Many, if not most, LLC owners overlook a critical element of their operating agreement that can save them both money and angst: buy-sell provisions. When you create buy-sell, or buyout, provisions for your operating agreement, you and your co-owners can prepare for events that have been the downfall of more than a few successful small businesses — namely, the death, divorce, bankruptcy or retirement of one of the owners.
What is a buy-sell agreement?
Contrary to popular belief, a buy-sell agreement is not about buying and selling companies; rather, it is a binding contract between business owners. A buy-sell agreement is made up of several clauses in your written operating agreement (or it can be a separate agreement that stands on its own) that control the following business decisions:
- who can buy a departing member’s share of the business (this may include outsiders or be limited to other LLC members)
- what events will trigger a buyout (see the list below), and
- what price will be paid for a member’s interest in the LLC
It may help to think of a buy-sell agreement as a sort of “premarital agreement” between you and your co-owners.
What events should you cover under a buy-sell agreement?
Your buy-sell agreement will instruct and remind you and your co-owners how you have agreed to handle the sale or buyback of an ownership interest when one member’s circumstances change. Typically, the events that trigger a buyout of a member’s interest under a buy-sell agreement are:
- an attractive offer from an outsider to purchase a member’s interest in the company
- a divorce settlement in which a member’s ex-spouse stands to receive an ownership interest in the company
- the foreclosure of a debt secured by an ownership interest
- the personal bankruptcy of a member, or
- the disability, death or incapacity of a member.
Why you need buy-sell provisions
It’s a huge mistake to ignore the fact that sooner or later your business will change. If you doubt this even for a minute, think about what would happen if you don’t create a buy-sell agreement and one of the following occurs:
- One member quits to move to another city or leaves to start another business. Without an agreement, your LLC might be automatically dissolved, forcing you to divide any assets and profits among the LLC members and decide whether to start a new LLC with the remaining LLC members. If your LLC doesn’t end, you must still decide whether you should buy out the departing LLC member’s ownership interest, and for how much.
- One member dies, gets divorced or becomes mentally or physically incapacitated. In this case, you might have to work with the spouse or other family member of a deceased, disabled or divorced owner. There is a substantial possibility that the family member would be inexperienced or otherwise unable to act in the best interests of the business. On the flip side, you (or your family) might get stuck with a small business interest that no outsider wants to buy and for which no insider will give you a decent price.
- One member sells his or her share to a stranger or to someone you know well and can’t stand. In this case, you may be forced to share control of the company with an inexperienced or untrustworthy stranger — or you’ll be faced with the struggle of running a business with someone you’d rather not even see on the street.
Just looking at this list, it should be obvious that if you don’t anticipate and plan for circumstances like these, you’re risking serious personal and business discord — perhaps even court battles and the loss of your business.
Creating a buy-sell agreement
To create buy-sell provisions, you can use either a self-help resource or see a lawyer — or both. One good tool is Nolo’s Business Buyout Agreements: A Step-by-Step Guide for Co-Owners, by attorneys Anthony Mancuso and Bethany K. Laurence, which contains a disk with fill-in-the-blank buyout clauses and instructions on how to incorporate them into your operating agreement. Even for those who want the services of a lawyer, this book walks you through the necessary discussions with your co-owners, so you can decide on your own time — not your lawyer’s — which terms you want to include.