Chapter 7 Buy Sell Agreement for Multi-Member LLCs

Chapter 7 Buy Sell Agreement for Multi-Member LLCs2016-03-22T06:59:25+00:00

Section 7.1 What is a Buy Sell Agreement

Single member LLCs and two member LLCs owned by a married couple do not need a Buy Sell Agreement, but it is an extremely important document needed by every multi-member LLC. A Buy Sell Agreement is an agreement between members of an LLC that contains their exit strategy. Companies owned by unrelated people need a Buy Sell Agreement because without one they can never consummate a company divorce unless they voluntarily agree on the terms and conditions of the divorce or spend far too much money on lawyers litigating a judicial dissolution of the company.

When unrelated people go into business together, the chances are very great that one day one or more of the owners will want a “company divorce.” The a Buy Sell Agreement contains exit strategy provisions, which are provisions that on the occurrence of one or more triggering events, the company and/or one or more members has an option to purchase the interest of a member or the company or one or more members may be forced to purchase the interest of a member. Without a Buy Sell Agreement (the exit strategy) the members are stuck forever and cannot easily divorce without an expensive, time-consuming and emotionally draining lawsuit.

To learn more about Buy Sell Agreements, read my article called “A Multi-Member LLC’s Most Important Document: Why Multi-Member LLCs Need a Buy-Sell Agreement.”

Section 7.2 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 4,900+ 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.

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 it. 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.

Section 7.3 Typical Buy-Sell 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:

Triggering EventPurpose
Triggering EventPurpose
Any event the members desireEach 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.
DeathThe 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.
DivorcePrevents 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 employmentEspecially important when the employee is a minority member and should only own an interest while employed.
Default under the Operating AgreementAllows 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 minority 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 membersThe 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 licenseCommonly 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 felonyMany LLC members do not want to have another member who has been convicted of a felony.
DisabilityUsed to acquire the interest of a member who become permanently disabled and unable to provide needed services for the LLC.
RetirementMembers sometimes want to retire, but without a Buy Sell Agreement that provides for a retirement purchase, it probably will not happen.
BankruptcyIf a member files for bankruptcy, the company and other members may be able to buy the interest from bankruptcy court for the fair market value of the bankrupt member’s interest.

Section 7.4 Fixing the Purchase Price on a Buy-Out

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 the following three primary methods to determine the purchase price of a membership interest:

a. 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.

b. 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.

c. 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.

My Buy Sell Agreement actually contains six different LLC valuation methods. I ask the members to select one of the six methods that works best for them, modify one of my six methods or create their own valuation method. When we prepare a Buy Sell Agreement, we customize the provisions to meet the desires of all the members of the LLC.

In my experience as an Arizona business lawyer who has been preparing Buy Sell Agreement 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.

Section 7.5 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.

Section 7.6 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.

Section 7.7 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:

a. We 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.

b. Members review the Buy Sell Agreement and make notes of text to be changed, questions about provisions and additional issues to be covered.

c. We meet with the members in our office or via a conference call to discuss the Buy Sell Agreement, answer members’ questions and decide on changes to be made to the agreement.

d. We revise the Buy Sell Agreement and send it to the contact person to forward to all the members for their review.

e. We make any additional changes requested by the members (via email, phone or in person) and send the final agreement to the contact person.

f. Members sign the agreement.

Section 7.8 My Fee to Prepare a Buy Sell Agreement

My fee to prepare a custom Buy Sell Agreement is:

  • $897 if we are forming the LLC simultaneously with preparing the Buy Sell Agreement, or
  • $1,497 if we did not form your LLC or if we formed your LLC, but more than three months has passed since it was formed.

Note: There is a $600 discount when we form the LLC, but only if you purchase it at the time the LLC is formed or within three months thereafter. The reason for the price increase is because I want to give multi-member LLCs an incentive to adopt a Buy Sell Agreement when the LLC is formed because I know that if the members do not do so at that time, it is unlikely they will ever enter into a Buy Sell Agreement.

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.

Section 7.9 Our Fee Includes Attorney Consultation & Revision Time

The fee we charge to prepare a Buy Sell Agreement 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 Buy Sell 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.

Section 7.10 How to Hire Richard Keyt to Prepare a Buy Sell Agreement

To hire Richard Keyt to prepare a Buy Sell Agreement for your LLC all you have to do is submit our question and pay in our secure online order form.

  • 3rd payment option:  Call my legal assistant at 602-906-4953, ext. 5 and give us your credit card information.

If you have questions about Buy Sell Agreements, call me, Richard Keyt, at 480-664-7478 or my son LLC attorney and former CPA Richard C. Keyt at 480-664-7472.

Section 7.11 My Recommendation for Multi-Member LLCs

I have practiced business law since 1980 and formed 4,900+ Arizona companies of all types. I have been involved in far too many disputes between owners of companies who desperately wanted to extricate themselves from businesses formed with other people. It is sad for me to watch people suffer through company divorces that could easily have been consummated smoothly and relatively pain-free if only the members had entered into a Buy Sell Agreement when they first formed the company or when the company first admitted an additional member who was not related to the initial member.

I always recommend without exception that every multi-member LLC that has one member who is not a close relative to the other member(s) adopt a Buy Sell Agreement so the members have a built in exit strategy that is there if and when it may be needed. Although the risk of a company divorce is less when the LLC is owned entirely by close family members, I also recommend that close family owned companies also adopt a Buy Sell Agreement.

Section 7.12 Best Time to Adopt a Buy Sell Agreement

One sad, but true fact of business life I have learned from practicing business law for over thirty years is:

If the members of an LLC do not agree on and sign a Buy Sell Agreement soon after the company is created, it is unlikely that they will every do so.

For those of you who are members of a multi-member LLC that did not purchase my Buy Sell Agreement, your company’s biological Buy Sell Agreement clock is ticking. I urge you to purchase it now before it becomes too late.