I'd like to apologize first for this long thread. I am ready to take this to an accountant and a lawyer, but I wanted to share it here, hoping the collective wisdom can give me some good advice. I hope you can provide some objective suggestions on valuation and how to proceed. Thanks in advance!!!
We bought a business in Feb. for $300k. There are 2 owners, with an ownership split of 51-49, with us holding the majority ownership.
Out of that 300k, we put out $60k in equity between us ($30,600 from us representing 51%, 29400 from the other partner for their 49%). $170k of the sale price was through seller financing. 55k of the remaining $70k ($300k - $170k - $60k) was raised this way:
$35k - from friends/family that we're paying a good rate of 8% over 3 years
$20k - from 2 credit card AOR's we got on behalf of the business that offered us 0% for 12 months
By the time of closing, we were short about $15k. On top of that, closing cost was another $15k, so a total of $30k. To be able to raise that money, we decided we would work together to each try to raise half of that ($15k each) in whatever means we can - friends short term loans, personal credit cards, or even loans from ourselves. In the end, for our part, we ended up getting our 15k covered by a family short term loan, and a personal credit card. For our partner, since they can't get a short term loan from friends/families, it was $11k from their personal credit card, then $4k of their own money.
We all agreed that personal loan from us would be earning 0% interest initially since it was our business. The personal credit cards we used to fund our purchase was going to be treated as a loan by the company. The company would pay any interest (there were none since they were 0% offers) and the balance transfer fees.
So we did close and are running the business now. Everything is fine. The one thing that hasn't been ok is the partnership. Long story short, they want out of the business due to differences in what direction to take. Unfortunately, we were engrossed with the prospects that we didn't take care of the legal matters that related to our business relationship. In other words, we don't have legal documents about our partnership (except the incorporation), how the buyout or sellout would work, etc.
What they are asking now is for us to buy them out. They are requesting we return their equity investment of $29400, the loans they personally made out to the company, including the personal credit card loans, and apparently pay the loans that were made out to their friends/family (about $19k of that $35k that we're paying 8% interest over 3 years).
A few people told us we should look at the valuation of the business right now to get a good understanding of how much equity we have on the company.
Currently, the company's gross income from the time we bought it until now is $240k. Expenses are at $230k, but that includes paying off some of the loans. Out of the total loan the company owes of $255k, we paid about $30k. So $30k of our $230k expenses was for loan payout.
Are we correct to say that they cannot request us to payoff the loans that their families/friends made since those loans were made out to the company and it's the company's responsibility to pay it during the course of the agreed terms. Isn't that the same with the personal loans that the partner put out from their own money? Even the personal credit card they used? Those are loans against the company too, and there are terms associated that were agreed to. All these are documented in email threads.
So if we are buying them out, the only consideration should be the equity. Considering the amount of liabilities the company has right now, do we really have any equity available? The partner is insisting the loans we paid off count towards equity so technically the net income of the company is around $40k, instead of $10k. Are they correct? If so, will the equity buyout be then based off that $40k (49% of that)?
The other option they're saying is to continue with the partnership but they want to revise some terms of agreement. For one thing, they want moving forward, if the company will need to loan additional money and the company cannot use its name to get that loan, the partner is insisting we do 51-49 in terms of finding the funds for the loan. Meaning for a $10k loan, $5100 will be our responsibility to raise, they'd be responsible for the other $4900. If we end up getting a personal credit card to cover our $5100 at 0%, the partner is insisting we will have to cover the BT fee (if any) personally. So if there was a $300 BT fee, I will have to pay that and not charge it against the company. Why would we agree to that? We had to take that route because of the company in the first place, so why would we suffer personally? They're saying that if we let the company shoulder that $300 BT fee, that's $300 less we would be splitting as net income, so from their perspective, they'd be getting $147 less (49% of $300) after everything.
Also, from the personal credit card loans we all took, 2 of the cards under my name have already been paid off (since the terms were already due) and we all agreed to have the company pay them off. That means there is 1 card right now that's under my partner's personal account. They are saying the loan balance on that credit card (about $8k) should be split so that it reflects a 51-49 split. What they mean is we should give them $4080 (51% of 8k) from our personal money so that the 8k loan on the card reflects our ownership. Does that sound right?
I apologize for this very long thread. I am quite desperate since instead of dealing with running the business, we have to deal with this also. Our focus is keeping the business afloat, so this is unwelcome distraction. We are seriously considering buying them out just to end the stress with dealing with a partner, but we need some guidance. On one hand, we are thinking of just doing what they asked for - return their equity investment, but we wanted to be sure we're doing the right thing. One thing we've learned - friends as business partners? --- be very careful. It doesn't all turn out well, no matter how close you are.
Here are the numbers:
Purchase Price: $300k
Other closing costs: $15k
Total Purchase Price: $315k
Loans to fund the purchase (Liability):
Seller Financing: $170k (terms: 6% over 5 years)
Owners Equity: 51% = $30,600 (us)
49% = $29,400 (partner)
Business CC's = $20k
Friend/Family 1(us) = $16k (term: 8% over 3 years)
Friend/Family 2 (partner) = $10k (term: 8% over 3 years)
Friend/Family 3 (partner) = $5k (term: 8% over 3 years)
Friend/Family 4 (partner) = $4k (term: 8% over 3 years)
Friend/Family 5 (us) = $8k (term: 4% over 6 months initially, has been extended)
My Personal CC BT = $7k (term: 0% over 9 months)
Partner personal CC BT = $11k (term: 0% over 15 months)
Partner personal loan = $4k (term: 2.25% over 6 months initially, but has been extended)
Cash Flow from Feb- Sept:
Gross Income: $240k
Expenses: $200k (does not include $30k that have been used to pay some of the loans)
We do not receive salaries in the business (not currently, maybe in the future)
For the $30k used to pay off loans and interests:
My Personal CC BT = $7k principal (paid off). Does the $200 BT fee count as interest payment?
Partner Personal CC BT = $11k principal has been reduced to $8k. BT fee was $300.
Friend/Family 5 (us) = $8k principal reduced to $4k. Interest has been deferred until full loan is paid
Seller Financing = $15,500 paid (approx. $11k in principal, $4.5k interest)
Current Liability (principal + interest):
Seller Financing: $214k
Business CC's = $14k
Friend/Family 1(us) = $16k
Friend/Family 2 (partner) = $10k
Friend/Family 3 (partner) = $5k
Friend/Family 4 (partner) = $4k
Friend/Family 5 (us) = $4.6k
Partner personal CC BT = $8.3k
Partner personal loan = $4k
We do not store any inventory since it's a service oriented business. Estimated assets worth: $10k