LLCs, or limited liability companies, are a form of legal structure for small and mid-sized businesses. Each owner of an LLC is referred to as a member. When an LLC has multiple members, having a well-structured, written LLC operating agreement that includes buy-out provisions (often called buy-sell provisions) is advisable. During the course of business a variety of events may cause a member to want or need to leave the LLC, and a well-drafted LLC operating agreement spells out pre-agreed-upon buyout provisions for the members.
Several triggering events are usually included in buyout provisions of LLC operating agreements. Death, disability, retirement and malfeasance are the most common triggers, but others may be included. Some triggers such as death and disability are for unforeseen circumstances, and insurance funds the buy-out provisions. The retirement trigger is usually used to gradually phase out members by mutual agreement. Malfeasance triggers are used to protect the good name of the other members of the LLC should one become insolvent or commit a felony.
Method of Payment
When a buy-out event is triggered, the agreement dictates how payment for the buy-out is to be made. Events such as death and disability, which are insured against, typically trigger a cash buy-out that is paid for with insurance proceeds. Events such as retirement are often financed buy-outs where the departing owner gives up his equity ownership in the company immediately but is paid for that membership stake over time via a promissory note.
Each buy-out trigger also has a business valuation associated with it. Valuations are used for various reasons, and different buy-out triggers use different valuation methods. A buy-out triggered by malfeasance may trigger a book-value buyout, whereas a buy-out triggered by a death may use a flat buy-out value that matches the insurance policy on the member. Retirement buyouts may use an altogether different valuation based on the earnings of the LLC. Buy-out valuations can be as creative as the members of the LLC want them to be.
All of the buy-out options for an LLC are agreement-driven. Operating agreements govern every aspect of an LLC and having them drafted accurately is important. Consult with an attorney to draft your operating and buy-out agreements. Also consult with an accountant or tax adviser when calculating buy-out values and payment methods.
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