If you are a party to a Buy Sell Agreement or an Operating Agreement that has buy out provisions you owe it to yourself to take the following test and find out if your agreement sucks and needs to be replaced. If your answer to any question below is Yes, your agreement sucks and needs to be replaced asap. One No answer means that if a buy out were to occur under your agreement either the buyer or the seller will love the value of the membership interest being sold and the other party will be extremely unhappy because the appraiser’s value will surprise everybody.
Click on a plus + symbol below to read the answer to a question.
Warning: This is a huge issue that if not addressed is guaranteed to cause one party to be very happy and the other party to be very angry after an appraisal.
Homer owns 51% of World Wide Widgets, LLC. Ned owns 49% of the company. The company has one asset, 1,000 shares of stock of a public company that would generate $1,000,000 if the company sold the stock today. Even an inexperienced valuation person should find the value of the company is $1,000,000, but what are the values of each member’s membership interest in the company?
Valuing the members’ interests is where a problem arises if the agreement does not state how the appraiser is to value the membership interests of the members. Consider the following:
Example 1: The value of a membership interest being sold is the prorata share of the value of the company determined without any discounts for lack of marketability or minority interest or increases for control or marketability. Without these considerations the value of Homer’s membership interest is 51% of $1,000,000 or $510,000 and the value of Ned’s membership interest is 49% of $1,000,000 or $490,000.
Example 2: The value of a membership interest being sold is determined after taking into account discounts for lack of marketability and minority interest or increases for control and marketability. With these considerations the value of Homer’s membership interest is $714,000 because his 51% membership interest value is increased by 40% because Homer has control of the company and his membership interest is marketable. Ned’s 49% membership interest would be valued at $269,000 after a 40% discount because it lacks control and is not marketable.
Bottom line: The difference in values in example 1 vs. example 2 is huge. If there were a sale Homer would get $204,000 under example 2 than under example 1 and New would get $196,000 less under example 2 than example 1. Don’t leave the decision as to which valuation assumptions the appraiser should use to the discretion of the appraiser. The members of your LLC need to decide which valuation assumptions to use and put the appropriate language in your Buy Sell Agreement. Your agreement must tell the appraiser whether or not to consider or not consider increases for control and marketability and decreases for lack of control and marketability. If your agreement is silent on these issues then the parties are at the mercy of the appraiser who may unilaterally decide to apply or not apply increases or discounts.
If the answer is yes you need a new Buy Sell Agreement because: (i) the value stated in your agreement is probably way out of date, and (ii) most importantly the value is merely the members’ guess as to what a membership is worth rather than an accurate current value. The owners of a company have no clue as to the value of the company because they are not qualified appraisers. If you were to die and the company is required to pay your loved ones the value of your interest don’t you want the amount paid to equal the actual value of your membership interest rather than be determined by a guesstimate of the members?
Valuing a company and a business is not something you want an inexperienced and valuation ignorant person to do. You would not ask your accountant to perform surgery on you because you know your accountant knows nothing about surgery so why would you let a person who lacks the valuation knowledge and credentials to value your company? If your agreement does not state the required qualifications of the appraiser or if the qualifications do not require the appraiser to have one of the credentials listed below then you need a new agreement.
My Buy Sell Agreement requires appraisals be performed only by a professional appraiser who has one or both of the following credentials for at least ten years:
- an Accredited Senior Appraiser designation from the American Society of Appraisers. The appraiser must follow the Uniform Standards of Professional Appraisal Practice and the ASA Business Valuation Standards of the American Society of Appraisers.
- an Accredited in Business Valuation designation from the American Institute of Certified Public Accountants. Appraisers with this valuation credential must follow the AICPA’s Statement on Standards for Valuation Services 1.
Why in the world would you want values to be determined by a person who has zero experience and no knowledge about valuing companies and membership interests? A lot of money could be at stake so you want the values to be determined by a qualified business valuation appraiser.
Question 5: Does your agreement state that the buyer and the seller will each appoint an appraiser to value the company and the membership interest being sold or does it say that if the parties cannot agree on the appraiser buyer and seller will each appoint appraiser who will appoint a third appraiser and the values will be the average of the three appraisals (or a variation on this theme)?
If you answered yes you’ve created a very expensive and time-consuming valuation process. It’s best if the members agree in advance on their first, second and third choices of the qualified appraiser that they will use when an appraisal is needed.
Homer, Ned and Bart each own one third of the membership interests of an LLC. Homer and Bart want to sell their two thirds interest in the company, but the buyer insists on buying 100% of the company or nothing. Ned does not want to sell so the sale dies. If the members signed an agreement that contained a drag along clause then Ned would be forced to sell his 33.33% interest in the company to the buyer on the same terms and conditions as the purchase of Homer and Bart’s interests. The drag along clause gives the majority member(s) the ability to force a sale of all of the membership interests in the company. This is an important clause because few buyers want to buy less than all of a company because they don’t want to become partners with a minority member they don’t know.
Same example as in Question 6 except Homer and Bart sell their two thirds of the LLC to the buyer without giving Ned the opportunity to sell his one third membership interest. Ned is now partners with a buyer he doesn’t know that owns a two thirds controlling interest in the LLC. If the members signed an agreement that had a tag along clause Ned could have forced Homer and Bart to require the buyer to buy Ned’s one third interest on the same terms as the sale of Homer and Bart’s interests.
A triggering event is an event that when it occurs gives the company and/or the members an option to buy out the membership interest of the member who suffers that triggering event. For example, death of a member is a common triggering event. Some triggering events cause a mandatory buy out.
Check the list of common triggering events in the table below. If you find a triggering event that you like that is not a triggering event in your agreement your LLC needs a new Buy Sell Agreement.
|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.|
Hire the Keyts to Prepare a Buy Sell Agreement
We prepare Buy Sell Agreements custom drafted specifically to meet the desires of the members of Arizona LLCs. Our Buy Sell Agreement is the end result of Richard Keyt preparing this type of business agreement many times since practicing law in Arizona since 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 a new or amended Operating Agreement for $497.
Here’s the sequence of events when somebody hires us 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 Emily Conrad - 480-664-7846 and giving your 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 to discuss the agreement with the members and modify 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 can sign the agreement the old fashioned way or we can arrange for digital signatures for no additional cost.
We 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
Our 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 the Keyts to Form Your New LLC
To hire us 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.