Option to Purchase Membership Interest in LLC
The option to purchase membership interest in LLC differs from purchasing the interest in other types of business.3 min read
2. Put Option
3. Call Option
4. Funding a Buy Out
5. Equity Compensation in an LLC Structure
Buyout Options in an LLC
It is a good idea to have a buyout option in an LLC with multiple members. This is often referred to as a buy-sell option. A buyout option covers the regulations and processes in the event that one member wants to exit the business. This option should be included in the operating agreement. The specific details and requirements should be decided when initially forming the LLC to prevent disagreements later.
The buyout might include the following details:
- Whether or not the member leaving can force the other members to buy them out.
- Which members are allowed/not allowed to purchase the available interest.
- How the value of their interest will be determined.
- What events allow for a buyout to occur. This might include disability, fraud, or death. A member's divorce or bankruptcy might also force them to sell their interests in the LLC business.
- If inheriting interests is allowed with the death of an LLC member.
- How the payment will be arranged in the event of a member's buyout.
Creating buyout specifications ahead of time can help to prevent any disagreements later on. Without clear buyout requirements, LLC members can be faced with costly lawsuits. It is also possible that the state could require the LLC to completely dissolve if an agreement is not made. Another possible concern is without regulation, one member could sell their interests to a party that is not approved by the other LLC members.
Many LLCs have a requirement that if one member wishes to sell their shares, they must first offer them to the other LLC members. They can then only sell their shares to an outside party if every other member first declines to purchase. A put option is a legal obligation to the other LLC members to buy a party out. If the party interested in leaving is unable to secure a buyer, then the other LLC members are required to purchase their shares.
In order to activate the put option, the party wishing to leave notifies the other members of their desire. Once they have served that notice, the other members must purchase the shares at a previously agreed price.
A call option is essentially the opposite of a put option. A call option is activated when one member retires, is disabled, or dies. In this case, the other LLC members will call for the member to sell his shares. This requires the leaving member to completely cut ties with the LLC business.
Funding a Buy Out
It can be difficult assigning a value to an LLC member's shares. This is why it is important to place a value on the share when first giving the shares. If an amount is not previously assigned, it may be valued by the following methods:
- Malfeasance buyout: This may be valued with a book-value buyout.
- Death of an LLC member buyout: This may match the insurance payout amount.
- Retirement buyout: This will usually be based on the earning statement of the LLC.
In some cases, the death or disability of a member's shares could be paid through insurance. It is possible to take out an insurance policy against these types of events. Retirement funds are not always paid out immediately either. They may be paid over a period of time through a promissory note.
Equity Compensation in an LLC Structure
More and more businesses are choosing to offer equity compensation as a part of the benefits package when hiring new employees. LLCs are allowed to offer equity compensation for employee services. These types of agreements, however, require careful planning and detailed agreements. Additionally, LLCs can choose to include two different types of equity:
- Capital interests: Ownership that offers a share of interest in the business.
- Profits interests: An economic interest that offers the employee future profits of the business.
It is important to consider how your LLC is structured and decide which type of equity interest makes the most sense for your business. If you need help with an option to purchase membership in LLC, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.