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 (when they usually cannot agree on anything else) or a judge will have to do it for them.
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 a LLC are stuck with each other in sickness and in health and even after death because Florida law does not provide for the mandatory acquisition of members’ interests in a LLC.
An Actual Client Example
In early 2013 I formed an LLC for two people to operate a consulting business that quickly became very profitable. For the original members I drafted a comprehensive Operating Agreement that included buy-sell provisions, but the members were working on-site in different states at the time and never came in to execute the documents – I sent it to them and hoped for the best. In 2014, apparently after an extended period of disagreement and infighting among the members – the two original members and apparently new members that bought into the LLC – the situation exploded. After years of failing to document transactions such as the assignment of membership interests, the original owners could not agree on how to split the company and now there were others involved who believed they were also members!!
Result: A very expensive, time-consuming, and worrisome 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; I could not ethically represent any of the parties because I had represented the LLC) are making a bundle of money BECAUSE THE LAWSUIT IS STILL GOING.
This lawsuit could have been avoided if the members had properly documented their contributions and activities and entered into a Buy Sell Agreement when they first formed the company. 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 entirely. If the 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.
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:
- Termination of employment (working owner quits or is fired)
- Material Default under the Operating Agreement
- Sale of a majority interest in the company (“drag-along”)
- Sale of a minority interest in the company (“tag-along”)
- Transfer of membership interest without consent of the members
- Loss of professional license
- Conviction of a felony
Setting the Purchase Price
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. 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. Some are more complicated than others and for that reason I will leave that for next week.