LLC Buy Sell Agreement Sample: Everything You Need to Know
An LLC buy-sell agreement sample provides a framework for writing a legal contract that details how shares of your LLC can be transferred in ownership.6 min read
An LLC buy-sell agreement sample provides a framework for writing a legal contract that details how shares of your limited liability company (LLC) can be transferred in ownership. For example, will you permit shares to be sold to an outside entity if your business partner passes away, or will his or her estate inherit ownership? A buy-sell agreement provides the answers to these and related questions.
What Is a Buy-Sell Agreement?
The buy-sell provisions can be detailed as part of your LLC operating agreement or in a separate agreement. Without having a buy-sell agreement in place, you may be subject to a costly legal battle if one owner wants to leave the LLC, gets divorced, retires, or dies. The buy-sell agreement details:
- Whether outside members can buy a departing member's ownership share or if it must be sold to remaining LLC members.
- Which circumstances trigger a buyout.
- The price of each member's interest in the company.
When Do I Need a Buy-Sell Agreement?
While a buy-sell agreement is useful for all small businesses, it's especially critical for LLCs with more than one owner. This prevents the LLC from dissolution if a member leaves while accounting for the rights of the member and his or her family. For a sole proprietor, a buy-sell agreement can arrange for an employee or a family member to take over if the original owner retires or passes away. For example, leaving the business to a successor can decrease the LLC's owed estate taxes.
Although a buy-sell agreement is often established when the business is created, it can be put in place at any time. It makes sense to implement a buy-sell agreement when:
- You want to keep other business owners from selling their interests in the company to others who may not have its best interests in mind.
- You want to make sure an owner sells his or her business interests to another member or to the LLC itself rather than to an outside entity.
- You want to require remaining owners or the LLC to buy the interests of a member who leaves.
- You want to make sure business interests have a fair market value established to prevent disagreements between a departing member and remaining members.
- You want to establish the terms and conditions of a future business interest purchase, including the price.
Even if you don't think a co-owner will ever want to leave the business, statistics show that most multi-owner companies eventually part ways with at least one member. If this happens without a buy-sell agreement in place, the business will likely need to be dissolved and assets liquidated. Think of the buy-sell agreement as a prenuptial agreement for your business. Although you hope you never need it, it gives you a legally binding exit strategy should any of the members decide to part ways.
Consequences of Operating Without a Buy-Sell Agreement
Without a contract in place, several potential scenarios can occur if a member retires, dies, or otherwise leaves the LLC. For example:
- If a member dies, his or her shares would automatically pass to heirs, who could sell them off or attempt to run the company in a way the other owners disagree with.
- If a member divorces, the court could award his or her shares in the business to the ex-spouse, who could also sell or interfere in the business.
- If a co-owner wants to sell his or her shares, a dispute over proper value could result if an agreement is not in place. The company could be dissolved if there is no resolution.
- In the event of a disagreement, an owner could sell shares to a competitor or another unapproved individual or entity.
Events That Can Trigger a Buyout
When drafting a buy-sell agreement, members can include virtually any type of event that they consider important and would affect the future of the company. These do not need to be standardized and can be customized to the members' needs and desires. However, there are several triggering events that are commonly included:
- Death: The deceased member's ownership interest must be purchased by the surviving members of the LLC. If this is included, purchasing the interest is mandatory. Members' life insurance policies can help fund these buyouts.
- Divorce: If a married couple shares ownership in an LLC, this stipulation determines which spouse acquires the Limited Liability Company's interest when a divorce takes place.
- Termination: If one of the LLC members decides to leave the company or is fired, this section of the agreement specifies that they can only own an interest in the company while employed by the company.
- Default Under the Operating Agreement: If a member defaults under the operating agreement, the other members of the LLC will be allowed to purchase that member's interests in the company. A common reason for this is the failure of a member to contribute money or property as required in the company's operating agreement. In such cases, the purchase price may be lower than the fair market value of the company interest.
- Sale of a Majority Interest (“Drag Along”): A member who owns the majority interest in the LLC and decides to sell out can require other, minority owners to sell their interests as well. Typically, the terms and conditions of the minority members' sale are the same as that of the majority member.
- Sale of a Majority Interest (“Tag Along”): If the majority owner of the LLC decides to sell, minority owners have a right to require the sale of their own interests alongside the majority member's interest. In this way, they ensure that they receive the same terms and conditions as the majority member during the sale of their interest.
- Transfer of Membership Interest Without Consent: It's recommended that an LLC Operating Agreement specify that members are not allowed to transfer their interest in the company to another party unless the other members approve. Therefore, if a member violates this rule, the other LLC members have the option to purchase that member's interest. Again, the purchase price may be lower than the fair market value.
- Loss of Professional License: When an LLC is owned by members who need licenses, the buy-sell agreement may offer an option for LLC owners to purchase the interest of any member who loses their license for any reason.
- Felony Conviction: If a member of an LLC is convicted of a felony, the other members may not want to do business with them anymore. Therefore, they will be able to acquire their ownership interest.
- Disability: A member who becomes permanently disabled may no longer be able to perform their services in the LLC. Therefore, the remaining members will be allowed to purchase that member's ownership interest.
- Retirement: An LLC member who wants to retire faces a more complicated situation than a standard employee. The buy-sell agreement should include a section covering the retirement process, allowing other members to purchase the retiree's membership interest.
- Bankruptcy: An LLC member who files for bankruptcy could lose their membership interest in the LLC. However, if bankruptcy is covered as a triggering event in the buy-sell agreement, the other members will have the option to purchase that member's interest from the creditor who has acquired it.
Fixing the Purchase Price
Calculating the fair market value of your LLC is one of the most important steps in creating a buy-sell agreement. The agreement is not enforceable unless it includes a purchase price, which can be derived through several methods.
- Stated value method: members agree on a purchase price and document it in the buy-sell agreement.
- Formula method: members agree on a procedure for calculating the fair market value, such as three times the average value of net profits for the last three years.
- Future appraisal method: members agree on an independent appraiser to determine the LLC's value. Otherwise, each party may hire and pay for an appraiser of their choice. If the difference between both party's appraisals is less than 15 percent, the market value will be the average of the two. If it is more than 15 percent, a third appraiser is hired, and the cost is split between LLC members. As long as the value determined by the third appraiser is somewhere between the first two appraisals, the third appraiser's value is considered the final fair market value.
- Single appraiser method: an experienced appraiser is hired to determine the current value of the LLC. This is also called the “select now, value now method."
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