by Arizona LLC attorney Richard Keyt who has formed 7,000+ Arizona LLCs
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
A Real Life Example of the Disaster Caused by the Lack of a Buy Sell Agreement
In 2018 I represented an LLC owned equally by Bob and Mike. Bob was not married, but he had a long time live in significant other called Mary. Without Mike’s knowledge or consent Bob caused all the income of the LLC to be deposited into Mike’s personal bank account of which Mary was a co-owner. Bob died without a Will or a Trust that provided who would inherit Bob’s 50% of the LLC.
Mike suddenly became partners with an estate. Mike did not know who inherited Bob’s share of the LLC. He knew that Mary did not inherit Bob’s membership interest because Bob did not have a Will or a Trust. We filed an an Amendment to the Articles of Organization of the LLC with the Arizona Corporation Commission to name Mike as the manager and show that Mike’s interest was owned by the Estate of Mike.
A buyer wanted to buy the LLC, but Mike could only sell his 50%. Because there was nobody who could sign legal documents to sell Bob’s 50% the sale fell through. Bob’s failure to plan by having a Will or a Trust that left his share of the LLC to Mary cost her one half the value of the LLC. Bob should have hired me to prepare his estate plan with a Will and a Trust. See my free ebook called “Family Asset Protection” to learn more about estate planning and how it protects your loved ones.
Bob and Mike’s failure to plan by signing a Buy Sell Agreement hurt Mike and Bob’s estate big time. If Bob and Mike had signed a Buy Sell Agreement that required the LLC to buy Bob’s 50% on his death and pay the money to Mary then after Bob’s death Mike would have owned all of the LLC and the money to buy Bob’s 50% could have been paid to Mary. They could have funded a buy out after death by each member having life insurance on the other member. If Bob and Mike had funded a Buy Sell Agreement with life insurance then on Bob’s death Mike would have collected the life insurance proceeds and paid the money to the person who inherited Bob’s 50% of the LLC.
Bottom Line & Number 1 Reason Multi-Member LLCs Need a Buy Sell Agreement:
People die. Planning for the death of a member is the number 1 reason why a multi-member LLC needs a Buy Sell Agreement. The members of an LLC must plan for the death of a member. If you are in a multi-member LLC ask yourself who would inherit the membership interest in the LLC if a member were to die and are you ok with who would inherit? Consider these possible people who could inherit a deceased member’s membership interest:
- significant other
- adult child
- minor child
Members of a multi-member LLC who DO not sign a Buy Sell Agreement are stuck with each other or their heirs FOREVER unless they can agree on a buy out after death and 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 7,000+ 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.
Another 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:
|1. Any event the members desire||A Buy Sell Agreement can include any 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.|
|2. Operating Agreement default||If a member defaults under the Operating Agreement signed by all of the members the LLC has an option to buy out the defaulting member.|
|3. Member fails to contribute money or property||This provision encourages a member to satisfy the member's obligation in a written document to pay money or assign property to the company because if the member fails to satisfy that obligation the LLC will have an option to buy out the defaulting member.|
|4. Death of a member||The LLC or surviving members have an option to purchase the interest of a deceased member. The Buy Sell Agreement can also require the LLC to buy-out a deceased member. These types of buy outs can be funded with life insure on the lives of members.|
|5. Member is convicted of a felony||Many LLC members do not want to have another member who has been convicted of a felony.|
|6. Divorce of a member||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.|
|7. Member files for bankruptcy||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.|
|8. Member transfers all or part of the member's membership interest without the approval of the other members||The Buy Sell Agreement provides 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 and/or the Buy Sell 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.|
|9. Termination of employment of a member||Applies only to a member who is employed full time by the LLC. Especially important when the employee is a minority member and should only own an interest while employed.|
|10. Member loses his or her 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.|
|11. Majority member sells membership interest||"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.|
|12. Majority member sells membership interest||"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.|
|13. Member is disabled||Used to acquire the interest of a member who become permanently disabled and unable to provide needed services for the LLC.|
|14. Member retires||Members sometimes want to retire, but without a Buy Sell Agreement that provides for a retirement purchase, it probably will not happen.|
|15. Member is incompetent||Applies if a member loses his or her mental capacity and a court appoints a conservator to manage the members financial affair.|
|16. Member files a false document with the ACC||If a member causes a false document to be filed with the Arizona Corporation Commission it is a triggering event that can cause a buy out,|
|17. Member causes somebody to be added or removed from the LLC's bank account||If a member causes a signer to be added or removed on the company's bank account without the approval of the members per the operating agreement it is a triggering event that can cause a buy out.|
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 years of experience as an Arizona business lawyer who has formed 7,000+ Arizona LLCs, 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.
We have three prices for our custom drafted Buy Sell Agreement. The prices are:
- $897 if we formed the LLC within the last 90 days
- $1,497 if we formed the LLC more than 90 days ago or if we did not form the LLC
- $1,394 if you purchase a Buy Sell Agreement for $897 and an Operating Agreement for $497.
Here’s the sequence of events when somebody hires me to prepare a Buy Sell Agreement for their Arizona LLC:
1. The purchaser completes and submits our online Buy Sell Agreement Questionnaire.
2. The purchaser pays for the Buy Sell Agreement with a credit card in our secure online store at one of the following links:
a. $897 Buy Sell Agreement Order Form if we formed the LLC within the last 90 days.
b. $1,497 Buy Sell Agreement Order Form if we formed the LLC more than 90 days ago or if we did not form the LLC.
c. $1,394 Buy Sell Agreement & Operating Agreement Order Form if we did not form the LLC and you are purchasing a Buy Sell Agreement and an Operating Agreement.
You can also pay by or by calling my legal assistant at 480-664-7846 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.
3. After paying and completing our Questionnaire Richard Keyt will prepare the Buy Sell Agreement within 3 – 5 business days 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. The members can email their changes to Richard or call Richard at 480-664-7472 and 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. The BSA 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 $295/hour.
5. 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.
6. Members sign the agreement the old fashioned way, but we can arrange for digital signatures for no additional cost.
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 $295 per hour.
How to Hire Richard Keyt to Form Your New LLC
To hire Richard Keyt to form your Arizona LLC compare the contents of our three LLC packages ($397 Bronze, $597 Silver & $997 Gold [the confidential LLC]) and complete our LLC Formation Questionnaire.