Recently a new client asked me to review his company’s Buy Sell Agreement because he and the other fifty percent owner of the company could not stand each other and were suing each other over the ownership of their four year old company that generated $20 million in gross revenue. One man did all the work and the other man had nothing to do with the company other than collect big checks.
The good news was they did sign a Buy Sell Agreement, but the bad news was the agreement was grossly deficient as to the terms and conditions of a buy out and its valuation method was what is called a “shot gun” buy out valuation method. Here is how a shot gun buy out method works:
1. At any time a member of the LLC (Member 1) can notify the other member (Member 2) that Member 1 invokes the shot gun buy out clause in the Buy Sell Agreement.
2. Member 1 names the buy out price per share (if the company is a corporation) or per membership interest percentage (if the company is an LLC).
3. Member 2 then has a specified period of time to tell Member 1 if Member 2 will be the buyer or the seller at the price set by Member 1.
4. Once the buyer and seller are determined the purchase and sale transaction is consummated per the terms and conditions set forth in the Buy Sell Agreement. Hopefully the terms and conditions of the sale are clear and workable.
In my 32 years of experience has a business lawyer who has formed 9,300+ companies I’ve had many people contact me because they did not want to continue in business with another member of an LLC. A good Buy Sell Agreement may contain many “triggering events” such as a default under the LLC’s Operating Agreement, bankruptcy, conviction of a felony, death of a member and other situations, but it is common for one or both members to want to terminate their business relationship when no triggering event has occurred that would result in a forced buy out. The purpose of the shot gun buy out clause is to give the members of a multi-member LLC a method that will result in one member buying the membership interest of another member when there has not been a triggering event under a Buy Sell Agreement.
Most members of a multi-member LLC do not have a Buy Sell Agreement or buy out clauses in an Operating Agreement. Smart members of a multi-member LLC do sign a Buy Sell Agreement that contains triggering events they have selected, but most Buy Sell Agreements do not contain a shot gun buy out clause. If you are a member of a multi-member LLC and you want to prevent a future situation where one or more members wants to terminate their relationship with one or more other members, you need a shot gun buy out clause in your Buy Sell Agreement.
In the example of the $20 million LLC mentioned above where one member exercised the shot gun buy out clause the result was the member who caused the LLC to be successful bought out the passive member for $7 million cash.