In a Limited Liability Company, or LLC, with more than one member, it often makes sound business sense to have a buyout option, also called a buy-sell option. The buyout option is an agreement between the members that states what will happen when one member wants to leave the company, dies or goes bankrupt. The buyout option is often included as part of the LLCs operating agreement, which is the contract that governs how the LLC operates.
Fit your business needs with the right LLC package
Buyout options are important because they may help to avoid potential problems in the future. Without a clear buyout option, a change in circumstances could lead to costly lawsuits or the end of the business. Most states have no set laws governing buyouts, so if a member wants to leave, and there is no agreed buyout option, the LLC may be automatically dissolved, often forcing a sale of the assets. Similarly, without a buyout option, a member could sell his interest in the business to someone you do not want to be associated with.
A buyout option can be thought of as a premarital agreement for the business. As such, members can include any circumstances they wish in the option. Buyout options generally set rules relating to whether the departing member can force the remaining members to buy her out; which members are allowed to purchase the departing member's interest in the business; how the price of the departing member's interest will be determined; what events can trigger a buyout; and whether interest in the business can be inherited in the event of a member's death.
The buyout option usually states what events will trigger a buyout. The most common triggers are usually death, disability, retirement and fraud or malfeasance against the LLC. Other triggers can include offers from outside the company to buy a member's interest; a divorce settlement involving a member's interest; foreclosure of a debt secured by a members' interest; or personal bankruptcy of a member. Malfeasance, bankruptcy and fraud triggers are often used to protect the reputation of the company and the other members.
The buyout option should also include how payment for the buyout will be funded. Events such as death and disability can be funded from insurance, provided the LLC has taken insurance against these events. Retirement may be financed through direct payments from other members, or over time through a promissory note. Each buyout trigger should also have a valuation associated with it. This prevents arguments over the value of a member's interests. Thus, a buyout triggered by malfeasance may have a book-value buyout, while a buyout triggered by a death can have a value that matches the insurance payout. Retirement buyouts are often based on the earnings of the LLC.