Why Multi-Member LLCs Must Adopt a Buy Sell Agreement
A Buy Sell Agreement is the Members’ Exit Strategy. Don’t Go Into Business With Unrelated Parties Without an Exit Strategy
Bottom Line & Number 1 Reason Multi-Member LLCs Need a Buy Sell Agreement: Members of a multi-member LLC who DO not sign a Buy Sell Agreement are stuck with each other FOREVER unless they can agree on how to split the LLC pie when they cannot agree on anything else.
Although Arizona LLC law does not require that members of an Arizona LLC enter into a Buy Sell Agreement, I recommend that the members of every multi-member Arizona LLC (other than a husband and wife owned company) sign a Buy Sell Agreement. The purpose of a Buy Sell Agreement is to create a mechanism for the orderly acquisition of the membership interest of a member of the LLC on the happening of a specified triggering event. Without a written agreement that contains an exit plan, the members of an Arizona LLC are stuck with each other in sickness and in health and even after death because Arizona LLC law does not provide for the mandatory acquisition of members’ interests in an AZ LLC.
I have formed 4,800+ Arizona LLCs. As a business lawyer who began practicing in Arizona in 1980, I have seen the unfortunate results of too many companies (corporations and LLCs) where over time the owners became at odds and desperately needed a “company divorce,” but were forced to “cohabitate” indefinitely together in the business because they never signed a Buy Sell Agreement that contained a mechanism for a mandatory buy-out of an owner.
An Actual KEYTLaw Client Bad Example
In 1994 I formed an LLC for a small group of people to operate a business that became very profitable. I gave the members my comprehensive Operating Agreement that included buy-sell provisions, but the members never signed the Operating Agreement. In 2002 after an extended period of disagreement and infighting among the members, the company’s built-in hair-triggered IED (improvised explosive device) exploded. After years of failing to document transactions such as the assignment of membership interests, the owners could not agree on who the members were or the membership percentage of each member. Result: A very expensive, time-consuming and worrisome Superior Court lawsuit where the parties sought to have the court determine who owned what and what to do with a group of owners who could not agree on anything. The litigation lawyers (not me because I don’t litigate and I could not ethically represent any of the parties because I had represented the LLC) made a bundle of money. The lawsuit could have been avoided if the members had entered into a Buy Sell Agreement when they first formed the company. DO NOT LET THIS HAPPEN TO YOU AND YOUR LLC.
Prudent people who go into business together plan for a company divorce and hope it never happens. The statistics, however, show that eventually most multi-owner companies will reach a point where at least one owner will want to eliminate another owner or have the owner’s interest acquired by the company or another owner. If your multi-member LLC does not have a Buy Sell Agreement, the members will not have any way to go their separate ways if they cannot agree on the terms and conditions of their split up.
A Buy Sell Agreement is like an insurance policy. It is a cost of doing business that you hope you never need, but when you need it, you are really glad you purchased it. A good Buy Sell Agreement is an important part of your business plan. No prudent business person would invest in a new business with unrelated co-owners without first creating an EXIT PLAN. Not only does a Buy Sell Agreement create binding legal obligations to buy and sell an interest in the company, it also sets the purchase price and the terms and conditions of the purchase.
Typical Triggering Events
Here are some of the common events that can trigger a buy-out of a member, all of which are optional and selected by the members:
Any event the members desire
Each Buy Sell Agreement can include any all triggering events that are important to the members. For example, the members could agree that if the New York Yankees win the World Series, member 1 must sell to member 2 for $100.
The LLC or surviving member purchases the interest of a deceased member. Mandatory buy-outs after a death can be funded with life insurance on the lives of the members.
Prevents the wrong spouse from acquiring an interest in the LLC if two members own their interest as community property and they get divorced and the wrong spouse becomes the sole owner of all or a portion of the membership interest.
Termination of employment (owner quits or is fired)
Especially important when the employee is a minority member and should only own an interest while employed.
Default under the Operating Agreement
Allows the LLC or other members to purchase the interest of a member who defaults under the Operating Agreement. Especially important when a member fails to make a required contribution of money or property. Purchase price may be less than fair market value.
Sale of a majority interest in the company
"Drag Along" provision: Majority member has the option to require minority members to sell their interests in the LLC if the majority member sells. The sale of the minority members' interests are on the same terms and conditions as the sale of the majority member's interest.
Sale of a majority interest in the company
"Tag Along" provision: Minority members have the option to require the majority member to include the sale of the minority members' interests in the LLC if the majority member intends to sell. The sale of the minority members' interests must be on the same terms and conditions as the sale of the majority member's interest.
Transfer of membership interest without consent of the members
The LLC's Operating Agreement should provide that a member may not transfer or encumber all or any interest in the member's interest in the company without the approval of the members and compliance with the terms and conditions of the Operating Agreement. If a member violates the no transfer/encumbrance provisions, the LLC should have an option to acquire the interest of the defaulting member, perhaps at an amount less than the fair market value of the interest.
