if they default on their share of expenses you are left holding the bag and either having to float them during the lean times or let the biz. go, possibly in a bankruptcy situation if you both fall behind on payments and biz. is slow.

I was poised to jump into a 50–50 partnership with a local biz. I work for, but, upon further questioning of the partner that was opting out, I determined that the risk was too high for me, as they had to float the other partner on the building lease on several occasions this last year.

I wasn’t willing to buy into to a potential situation where I would have to float the first owner, not once, not ever, and certainly not with full disclosure that this was a strong probability.

I’d proceed with extreme caution and get legal counsel.

cazzie's avatar

NEVER sign anything like this without first talking to a lawyer AND an accountant. I can speak from 15 years experience in accounting, that I would advise incorporation rather than partnership, especially if you don’t know the person from a bar of soap and they are asking for a controlling interest (the 51%..)

He needs to do what is called ‘due diligence’. Without looking at the assets and liabilities of the company, he will have no clue what he is getting for his money. Also, I am sure the person with the 51% presented your friend with all sorts of fancy charts and cashflow projections, but, knowing the man behind the curtain as I do, they usually are not worth the paper they are written on.

There are some serious questions needing to be asked. Was it an established partnership before? Or is this a new one being set up?

When you buy into a ‘going concern’ of any type, you take it on, lock stock and barrel, including debts held in the business’ name. If it is a new set up and those debts are still in the previous person’s personal name, perhaps with his personal security used as collateral in those loans, this issue could be used as leverage in your friend’s favour. If, however, they are in the business name, secured on assets owned by the going concern, then, the argument is really in favour of having them introduced into the partnership. This is just how it is done.

If your friend can’t read a balance sheet or a understand the legal and debt ramifications of entering a partnership (his personal assets are well and truly exposed…. if the partner does a runner, he is in deep deep doo doo.) Get to a lawyer/accountant.

cazzie's avatar

Your friend could agree to help refinance the loan she currently has. Pehaps, by spreading the risk with the bank, the partnership could get a better finance rate for the loan. If she has used her house as collateral, then if they bank is willing to write up the loan document in the partnership name, using personal collateral of your friend’s, thereby spreading its risk, they could get a better deal, saving the business hundreds of dollars a year.

Who is doing the work in the business? Are they taking a salary? What are the current owners drawings? Do they seem reasonable? Oh…. yes… many questions…..

marinelife's avatar

1. I think your friend should run not walk away from this deal.

2. At the very least, she needs legal representation and a review of the deal.

andrew's avatar

IANAL, IANAA, but I’ve dealt with this a lot.

#3 doesn’t strike me as odd, especially if the loan is in the business’ name (if it’s not then something is fishy). Your friend is paying for equity the business, and that equity includes whatever assets or liabilities the company currently has.

To put it this way—say the company owns something (like a car) that it paid for before your friend buys in. After he or she buys in, they decide to sell the car: he or she’ll be eligible to 49% of the profits from that. It doesn’t matter the fact that the car was bought before he invested.

It’s the same with the loan—it’s a liability on the books, and your friend is buying into that. He or she needs to evaluate whether the asking price is worth the potential profit the company could make.

That said, everything is negotiable. It may be that the value of the company is too large: at 49% ownership at 100K, the company is ‘worth’ $204K. If you friend feels that the company isn’t worth that much (considering the 125K in debt) he or she should offer less.

#1 Not uncommon, but not the simplest approach.

I really like the 51/49 split because it establishes a clear deadlock if they can’t agree. Great. A simpler approach is to split profits (and debt!) 51/49. You can split profits (dividends) 50–50 with a 51/49 ownership, but you can’t as an S corp, which leads me to the best advice:

FORM AN LLC, NOT A PARTNERSHIP. LLCs protect your personal assets from the business, and are less likely to be audited.

In general, depending on how friendly the friend and the seller are, I’d avoid lawyers in the negotiation process. Agree to the terms, then pass it to the lawyers once you’ve agreed. Otherwise you’re just wasting money.

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