This article is a paraphrased response I gave to a question I had from an owner of one firm who had entered into a verbal agreement to go to another firm. He had the expectation that he and his current business partner would buy out that firm in the future and wanted to know how he and his current business partner should be compensated. None of this was documented in written form. First, I summarize the issue by paraphrasing.
Question: Summary of Silent Partner Dilemma and Concerns
You and another individual own a remodeling business, which I shall refer to as “Remodeling Company”. You still own Remodeling Company but became a passive owner when you left the business to go work for another company, Construction Company. Your Remodeling Company business partner now has full management control of the business. Construction Company, the firm you now work for, is owned and operated by individuals who are nearing retirement. Your Remodeling Company business partner has a stated intention, in writing, of joining you at Construction Company. However, the owners of Construction Company have not provided a written contract or made a formal job offer to your partner . Both you and your Remodeling Company partner intend to purchase Construction Company and have verbally shared this with the Construction Company owners. However, you have no written option contract or offer to purchase.
Furthermore, your Remodeling Company and their Construction Company are in different sub-industries; therefore, you and Remodeling Company business partner will not merge or otherwise combine the two companies. Finally, the Remodeling Company is highly recognized (i.e., has high visibility) but, unfortunately, does not generate sufficient net income to pay you and your business partner what you could earn as employees elsewhere. However, Construction Company can not only pay you and your business partner an industry-standard wage, but Construction Company is more profitable, has a strong balance sheet, and more revenue opportunities and can therefore offer you and your partner more net worth creation than Remodeling Company can.
Your question is multi-fold:
- Should you and your business partner sell the Remodeling Company to an employee? or
- Should you both keep the Remodeling Company and just scale it back so your partner can run it alone?
My Response: A Few Additional Concerns
Warning! Warning! Warning! You are placing far too much weight on your future goals and activities on an assumption! That assumption is that you and your business partner will be able to buy Construction Company at some future date when the current owners actually retire. I and others I know have been in the same situation. Rule number 1: Nothing ever remains the same! The Construction Company owners could fully intend to sell to you today, but one could die six months from now, or the owners could receive a really attractive offer from a competitor, a current family member or business acquaintance, or larger company in the industry to buy the business. Who knows? There are far too many things that could change in three to five years.
Therefore, before I answer your question, I say to you: You MUST document this purchase “intention” in writing, either as an Offer / Agreement to Purchase or an Option to Purchase. You have numerous options to clearly and fully document this intention to purchase the Construction Company in writing. These include the following:
- You could execute a sales agreement to purchase the Construction Company now, but pay for the purchase over the next three to five years.
- Option 1: Structure this as an installment sale. (This option could help the sellers save on taxes.) or
- Option 2: Structure this as an equity buy down over the three to five year period.
- (Other options exist, but deal structure is not the point of my answer; the need for a written agreement is.)
- You could enter into an option to purchase agreement or an agreement that provides you and your business partner with the right of first refusal to purchase the Construction Company.
- This alternative is attractive if you and your business partner do not currently have the funds to purchase the Construction Company, the current owners are unwilling to sell today, or you are simply unable to negotiate a buyout today.
I strongly recommend the following action steps:
- Discuss with your current business partner what you both want to do with regards to purchasing the Construction Company.
- Speak to the owners of the Construction Company and come to a specific verbal agreement regarding a purchase, option, or variation thereof.
- Consult with a business acquisition attorney to help you document and structure an offer that meets everyone’s primary needs and wants.
For the actual answers to the questions, and the second and final half of my response, please view this blog on Monday, August 25.