Loss of professional license
Commonly used for LLC's that are owned by members who must be licensed in a particular area. For example, the Buy Sell Agreement of an LLC owned by physicians might give the LLC and other members an option to acquire the interest of a physician/member who loses his or her license to practice medicine.
Conviction of a felony
Many LLC members do not want to have another member who has been convicted of a felony.
Used to acquire the interest of a member who become permanently disabled and unable to provide needed services for the LLC.
Members sometimes want to retire, but without a Buy Sell Agreement that provides for a retirement purchase, it probably will not happen.
If a member loses the member's interest in the LLC because of filing for bankruptcy, the company and other members should be able to buy the interest from the creditor who acquires it out of the bankruptcy.
Fixing the Purchase Price
A very important task of the Buy Sell Agreement is to state how the purchase price will be calculated. The purchase price is a material term of the contract to purchase a membership interest. If the purchase price cannot be determined from the agreement, it will not be enforceable.
A Buy Sell Agreement may use one of several methods to determine the purchase price of a membership interest:
1. Stated Value Method. The members agree on the value of the LLC, they state the value in the Buy Sell Agreement. For example, if they agree the LLC has a value of $100,000 then the purchase price for the interest of a 40% member would be $40,000. Stated values also work well when the purchase involves the membership interest of a minority member who is an employee. If Jane purchased a 2% interest in the company for $2,000, the agreement might provide that the company will repurchase her interest for the same amount if she terminates her employment with the company. It is important that the members update the price regularly because the price always changes.
2. Formula Method. The members agree on a formula that computes the value of the company. For example, they might agree that the value of the company is: (i) the average of the net profits (defined in the agreement) of the LLC for its last three fiscal years multiplied by three, or (ii) two times book value.
3. Future Appraisal Method. The selling member and the company mutually select an appraiser to value the LLC, but if they cannot agree, each party selects an appraiser (and pays the cost thereof) and the value of the LLC is the average of the two appraisals unless the difference between the two appraisals is more than 15%. If the difference is too great, the two appraisers select a third appraiser (the cost is split) and the value determined by the third appraiser is the value if it is between the first two appraisals.
4. Single Appraiser – Select Now, Value Now Method. The company hires an experienced appraiser to value the company now. For more on this very important valuation method and why Richard only uses this method for companies that have substantial value read “The Single Appraiser, Select Now and Value Now buy-sell agreement valuation process is the one I recommend for most successful closely held and family businesses.”
There are other valuation methods. In fact, the Buy Sell Agreement I prepare for companies contains six different methods for determining the value of an interest is an Arizona LLC when there is a forced buy out. The members review the six proposed method and then tell me which method works best for them. Many times the members will also modify the valuation method they pick.
In my experience as an Arizona business lawyer who has been preparing Buy Sell Agreements for my clients since 1980, it is very rare for owners of a company to be able to agree on the stated value method or the formula method. I estimate that over 95% of the Buy Sell Agreement I have prepared use the appraisal method to determine the value of the company.
Mandatory Versus Optional Triggering Events
After the members decide which triggering events are needed for their LLC, they must then decide which events result in mandatory acquisitions and which events merely give the company and other members an option to purchase. Some triggering events such as termination of employment are almost always mandatory purchases. A Buy Sell Agreement that provides for mandatory purchases of the interest of a deceased member usually require that the company buy and the estate of the deceased member sell the interest of a deceased member. An excellent way to fund the purchase of the interest of a deceased member is for each member to purchase a life insurance policy on the life of the other members.
Terms and Conditions of the Purchase
Once a member becomes obligated to sell and the company or other members become obligated to buy, the Buy Sell Agreement sets the terms and conditions applicable to the sale. I can draft any terms and conditions that the members desire, but a common scenario is that: (i) the closing of the sale will occur within 60 days of the date the buyer becomes obligated to buy, (ii) at closing the buyer will pay not less than the greater of 20% of the purchase price or the amount of insurance on the life of a deceased member (not to exceed the purchase price), (iii) the balance of the purchase price will be evidenced by a promissory note signed by the buyer that provides for equally monthly payments of principal and interest over five years with interest to accrue at Bank of America prime, (iv) the continuing members of the LLC and their spouses must guaranty payment of the promissory note, and (v) the guaranties of the members are secured by pledges of their membership interests.
Richard Keyt’s Table of Contents of His Buy Sell Agreement
You cannot appreciate the important territory covered by my Buy Sell Agreement without reading its Table of Contents and LLC attorney Richard C. Keyt’s letter of explanation. You can see from the Table of Contents of my Buy Sell Agreement that the document is very comprehensive.
From my 36+ years of experience as an Arizona business lawyer who has formed thousands of companies, I recommend without exception that every multi-member LLC purchase my Buy Sell Agreement so the members can create an exit strategy in advance to minimize or eliminate the difficult company divorce that occurs with over half of all businesses. OK, there is one exception to the preceding recommendation – a multi-member LLC owned only by a husband and wife.
