Buy-Sell Agreement: Overview

A buy-sell agreement LLC addresses major issues that many business owners don't always think about when forming a new company. For example, what would happen to the business if your partner were to pass away? Would you own the business outright or would you legally need to share the business with your former partner's heirs? Without a buy-sell agreement in place, you probably wouldn't know the answers to these tough questions.

If there is no buy-sell agreement in place, business owners can face all types of tax and financial issues if one of the owners gets divorced, dies, enters into retirement, or leaves the company for any other reason. The majority of LLC owners will overlook this critical aspect of an operating agreement. By including the details of the buy-sell agreement at the time of formation, you can eliminate stress and save money.

When you include buyout provisions or a buy-sell agreement with the operating agreement, all owners of the business can plan ahead for circumstances that could otherwise destroy the company. These circumstances often include retirement, death, bankruptcy, or divorce of one of the LLC owners. Within the buyout agreement, details include what the business owners plan to do in the event that one owner files for bankruptcy, passes away, goes through a divorce, or chooses to leave the business.

In other words, the buy-sell agreement is the exit strategy for an LLC member. You should never enter into a business agreement without a solid strategy for an exit. The main reason why an LLC with multiple members needs a buy-sell agreement is that all members will be legally bound to another unless they can determine how they want to split the business fairly. In a situation when members don't agree on other issues, this can be extremely challenging and frustrating.

The LLC laws in the state of Arizona don't require members to include a buy-sell agreement in their articles of organization, but it is still smart to sign one as part of the LLC formation. One exception to this rule of thumb is if the LLC is owned by a husband and wife. A buy-sell agreement exists to provide a way for all LLC members to protect themselves and the company should a specific event occur with one of the members. 

If you don't have an exit plan in writing for the business, all members are legally bound to one another, even if someone passes away. For example, in Arizona, the LLC laws don't provide any details about acquiring the interests of other members.

An LLC should use a buy-sell agreement if any of the following conditions apply:

  • You are a co-owner and want to put restrictions in place for other owners to sell their ownership to someone else, especially of the other business entity or person doesn't have the company's best interests at heart.
  • You wish to require an owner or the owner's estate to sell the business interests should the owner pass away, retire, or become disabled, giving the remaining owners control of the business.
  • You want the company or remaining owners to be able to buy out the business interests of an owner who passes away, retires, or becomes disabled, which can help maintain the market for the owner's business interests.
  • You wish to set a fair and reasonable price for any business interests should owners get into disagreements about selling the business versus staying in business.

What Is a Buyout, or Buy-Sell, Agreement?

Although many people believe buy-sell agreements relate to selling and buying companies, this is not actually the case. This type of agreement is a binding legal contracting between business co-owners, designed to govern what happens if certain circumstances occur, such as a new owner wishing to join the business or a current owner wishing to leave the business. Since this term can be confusing, many people refer to a buy-sell agreement as a buyout agreement.

Your company's operating agreement may include a few clauses that will become the buyout agreement, or you can create a separate written agreement on its own. It should include details of what will happen in the event of certain business situations or decision, such as:

  • Whether an LLC member can require other members to buy out his or her business interests
  • Whether LLC members can buy out a member's share or outside people can become financially involved
  • The value of an LLC member's business interests
  • Any other events that could trigger the buyout of another member

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