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Dear Quentin,
The gist of my question is I bought a store with a friend, and he now wants me to buy him out, but I feel I paid him more than his fair share. I’m trying to avoid an awkward conversation.
Here’s the full story: Around six years ago, I came across a small shop being sold at a very reasonable price. I’m a little old-school, and appreciate investing in real estate especially after seeing it work well for my parents. Also, it’s worth noting that the real-estate market in my country is very stable and has almost never crashed, unlike the volatility I see in other markets like the U.S. (Our real-estate market is based on cash and almost no credit, hence the stability.)
Even though the shop was at a great price, commercial real estate is always pricier and I couldn’t afford the whole price on my own, let alone the cost of work needed to finish the interior of the store.
So a friend of mine was happy to pitch in, and we agreed that I would pay the bulk of the property prices and he would contribute a little, as well as covering the full cost of finalizing the interior build of the store. The store price was $80,000, of which he paid $7,000, and I paid the remaining $73,000 in our local currency.
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‘This year, my friend wanted to sell his share and I offered to buy him out.’
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Over the last few years, my friend spent an additional $6,700 to fix up the store — bricks, tiles, paint, contractors, plumbing, electrical work, etc.
This year, my friend wanted to sell his share and I offered to buy him out. We asked around about the current market value and were pleasantly surprised that the value of the store had gone up over four times the original price, especially since all the interior work was done. So the store we got for $80,000 was now worth $320,000.
In calculating how much I should pay him to buy him out, he combined the original $7,000 he put in to buy the property, added the $6,700 he used to fix the place and said his share of the original $80,000 is 17%. So if the current price is $320,000, I should pay 17% of that to buy him out ($54,400).
This equation seems off to me. I believe he should get back $28,000 on his original capital investment — but not the money he spent on refurbishments. That was an expense, and that is included in the final price.
If anything, I can pay him back the $6,700 at its original value, but not more. Otherwise, it feels like I’m paying him back for plumbing and electrical work at four times what he paid. He maintains that the $6,700 he paid increased his share in the business itself.
I hope this makes sense because I’m going around in circles in my head. We have a great relationship, and I would have no issue talking to him about it. I just wanted to make sure I’m right before bringing it up and causing any potential awkwardness or conflict. Thanks a million in advance.
The Conflict Avoider
Dear Conflict Avoider,
When entering into a business arrangement with friends, family or any third party, never rely on a friendship, goodwill or a handshake over a contract. This is a textbook example of what happens when two friends get together and hit pay dirt. The nature of the relationship is irrevocably changed when you go into business. Large sums of money can shift loyalties further. Assuming this was the only refurbishment, the store technically cost $86,700.
Here’s what the Internal Revenue Service says constitutes capital improvements, per Dermody, Burke & Brown: “fixing a defect or design flaw; creating an addition, physical enlargement or expansion; creating an increase in capacity, productivity or efficiency; rebuilding property after the end of its economic useful life; replacing a major component or structural part of the property; adapting property to a new or different use.”
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‘Your friend’s investment in the refurbishment should be considered a capital improvement.’
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Your friend’s refurbishment is a capital improvement. You bought a commercial property and the value of the store and the building is reflected in the business over the years it has been in operation. On a separate note, it’s unlikely that you could have built the business into the success it has become without those improvements. Even without that guidance, err on the side of the friendship given the lack of paperwork.
He gets back $50,560 of his 15.8% investment — rather than $25,600 of his 8.75% investment in the original purchase. You both walk away happy, with a hefty profit, and you live to invest another day together (or, ideally, separately).
Congratulations to you both on the successful venture. In order to preserve the friendship, avoid a messy legal dispute and live up to your sobriquet, next time, put your deal on paper.
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