I also know from experience that if the members do not enter into a Buy Sell Agreement when they form the company, it is very unlikely that they will ever adopt the agreement. For new companies, time is of the essence. The members need to agree on their Buy Sell Agreement now or risk never having a BSA signed by the members.
Buy Sell Agreement Preparation Service
I prepare Buy Sell Agreements custom drafted specifically to meet the desires of the members of Arizona LLCs. My Buy Sell Agreement is the end result of preparing this type of business agreement many times since I first started practicing law in Arizona in 1980.
Here’s the sequence of events when somebody hires me to prepare a Buy Sell Agreement for their LLC:
1. LLC pays for the Buy Sell Agreement with a credit card in our secure online store at one of the following two links: (i) $897 Buy Sell Agreement Order Form – if we form the LLC and you purchase the Buy Sell Agreement within 90 days of the date the LLC was formed, or (ii) $1,497 Buy Sell Agreement Order Form – if we did not form the LLC. You can also pay by or by calling my legal assistant at 602-906-4953, ext. 5 and giving the credit card information over the phone or by sending a check payable to KEYTLaw, LLC, 7373 E. Doubletree Ranch Road, Suite 165, Scottsdale, Arizona 85258.
2. Complete our online Buy Sell Agreement Questionnaire.
3. After paying and completing our Questionnaire Richard Keyt will prepare the Buy Sell Agreement and email it to the LLC’s contact person along with a letter of explanation.. These documents are in digital (pdf) format for distribution to all members for their review and input.
4. Members review the Buy Sell Agreement, mark text to be changed and make a list of questions about provisions and additional issues to ask KEYTLaw business and contracts attorney and former CPA Richard C Keyt. Our Buy Sell Agreement comes with one hour of attorney time discussing it with the members and modifying it per the members’ instructions at the meeting. Attorney time incurred beyond one hour will be charged at $275/hour.
5. The manager or one of the members completes our online Buy Sell Agreement Modification Instructions (the BSAMI) and send it to us. This document is the easiest way to tell us which of the many optional provisions in the Buy Sell Agreement the members want to keep or delete and any other changes the members want to make to the BSA. The manager collects copies of all pages of the BSA marked by members for changes or questions and sends those pages to us.
6. If the Buy Sell Agreement Modification Instructions does not request a meeting with KEYTLaw business and contracts attorney and former CPA Richard C. Keyt, then we revise the Buy Sell Agreement and send to the contact person Adobe pdf versions of the final document for the signatures of the members and a pdf version that shows the changes we made to the first draft of the BSA.
7. If the BSAMI requests a meeting of the members with Richard C. Keyt, his legal assistant will schedule a phone conference or a conference at our office for Ricky to answer questions about the BSA and determine what changes, if any, the members want to make to the BSA above and beyond the changes indicated in the BSAMI.
8. Richard C. Keyt will revise the Buy Sell Agreement and send it to the contact person as an Adobe pdf file for the signatures of the members. Ricky will also send a pdf version of the agreement that shows the changes we made to the first draft of the BSA.
9. Members sign the agreement.
Our Fee to Prepare a Buy Sell Agreement
Our fee to prepare a custom Buy Sell Agreement is:
- $897 if we formed the LLC and the BSA is purchased within 90 days of its formation date, or
- $1,497 if we did not form the LLC or we formed the LLC, but the BSA is purchased more than one year after its formation date.
Our Buy Sell Agreement comes with two hours of attorney time discussing it with the members and modifying it per the members’ instructions at the meeting. Attorney time incurred beyond two hours will be charged at $275/hour.
Note: There is a $600 discount when we form the LLC and the BSA is purchased within 90 days of the formation date.
I constantly tell members of multi-member LLCs that the most important company document is the company’s Buy Sell Agreement because it is the only way to plan for the orderly future “divorce” of a member. Without a Buy Sell Agreement, the members are stuck with each other forever unless they are fortunate to agree on who will go, who will stay and how much, if any, the remaining members will pay the selling member.
Our Fee Includes Attorney Consultation & Revision Time
The fee includes one hour of attorney time conferring with members, modifying the agreement and drafting custom provisions. Few of our LLCs exceed the allotted attorney time to finalize their Buy Sell Agreement. We want the final agreement to contain all of the provisions desired by the members of each LLC. Some LLCs need more custom drafting of provisions for the Operating Agreement or need more conference time with members to discuss the agreement and make changes. We bill the LLC for any excess attorney time at $275 per hour.
How to Hire KEYTLaw to Prepare a Buy Sell Agreement
To hire us click on the appropriate link below to pay in our secure online store with your major credit card then click on the link below and complete our online Buy Sell Agreement Questionnaire.
- $897 Buy Sell Agreement Order Form – if we formed or will form the LLC and 90 days have not elapsed since the LLC was formed.
- $1,497 Buy Sell Agreement Order Form – if we did not form the LLC
If You Want Richard Keyt to Form Your New LLC
To hire Richard Keyt to form your Arizona LLC go to our comparison of our three online LLC formation packages and prices.