LLC Member Buyout Agreement: Everything You Need to Know
An LLC member buyout agreement is the process of a member or owner leaving a Limited Liability Company.3 min read
2. Changing LLC Ownership
Updated November 4, 2020:
How to Release a Member From an LLC
LLCs and corporations are similar in a lot of ways, but it is much easier for a shareholder to leave a corporation than it is for a member to leave an LLC. LLCs are completely owned by the members of the company, so it can be very hard to accurately assess the worth of any member's shares should they wish to leave. Because LLCs have a pass-through entity structure, each member of an LLC reports the company's profits on their personal income tax returns, which makes for complicated tax issues when a member wants to be bought out.
Follow these steps for releasing a member from an LLC.
- Take a look at the operating agreement for the LLC. This is a document that would have been created and agreed upon by the business's founding members. It should stipulate how the business is meant to handle the buyout of a member along with other information regarding potential issues within the LLC.
- Balance the capital account of the member who wishes to leave. This account should have been tracking all contributions and loans made to the company throughout the individual's membership. It should also have tracked any profit distributions and loans given to the member by the company. Any and all outstanding debts between the member and the LLC should be settled before the buyout takes place.
- The interest that the member still has in the LLC should be appraised by following the instructions in the operating agreement. If the agreement does not spell out how this should be done, an outside party can be brought it to complete the assessment in order to avoid disputes.
- Once the departing member's interest has been valued, you'll need to write a purchase agreement. This document will lay out the terms of the buyout and act as a legally-binding agreement. This document should line up with any specifications detailed in the LLC's operating agreement. It's always a good idea to protect your company by adding non-compete or confidentiality clauses to these contracts.
- Have the exiting member and an authorized member of the LLC read and sign the document. This authorized member might be any member of the company or someone who has been elected to represent the business in these types of situations.
- Once the member has undergone the buyout, all capital accounts will need to be adjusted in order to spread out the departing member's interest to the remaining members. This process should also be detailed in the operating agreement, but if it isn't the interest percentage should be equally divided among the accounts of all remaining members of the LLC.
- Finally, the K-1 report, created by the company, should be given to the departing member. This will detail any of the LLC's profits or losses that should be included on their personal income tax return for the year. This will be this member's final K-1 form and should be noted as such at the top of the sheet.
Changing LLC Ownership
Multi-member LLCs do carry extra risk with their structure because of the potential difficulties if one member decides to leave or dies.
The following events can lead to a change in LLC membership or ownership:
No matter the reason for the change, the members must create and sign a written document that displays the terms and agreement of all LLC members, including the departing member.
Also known as a buy-sell agreement or business continuity agreement, an LLC member buyout agreement outlines the handling of member departure and is agreed upon at the start of an LLC. This document should determine the handling of member interest and prices for those interests. Buy-sell agreements are actually written documents that detail exactly how a company should handle the leaving or adding of any members, and they have nothing to do with buying or selling businesses as many think they do.
The following information should be outlined in a buyout agreement:
- Rights of a departing member and other members in the case of a buyout
- Persons allowed to buy the interest of the departing member, and whether outsiders are allowed this purchase
- Interest prices
- Any events that may cause a buyout to take place
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