Many LLC owners neglect to create buyout agreements, but buyout provisions are critical when you co-own an LLC with other members. A buyout, or buy-sell, agreement states what will happen when one member wants to leave the company, or worse, dies, goes bankrupt, or gets divorced.
(To learn more about LLCs, see LLC Basics.)
What Is a Buyout, or Buy-Sell, Agreement?
Contrary to popular belief, buy-sell agreements are not about buying and selling companies. Instead, they are binding contracts between co-owners of a business that govern what will happen when an owner wants to leave or a new owner wants to join. Because of this confusion over terminology, we will use the term "buyout agreement" from here on.
A buyout agreement controls the following business decisions:
- Can a departing member force the other members or the LLC to buy him or her out?
- Who can buy a departing member's share of the business? (This may include outsiders or be limited to other LLC members.)
- What is the price for a member's interest in the LLC?
- What other events can trigger a buyout?
A buyout agreement is a sort of "prenuptial agreement" between you and your co-owners: If your happy union doesn't last, the buyout agreement spells out, in advance, what will happen to the business you own together.
What Events Are Covered Under a Buyout Agreement?
Typically, the events that trigger the buyout of a member's interest under a buyout agreement are:
- a member's retirement or resignation
- an attractive offer from an outsider to purchase a member's interest in the company
- a divorce settlement in which a member's ex-spouse stands to receive a membership interest in the company
- the foreclosure of a debt secured by a membership interest
- the personal bankruptcy of a member, or
- the disability, death, or incapacity of a member.
Why You Need a Buyout Agreement
It's a huge mistake to ignore the fact that sooner or later your circumstances will change. Here's how the buyout agreement can help in several situations.
A member leaves. The odds are good that a member will want to leave the company before the other members are ready to sell or close the business down. Without a buyout agreement, the LLC might be automatically dissolved when one member leaves, forcing the assets to be sold and divided among the LLC members. If the other members wish to continue the business, there are no rules determining in advance whether and how departing members will be bought out, or for how much. This can lead to serious personal and business discord -- perhaps even court battles and the loss of the business.
A new member wants to join. A buyout agreement also places controls on who can buy a membership interest in the company and how new members can join your ranks. Without this provision, another member could sell his or her share to someone you would rather not be in business with.
Encourages a discussion of expectations. In addition to avoiding potential problems in the future, writing a buyout agreement has a very real immediate benefit: It will force you and the other members of your ownership team to talk about your hopes and expectations for the business. This type of honest, open communication will put your LLC on the right track from the very start.
Creating a Buyout Agreement
A buyout agreement can consist of several clauses in your written operating agreement or it can be a separate agreement that stands on its own. To create one, you can either use a self-help resource or see a lawyer -- or both.
One good tool is Nolo's Business Buyout Agreements: A Step-by-Step Guide for Co-Owners, by attorneys Anthony Mancuso and Bethany K. Laurence. This book contains a CD with fill-in-the-blank buyout clauses and instructions on how to incorporate them into your operating agreement. For those who want the services of a lawyer, this book can guide discussions with your co-owners so you can decide on your own time -- not your lawyer's -- what the terms of your agreement should be. To find an experienced attorney in your area, check Nolo's Lawyer Directory.
For a step-by-step guide to running your LLC, see Your Limited Liability Company: An Operating Manual, by Anthony Mancuso (Nolo).