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Buyout Agreements: Changing LLC Ownership

Understanding buyout agreements is crucial when you're involved in a limited liability company (LLC). These agreements guide the process of changing LLC ownership, including interactions with the Internal Revenue Service (IRS). A buy-sell agreement, a business continuity agreement, or a buyout agreement is a contract between co-owners of a company. The agreement determines how to handle a member's departure.

A buyout agreement is an important part of LLC ownership. It regulates who can buy a member's interest and creates a predetermined price for ownership interests. The agreements guide the process of updating your business name and comprehending the intricacies of the LLC operating agreement. This article sheds light on these agreements, which are vital for running a small business or being part of an LLC.

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Who Needs a Buyout Agreement?

Buyout agreements are essential for several key players in an LLC. LLC members must be aware of these agreements—they directly impact their ownership percentage and personal liability. Small business owners, especially those transitioning from a sole proprietorship to an LLC, need to understand these agreements thoroughly. People joining an LLC must also be familiar with how ownership transfers are handled within the LLC ownership.

Most LLCs should create a buyout agreement. The few exceptions include a business that has:

How To Transfer LLC Ownership

Transferring LLC ownership involves several key steps:

  1. Review the LLC operating agreement. This document should outline the process for change of ownership within your LLC.
  2. Determine the value of the LLC. Establishing the business's value is critical for a fair transfer of ownership of an LLC.
  3. Complete the necessary paperwork. This includes drafting a buyout agreement or purchase agreement.
  4. Update the articles of organization. It may be necessary to file amendments with the secretary of state to reflect the ownership change.
  5. Notify the IRS. Update your employer identification number (EIN) and other tax-related information if needed.
  6. Amend licenses and permits. Ensure all business licenses and permits are updated with the new ownership information.
  7. Inform the registered agent and stakeholders. Keep all relevant parties informed about the ownership change.

Why Create a Buyout Agreement?

Chances are, a member will leave the company at some point. Without a buyout agreement, state law may force the LLC's dissolution when one member leaves. A buyout agreement can establish preset guidelines for handling ownership changes. It can prevent unwanted buyers from obtaining an interest in the company.

A buyout agreement can control:

  • The transfer of ownership
  • Whether the other members will buy out the withdrawing member
  • How to value an ownership interest
  • The terms of payment for a withdrawing member's interest

Buyout agreements are usually included in the LLC's operating agreement, but a separate document can also record buyout terms.

What Events Trigger a Buyout Agreement?

A buyout agreement comes into play under several circumstances. The departure of an LLC member, whether voluntary or not, often triggers these agreements. The process of integrating a new owner into the LLC is another common trigger. A buyout agreement determines what events will initiate a buyout of a member's interest.

Common events include:

  • Bankruptcy (this initiates an automatic sale of the member's interest back to the company)
  • Death
  • Retirement
  • divorce settlement that gives an ex-spouse an ownership interest (the ex-spouse must sell any acquired interest back to the company)
  • Disability or incapacity
  • Loss of a license
  • Default on a personal loan

Buyout Options and Forced Sales

When ownership interests change, a buyout agreement can not only give the LLC the right to purchase the departing member's interest, but it can also include terms that force the LLC to buy a departing member's interest.

  • Option to Purchase an Owner's Interest: This option gives the LLC and its members the right to buy back an ownership interest from a member, a member's family, or the member's estate within a certain time and according to a predetermined price. This option, for instance, can be used to buy an interest from the estate of a deceased member, from a member who retires or quits, or from a member who becomes disabled.
  • Right to Force a Sale: This provision gives a member who decides to leave or retire the right to force the company to buy their interest. The LLC or its members must buy the interest within a certain time and at a predetermined price if the departing member or the member's family makes a request.

Additional Considerations for LLC Owners

Drafting a detailed LLC operating agreement is crucial. It should align with the buyout agreement. Understanding the tax implications for different types of LLCs, such as S corps or single-member LLCs, is important. Accurately reflecting ownership changes in the annual report to the secretary of state is also essential.

Get Legal Help Changing Your LLC's Ownership

If you're in the process of deciding whether a buyout agreement is right for your LLC, you may want some professional legal advice. Contact a local business attorney who can walk you through your options if a member decides to leave the LLC. They can also help draft the buyout agreement if necessary.

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