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Arizona Law Arizona LLC Library Arizona LLC Buy-Sell AgreementWhy Multi-Member LLCs Need a Buy-Sell Agreement
A Buy-Sell Agreement is the Members' Exit Strategy. Don't Go Into Business With Unrelated Parties Without It
by Richard Keyt, Arizona LLC and business lawyer
Bottom Line & Number 1 Reason Multi-Member LLCs Need a Buy-Sell Agreement: Members of a multi-member LLC who have not signed a Buy-Sell Agreement are stuck with each other FOREVER unless they agree at a time when they cannot agree on anything else on when to part ways, who stays and who goes and how much money will change hands.
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 2,100+ 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.
An Actual KEYTLaw Client Bad Example
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 the Operating Agreement. 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 the 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.
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:
Triggering Event | Purpose |
1. Any event the members desire | Each 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. |
| 2. Death | The 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. |
| 3. Divorce | Prevents 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. |
| 4. Termination of employment | Especially important when the employee is a minority member and should only own an interest while employed. |
| 5. Default under the Operating Agreement | Allows 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. |
| 6. Sale of majority of 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. |
| 7. Sale of majority of 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. |
8. Transfer of membership interest without consent of the members | The 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. |
| 9. Loss of professional license | Commonly 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. |
| 10. Conviction of a felony | Many LLC members do not want to have another member who has been convicted of a felony. |
| 11. Disability | Used to acquire the interest of a member who become permanently disabled and unable to provide needed services for the LLC. |
| 12. Retirement | Members sometimes want to retire, but without a Buy-Sell Agreement that provides for a retirement purchase, it probably will not happen. |
| 13. Bankruptcy | If a member loses the member's interest in the LLC because of filing for bankruptcy, the company and other members should be able to buy the interest from the creditor who acquires it out of the bankruptcy. |
Fixing the Purchase Price
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.
Buy-Sell Agreements use the following three primary methods to determine the purchase price of a membership interest:
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.
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.
- 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.
In my experience as an Arizona business lawyer who has been preparing Buy-Sell Agreements 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 Agreements I have prepared use the appraisal method to determine the value of the company.
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. Buy-Sell Agreements that provide for mandatory purchases of the interest of a deceased member usually require that the company buy and the estate of the 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.
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.
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. I cannot prepare a Buy-Sell Agreement until after the members tell me what they want in the agreement. The members have many choices to make, which they do by completing my detailed online Buy-Sell Agreement Questionnaire. I use the information contained in the Questionnaire to prepare the Buy-Sell Agreement that expressly satisfies the desires of the members of the LLC.
Here's the sequence of events when somebody hires me to prepare a Buy-Sell Agreement for their LLC:
Members complete and sign my Buy-Sell Agreement Preparation Service Agreement and fax or email it to me.
LLC pays for the Buy-Sell Agreement with a credit card in our secure online store or by calling my legal assistant Katie at 602-906-4953, ext. 7 and giving your credit card information over the phone. You may also send a check.
Members complete and sign my Buy-Sell Agreement Questionnaire and fax or mail it to me. The members may suggest any provisions they want to include in the Buy-Sell Agreement and we will customize the document to the satisfaction of the members.
We prepare the Buy-Sell Agreement based on the information in the Buy-Sell Agreement Questionnaire and send it to the LLC's contact person for forwarding to all the members.
Members review the Buy-Sell Agreement and make notes of text to be changed, questions about provisions and additional issues to be covered.
We meet with the members in our office or via a conference call to discuss the Buy-Sell Agreement, answer questions and decide on changes to be made to the agreement.
We revise the Buy-Sell Agreement and send it to the contact person to forward to all the members for their review.
We make any additional changes requested by the members (via email, phone or in person) and send the final agreement to the contact person.
- Members sign the agreement.
Our Fee to Prepare a Buy-Sell Agreement
Our fee to prepare a custom Buy-Sell Agreement is based on the number of members of the LLC. Our fee is $997 for a two member LLC plus $500 for each additional member up to a maximum of $1,997. Spouses are considered one member, not two.
The fee equates to $500/member for a two, three or four member LLC. We base the fee on the number of members because we have found that as the number of members increases, the amount of attorney time tends to increase. More members usually means more questions, changes and meeting time.
Why Our Fee Is Not Cheap
Our fee to prepare a Buy-Sell Agreement is not cheap because we do not grab a one-size fits all form and squeeze every LLC into it. When we prepare a Buy-Sell Agreement for an LLC, it is custom drafted after we receive detailed input from the member(s). I challenge you to look at our 14 page Buy-Sell Agreement Questionnaire. It contains almost 200 choices that every LLC must make BEFORE we can prepare the first draft of the Buy-Sell Agreement. Each Buy-Sell Agreement is custom drafted from the answers to the 200+ questions to our Questionnaire.
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.
Our Fee Includes Attorney Consultation & Revision Time
The fee includes one hour of attorney time per member (up to 4 hours) 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 will bill the LLC for any excess attorney time at the attorney’s standard hourly rate.
How to Hire KEYTLaw to Prepare a Buy-Sell Agreement
If You Want Richard Keyt to Form Your New LLC
If you want Richard Keyt to form your new Arizona LLC and if you want a Buy-Sell Agreement, complete the online Arizona LLC Formation Agreement and check the second box on page 2 then indicate the number of members of your LLC by checking the appropriate box under the paragraph about the Buy-Sell Agreement.
Complete our online Buy-Sell Agreement Questionnaire, sign it and fax or mail it back to me to the address found on the last page of the Questionnaire.
If You Have an Existing AZ LLC or You Do Not
Want Richard Keyt to Form Your New LLC
Complete our Buy-Sell Agreement Preparation Service Agreement.
Click on this link to go to the KEYTLaw online store and purchase the agreement. Caution: Purchase the Buy-Sell Agreement that is for the number of members of your LLC.
- Complete our online Buy-Sell Agreement Questionnaire, sign it and fax or mail it back to me at the address found on the last page of the Questionnaire.
About the Author
Richard Keyt, J.D., LL.M. (income taxation New York University Law School) is a business, real estate, transactions, contracts and estate planning attorney licensed to practice law in Arizona. He has formed over 2,100+ Arizona limited liability companies in the last few years because his low cost high quality LLC package is second to none and it only costs $599 for everything. Rick has practiced law in Arizona since 1980. Rick can be reached by telephone at 602-906-4953, ext. 3. Email at rickkeyt@keytlaw.com and fax at 602-297-6890. Rick's web site located at www.keytlaw.com had over 3,000,000 visitors in 2006 - 2008. To follow Rick on Twitter go to www.keytlaw.com/twitter. Rick does not accept matters involving landlord / tenant disputes or litigation of any kind (other than tax lien foreclosures). Communicating with Richard Keyt via email or otherwise does not cause you to become a client or cause your communications to be confidential or subject to the attorney client privilege.
KEYTLaw LLC Formation Records: day: 17 (6/4/08); week: 27 (week ending 6/7/08); month: 64 (6/08); year: 425 (2007)
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This page was last modified on August 31, 2009.
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