How To Sell a Partnership: Strategies and Steps for a Smooth Transition
Business partnerships are like marriages. You work at them. You hope they’ll last. But sometimes things don’t work out. One partner might want to leave or all the partners might decide it’s time to move on, and when that happens, you’ll need a blueprint for selling the partnership or a partnership share.
Use a Partnership Agreement to Set Ground Rules
The time to start thinking about what will happen to your business if one or more of the business partners wants to leave is when you form your partnership.
Just as you and your business partners had to reach agreement on how the business will run, you should also have an agreed-upon plan to cover the possibility that some or all of the partners might decide they no longer want to be involved in the business.
The partners in a business partnership structure have broad leeway in deciding how one or more partners can leave the partnership, provided they build the rules into the partnership agreement. When there is no partnership agreement in place, state law dictates whether and how a partnership may be sold.
Build an Exit Strategy Into the Partnership Agreement
Many states require a partnership to be dissolved when one partner departs, so it’s important to construct your partnership agreement to maintain control over the process by accounting for the exit strategies of the partners.
Some of the partners might see the business as their career. Others might have a specific timeline for their involvement. You should also consider what you want to happen to the business if a partner retires, dies, or becomes disabled. In many partnerships, the partners are happy to work with one another, but they may not be open to the idea of a spouse or an adult child taking over a partnership share. Your partnership agreement should address these and other possibilities.
The Four Ds
Most agreements identify the four Ds—death, divorce, disability, and discharge—as acceptable reasons for individual partners to sell their shares. But the partners have discretion to include voluntary events in addition to those that are unexpected.
The agreement might restrict a partner’s ability to sell altogether, require the partner who wants to leave to sell their interest only to the remaining partners, or allow them to sell to a new owner.
The agreement should also cover the rules and procedures for selling the entire partnership.
Use a Buy-Sell Agreement to Set Sale Terms
There’s no requirement that a partnership have a buy-sell agreement. But having one in place ahead of an unexpected event—or even a planned one—can help prevent conflicts and ensure a smooth transition when a partner wants to leave.
What Is a Buy-Sell Agreement?
A buy-sell agreement, also called a partnership buyout agreement, details the procedure for transferring ownership.
The terms covered in a buy-sell agreement include:
- the events that can trigger a sale
- who is eligible to buy a partner’s share, including whether the remaining partners have the right of first refusal when a partner wishes to sell
- the way in which the purchase price will be determined
- the procedure required if there are no buyers for the selling partner’s interest
- the advance notice a selling partner must give to the remaining partners
- what will happen to the business if one or more partners wishes to sell
The buy-sell agreement also covers the possibility that all the partners will want to leave. It details the way debts will be settled, assets will be valued and sold, and sale proceeds will be distributed.
Valuing a Partnership Share
When a business is structured as a general partnership, the business and partners are not separate entities. For that reason, you can’t sell the business. You can sell only the partnership’s assets.
Partnership agreements typically require the partners to meet annually and agree to a value for the partnership’s assets. When the partners can’t agree, they’ll have to bring in an appraiser to conduct a valuation.
To value the business, the partners or appraiser assign a market value for tangible assets such as equipment and furnishings, add an additional amount to account for intangible assets such as customer lists, and subtract liabilities such as outstanding loans.
Each partner’s share is then typically valued based on their capital contribution to the business.
Determining the value of each partner’s share in partnerships differs between general and limited partnerships. In a general partnership, partners make business decisions and are liable for business debts. In a limited partnership, one partner owns and manages the business and the other partners are essentially investors who share in the profit or loss of the business. As a result, an appraiser is needed to determine the market value of the interest each of the limited partners holds.
Tax Laws for Partnership Sales
It’s important to note that the Internal Revenue Service has strict rules for the way partnership sales are treated for income tax purposes. In general, the difference between the sale price and the partner’s adjusted basis (the amount of money the partner invested in the venture) is subject to capital gains tax.
So-called hot assets (unrealized receivables and appreciated inventory), however, are treated as ordinary income. Partners who sell their shares must separate the assets sold accordingly when reporting to the IRS. Consult a tax professional to prepare your tax return to ensure that it complies with IRS rules.
How to Find a Buyer for Your Partnership Share
If the partnership agreement allows partners to sell their interests to a new partner, identifying buyers works much the same as it does for any other business sale. You can list your business on sites such as BizBuySell, use your network of business contacts such as vendors, your CPA and attorney, or you can use a business broker.
The biggest difference between selling a partnership share and selling another type of business structure is that, in most cases, the remaining partners have the right to approve your choice of buyer.
In a partnership structure, each partner can be held personally responsible for the liabilities incurred on behalf of the business by one of the other partners. As a result, partnerships are usually made up of individuals who share similar business philosophies and approaches and trust that they’ll see eye-to-eye on much of the decision making.
Because compatibility is so important in a partnership, bringing an outsider into the mix can be challenging. Selling a partnership share to one or more of the remaining partners avoids conflict and is often the preferred strategy when a partner wants to exit the business.
Likewise, it’s common for partnership agreements to give the remaining partners the right of first refusal to any new buyer a partner wants to bring in.
Closing the Transaction
When a partnership interest is sold, it changes the partnership. The remaining partners might be required to close and re-form the partnership to reflect the new lineup. At a minimum, the names on accounts the business holds should be changed, and accounts held in the name of the departing partner should be closed.
The sale of a partnership interest might also require state notifications and changes in the licenses the business holds.
Make sure you check with state authorities on their requirements, and file all the necessary paperwork when the ownership of a partnership changes hands.
When it comes time to sell a partnership, or your stake in a partnership, assembling a team of advisors is beneficial. Consider enlisting a CPA, attorney, or business broker to navigate the intricacies involved in the sale. Visit the BizBuySell Broker Directory to find a business broker to suit your needs.