Buyout Agreements: Changing LLC Ownership
A buy-sell agreement, a business continuity agreement, or a buyout agreement is a contract between co-owners of a company that determines how to handle the departure of a member. A buyout agreement is an important part of LLC ownership because it regulates who can buy a member's interest and establishes a predetermined price for ownership interests.
Who Needs a Buyout Agreement?
Most LLCs should create a buyout agreement. The few exceptions include a business that has:
- One owner
- Married owners
- Parent/child owners
Why Create a Buyout Agreement?
Chances are that at some point a member will leave a company. Without a buyout agreement, state law may force the dissolution of a limited liability company when one member leaves. A buyout agreement can establish preset guidelines for handling changes in ownership and can prevent unwanted buyers from obtaining an interest in the company. A buyout agreement can control:
- The transfer of ownership
- Whether the withdrawing member will be bought out by the other members
- How to value a ownership interest
- The terms of payment for a withdrawing member's interest
Buyout agreements are usually included in the LLCs operating agreement, but a separate document can also record buyout terms.
What Events Trigger a Buyout Agreement?
A buyout agreement determines what events will initiate a buyout of a member's interest. Common events include:
- Bankruptcy (this initiates an automatic sale of the member's interest back to the company)
- A divorce settlement that gives an ex-spouse an ownership interest (the ex-spouse must sell any acquired interest back to the company)
- Disability or incapacity
- Loss of a license
- Default on a personal loan
Buyout Options and Forced Sales
When ownership interests change, a buyout agreement can not onlygive the LLC the right to purchase the departing member's interest, it can also include terms that force the LLC to buy a departing member's interest.
- Option to Purchase an Owner's Interest: This option gives the LLC and its members the right to buy back an ownership interest from a member, a member's family, or the member's estate within a certain time and according to a predetermined price. This option, for instance, can be used to buy an interest from the estate of a deceased member, from a member that retires or quits, or from a member that becomes disabled.
- Right to Force a Sale: This provision gives a member that decides to leave or retire the right to force the company to buy their interest. The LLC or its members must buy the interest within a certain time and at a predetermined price if the departing member or the member's family makes a request.