Recapitalizing a Deal or Buying Out a Partner

A partnership can come under strain for reasons that have nothing to do with the property performing poorly. One partner may need liquidity for reasons outside the deal, a disagreement over whether to sell, refinance, or hold longer can become unworkable, or a fund partner may simply be reaching the end of its stated hold period and need to return capital to its own investors regardless of how the asset is doing.

Recognizing early which of these situations applies changes how the buyout should be approached. A liquidity-driven exit from an otherwise aligned partner is usually a more straightforward negotiation than a buyout forced by a genuine strategic disagreement about the future of the deal.

Most operating agreements specify a valuation mechanism, whether an independent appraisal, an agreed formula based on a capitalization rate applied to trailing income, or a right of first refusal process that lets the remaining partners match a third party offer. Where the agreement is silent or ambiguous, the parties typically negotiate directly or bring in an independent appraiser both sides agree to use.

The valuation needs to account for the property's debt, since the departing partner's interest is worth its share of the equity value, not the gross property value. A partner who has forgotten this distinction sometimes starts negotiations from an inflated expectation based on gross value alone.

Many operating agreements include a buy-sell or shotgun clause, under which one partner names a price and the other must either buy at that price or sell at that price, designed to produce a fair outcome when the partners cannot agree on value themselves. Other agreements use a more structured appraisal process, sometimes with each side naming an appraiser and a third resolving any gap between the two valuations.

The remaining partner or partners typically fund a buyout with a combination of new capital and, where the property has appreciated or amortized since the original financing, a refinance of the existing senior loan to pull out proceeds. Where a full refinance is not the right move, mezzanine debt or preferred equity layered above the existing senior loan can fund the buyout without disturbing the senior loan's terms.

The choice between a refinance and layering subordinate capital often comes down to whether the existing senior loan has a prepayment penalty or below-market rate worth preserving. A senior loan with a rate well below current market rates makes layering new subordinate capital more attractive than refinancing the whole stack.

A change in ownership, even among existing partners, typically requires the senior lender's consent under most loan documents, and the lender will want to understand who is buying out whom and how the buyout is being financed. Sponsors should raise the buyout with the senior lender early rather than after terms are agreed, since a lender that objects to the financing structure can delay or derail an otherwise agreed transaction.

A partner buyout draws in more parties than the two partners themselves. Counsel for each side drafts and negotiates the purchase agreement and any amendment to the operating agreement, the senior lender's counsel reviews the ownership change for consent purposes, and, if new subordinate capital is involved, that provider's counsel documents its own position in the stack. A title company may also need to confirm the transfer does not trigger a reassessment or transfer tax event depending on the jurisdiction and how title is held.

The core documents typically include a membership or partnership interest purchase agreement, an amended and restated operating agreement reflecting the new ownership split, payoff or funding instructions for the buyout price, and, where financing is involved, the loan or preferred equity documents for the new capital. Assembling a checklist of exactly which documents each party needs to produce, and by when, keeps a multi-party closing from stalling on a single missing signature.

As an illustration, a property with $12,000,000 in equity value has a departing partner owning 25%, or a $3,000,000 interest before any negotiated discount, adjustments, or transaction costs, bringing the actual buyout price to $2,500,000. The remaining partner funds $1,000,000 from available cash and layers $1,500,000 of preferred equity above the existing senior loan to cover the rest, avoiding a full refinance of a senior loan that is currently priced below the market rate available today.

A straightforward buyout between cooperative partners, with a valuation mechanism already specified in the operating agreement, can often move from agreement in principle to closing within a few months, most of which goes to documenting the transaction and obtaining lender consent rather than negotiating the price itself. A buyout complicated by a valuation dispute or a lender reluctant to consent can extend considerably longer.

A practical sequence starts with agreeing on valuation and price, then runs the senior lender consent process in parallel with sourcing any new financing, and closes once both the lender consent and the financing are in hand. Sponsors who try to finalize financing before valuation is settled often find themselves re-underwriting the buyout capital once the actual price changes.

A partner buyout can trigger tax consequences for both sides, including potential gain recognition for the departing partner and, depending on the structure, implications for the remaining partners' basis in the property. Transfer taxes may also apply depending on the jurisdiction and how the transaction is structured. These are questions to raise with tax counsel and, where relevant, the property's transfer tax advisor before finalizing the structure, not after.

Sponsors sometimes negotiate a buyout price before confirming the senior lender will consent to the transaction as structured, only to have to renegotiate once the lender's requirements surface. Another common mistake is treating the buyout as a simple cash transaction without considering whether layering subordinate capital would be more efficient than a full refinance.

H Equities evaluates preferred equity from $3,000,000 to $15,000,000 and mezzanine loans from $3,000,000 to $15,000,000, either of which can fund a partner buyout without necessarily disturbing an existing senior loan on favorable terms.