By Cliff Ennico
“A friend and I set up a limited liability company (LLC) 20 years ago.
The business was extremely successful, to the point that about 10 years ago we brought in a third partner who ‘earned his way’ into the company. My friend and I own 40 percent each of the LLC, and this third partner now owns the remaining 20 percent.
About eight years ago my friend and I ceased being involved in the business, as our third partner was doing a great job of running the business day to day and my friend and I were getting on in years.
My friend and I have reached the point where we want to retire permanently from the business. We offered our third partner the chance to buy us out for $300,000, but he flatly turned us down saying the business wasn’t worth more than $50,000.
With 80 percent of the LLC ownership, we decided to put the business up for sale. We found a buyer willing to pay us $200,000, but only if our third partner signed an employment agreement with the buyer. He turned down the employment offer, which we understand would have compensated him at a level equal to or greater than what he currently draws in compensation from the LLC.
Our third partner acknowledges that he was not a founder of the LLC, but says he believes he is “its face and its value,” such that without him the LLC has little if any value. He has offered to purchase our ownership stakes in the LLC for $50,000 ($25,000 each), but we have turned that down. We have an independent appraisal which values the LLC assets alone, not the business as a going concern, at $75,000. Using either a “benefit to owners” or a “gross sales” method of appraising the business places the value somewhere in the $200,000 range.
The discussions with our partner have so far been cordial, but we are getting nowhere with him. We cannot afford to lose him, yet we want to be compensated fairly for the many years we ran this business ourselves without him. Is there any way to break this impasse so we can retire comfortably and our third partner can move forward with the business?”
Sometimes even with 80 percent of a business you can’t always get what you want.
The problem here is that you allowed your third partner to become so indispensable that without him the business really has no value as a “going concern.” This is the price you paid for taking an “early retirement”!
Having said that, there are a couple of strategies that might work here, as long as you and the third partner keep your lines of communication open.
Strategy # 1. You can solicit bids from third parties to sell the assets of the LLC without an employment agreement with the third partner, and see if anyone “bites.” If they do, and you get an offer for more than $50,000 (what the third partner is willing to pay), there probably is a “right of first refusal” clause in your Operating Agreement saying you can accept the offer and sell out as long as you give your third partner a reasonable opportunity (usually 30 days) to match the offer. If he matches the offer, you sell to him; if he doesn’t, you sell out to the bidder.
The problem with that approach, of course, is that you probably won’t get as good a price for the assets of the business as you will for the business as a “going concern” (with the third partner on board). You also will have to share 20 percent of the proceeds with the third partner, who may not co-operate in getting the deal done since it will cost him his job. If he quits, you could sue him for breaching his “fiduciary duty” to the LLC, but getting that judgment won’t be easy.
Strategy # 2. You can offer to sell the business to your third partner for a purchase price of $50,000 (what he has offered you) plus a “royalty” of 10 percent to 20 percent of the LLC’s gross sales for the next five to 10 years. If he sells the business before that time, you would get 10 percent to 20 percent of the proceeds of sale.
It’s clear to me from your e-mail that your third partner does not have enough cash on hand to pay more than $50,000, and does not want to go into debt to pay you the $200,000 you probably deserve for the business. If I’m right, this arrangement may be acceptable to him since your royalty payments are not coming out of his pocket.
The downside, of course, is that 10 percent to 20 percent of gross sales may not give you anywhere near $200,000 if the business doesn’t perform well. You will also have to review his books and records periodically to make sure he’s not shortchanging you.
Cliff Ennico (www.succeedinginyourbusiness.com), a leading expert on small business law and taxes, is the author of “Small Business Survival Guide,” “The eBay Seller’s Tax and Legal Answer Book” and 15 other books. Follow Cliff: @cliffennico.