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  • Matthew McCabe

What is a Buy-Sell Agreement?

A buy-sell agreement is a legally binding contract between multiple members (business owners) in an LLC that sets forth what happens if specific events occur to one of the members. A buy-sell agreement is commonly utilized as a strategy to plan and prepare for situations that may arise. For example, what if a member dies, gets divorced, or wants to sell their membership interest.

Many business owners may wish to impose restrictions on the transfer of a member's interest or rights in the LLC. If you do not have an express agreement then you may be subject to the statutory default rules. Some owners may wish to provide for an absolute prohibition on members transferring their interest. Alternatively, if an interest is transferred to a bankruptcy trustee or receiver by operation of law, then a buy sell agreement could have language that gives the LLC the right to purchase the members interest.

It is often desirable for members to want to keep their interest in a LLC to members that they get along with. Would you want your fellow member to sell their interest to your arch nemesis or ex-wife? Probably not. A tool used in a buy-sell agreement to combat such situation could be a provision of a first right of refusal. In a first right of refusal provision before a member can sell or transfer their interest they must give the LLC (or other members) an opportunity to purchase the interest or membership rights which are proposed to be transferred.

Tag-Along or Drag-Along rights are another area often addressed in a buy-sell agreement. In lieu of, or in addition to a right of first refusal, the members may wish to include tag-along or drag-along rights. Tag-along rights permit another member (typically a member holding a minority interest) to participate or "tag along," if the majority member wants to sell their interest to a third party. This provision is often valuable to a minority member because a majority interest member often gets a higher valuation for their majority interest compared to a discounted or lower valued minority interest. Furthermore, it is often also advantageous for a minority member to have a tag along right for a protection against a majority member to transfer majority control of the LLC to a third party. Tag-along rights permit the minority member to participate in the sale by a majority member.

Conversely, drag-along rights are generally more beneficial for a majority member. A third party may not wish to purchase the interest of the majority member unless it can acquire all of the LLC member interest. Drag-along rights permit the majority member to force the minority members to participate in the sale of their interest to the purchaser.

The death or disability of a member is often addressed in a buy-sell agreement. Parties will often want the right, or obligation, to purchase the interest of a deceased or disabled member.

Valuation is also often addressed in a buyout arrangement. There are many different ways to determine the manner in which the valuation is made. Additionally, their can be different valuations for different events. Such as penalties for a forced buy out due to wrongful acts such as embezzlement. The terms of the purchase can also be set forth to not create burdens to buying parties to come up with the full purchase price in cash but instead allow an initial payment and subsequent payments at specific intervals over time.

Forcing the sale of one of the members can be advantageous in including in a buy-sell agreement if the members can no longer get along. Such a provision can be addressed in numerous ways. One way is called a "shotgun" clause wherein at any time one member can trigger a provision to serve notice on the other member and set a price paid for the membership interest of the other party. The other party then can either accept that price or alternatively, purchase the offering party's interest (if equal) for the same price. This is thought to provide an incentive to provide a good offer for fear that the offer could be used against them and the offering party now is forced to sell their interest and be out of the LLC.

As you can see there are many considerations to address in a multi-member LLCs. While hopefully many of these considerations do not come about it is best to plan for such contingencies. Thankfully Thunderbird Law offers flat fee pricing for a buy-sell agreement. If you have Thunderbird Law form a new LLC, then discounts for the buy-sell agreement are available. Contact Thunderbird Law, PLLC for assistance in drafting your buy-sell agreement. You can also schedule an consultation here:


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