Feature:
Buy-Sell and Other Exit Provisions for LLCs – Are You Prepared?

Even when the members of a limited liability company (“LLC”) have established and executed an Operating Agreement, they often fail to consider and include important “exit” provisions. Worse yet, they have used the boilerplate provisions found on-line in “Docs-in-a-Box” forms that fail to meet the members’ expectations and desires.

One common consequence is that the members find themselves obligated to share control of the business with disgruntled members or total strangers. The other party will be unable to sell and be paid for their share, and they will feel trapped. Although the respective sides might be able to work out a solution, such is not assured. This often results in bad feelings and may lead to expensive and agonizing litigation.

Individuals joining together in business can prevent unwanted outcomes and provide predictability simply by anticipating and saying in advance how they want to deal with the various exit contingencies. Just like a prenuptial agreement should be established before the marriage, the exit provisions should be established at the beginning when the LLC is formed. But even if an LLC has been operating without suitable exit provisions, the members should consider adding them to their agreement now, before it is too late.

A buy-sell provision typically provides one member with predetermined rights to purchase from another member (or sometimes to sell to another member) upon the occurrence of the designated event. The members must agree on the different events and conditions that will invoke the buy-sell and exit provisions.

Events that are commonly used to trigger buy-sell provisions include the voluntary departure of a member, the involuntary departure of a member as the result of disability or death, and voting deadlocks caused by intractable disagreements. Small investors in the LLC with no voting control may seek protection from the whims of the large investors through “put” options that would require the controlling investors to buy them out upon the occurrence of the triggering events.

When triggered, the buy-sell provision obligates one member to sell his interests to the other members for a price determined according to the stated method, such as a business valuation by one or more independent appraisers, a multiple of revenues, or a specific price agreed in advance.

In the case of a member’s death, the buyer’s purchase obligation can be funded and thus assured through the use of life insurance. Through this simple technique, the deceased member’s family is assured of payment for their share and the remaining members are protected from the unwanted participation of the family. Other events that do not generate life insurance proceeds, may require seller financing commitments as the only reasonable means for the buyer to finance the purchase obligation.

LLC members have several options to consider when establishing appropriate buy-sell and exits provisions. Once in place, the exit provisions should be routinely reviewed from time-to-time and, for certain, anytime ownership circumstances have changed.

David M. Rhodus, is the founder of the Rhodus Law Firm, LLC., in Johns Creek, Georgia, and may be contacted at (678) 475-9500 or drhodus@rhoduslaw.com. Used with Permission. Copyright © 2009