When you run a business that is a limited liability company, you have much personal and legal protection from your business debts like a corporation does. Unlike a corporation, though, paying your taxes is simple and similar to what you would do if you were a sole proprietor. If you are running your LLC with more than one member who is not your spouse, parent or child, you should create a buyout agreement. Otherwise, if even one member decides to leave the LLC, the company could cease to exist. A buyout agreement also governs situations in which a new person wants to be part of the LLC, which is important when you are not thrilled with the idea of doing business with that person. Here are a few considerations worth thinking about for buyout agreements changing LLC ownership.
1. Understanding the Purpose of Buyout Agreements
“Buyout agreements” might be a misleading term. In fact, they are agreements between or among folks who own a business about what happens in cases of a member leaving. They should also include provisions for triggering events such as divorce, bankruptcy and death. A buyout agreement functions somewhat like a prenuptial agreement does for married couples, and it helps ensure the smooth functioning and transition of a business.
2. Common Areas to Cover
When you are starting up a business, it is easy to get caught in the rosy glow of promise, but buyout agreements force you to be realistic. Your buyout agreement should include areas such as whether an owner who is leaving can force the others to buy him or her out and who is eligible for buyouts. For example, could a person outside of the LLC qualify to do a buyout? Your agreement should include price considerations and triggering events for a buyout. Common ones include disability, loss of a license, contract breaches, owner disagreement, felony conviction, divorce, death and bankruptcy, but you do not necessarily need to cover all potential triggers.
3. What Happens After a Triggering Event
Typically, one of three things happen after a triggering event. In one case, both the buyer and the seller could sell their ownership interests. In the other two cases, either the buyer or the seller could exercise the option to have the other sell or buy the other’s interest in the business.
4. Pricing and Terms
Pricing your ownership interest can be subjective. One approach is for the owners to agree on a fair price each year, but they might forget, and the price gets out of date. Thus, when the triggering event occurs, the buyer and seller have vastly differing views as to price. To take care of this problem, many LLCs turn to a professional arbiter or appraiser. It is probably important to you for your LLC to set buyout terms that are fair and realistic. Price a buyout too high or make the terms too complicated, and no one will be able to buy the ownership interest. Consider these factors:
- Down payments
- Interest rates
- Loan terms
- Buyout period lengths
- Using LLC assets (or not using them) in order to secure a new loan
- Life insurance requirements
The laws of some states require that LLCs have operating agreements. It is in such a section that you would put a buyout agreement, which you should do whether state law requires it or not. After a partner leaves a LLC, remember to remove any access to credit cards, business documents, business bank accounts and the like. Also check potential tax implications; for example, if you were in an LLC with a partner who leaves, your partnership now becomes a single-member LLC, and you probably must file taxes differently.It is a good idea to take the time to develop a buyout agreement before your LLC is officially formed. You are acting to save your business a lot of potential trouble and headaches down the road.
The content on our website is only meant to provide general information and is not legal advice. We make our best efforts to make sure the information is accurate, but we cannot guarantee it. Do not rely on the content as legal advice. For assistance with legal problems or for a legal inquiry please contact you attorney.