What happens if your business partner dies, gets divorced, or wants to walk away? If you own part of a company along with other partners, you need to understand and be prepared for a potential business divorce. That is what buy-sell provisions cover. These provisions outline the terms and conditions under which membership interests in a company can be purchased and sold. Different terms often apply depending on whether a member is selling its interest involuntarily or voluntarily. This article explores the types of buy-sell provisions and why they matter.
Types of Buy-Sell Provisions
- Voluntary Transfers
Voluntary transfers occur when a member chooses to sell or transfer their ownership interest. Buy-sell provisions typically require that the selling member first offer their interest to the company or the remaining members before selling to an outside party. This is known as a “right of first refusal.” The goal is to keep ownership within the existing members and maintain control over who becomes a member. Typically, buy-sell provisions for voluntary transfers have pre-determined pricing or valuation mechanisms, such as conducting a third-party appraisal to determine fair market value. There are also typically notice requirements and timelines for exercising purchase rights, streamlining the transfer process.
- Involuntary Transfers
Involuntary transfers are triggered due to events outside a member’s control, such as death, divorce, disability, or bankruptcy. Involuntary transfers can also result from a member committing wrongful acts like fraud, dishonesty, breaching the operating agreement, or being convicted of a felony. These situations can introduce unwanted or unqualified owners into the company, which the remaining members will want to restrict. Buy-sell provisions address these risks by giving the company or remaining members the right to purchase the affected member’s interest before it passes to heirs, ex-spouses, or creditors, or is owned by a bad actor. For certain instances, including divorce or the buyout of a member who commits certain wrongful acts, the company or its members can purchase the interest at a discount, such as 80% of fair market value.
Why Buy-Sell Provisions Matter
Buy-sell provisions set forth agreed upon terms under which membership interests can be sold which serves to resolve potential disputes or issues. Essentially, buy-sell provisions help ensure smooth transfers of ownership in an attempt to mitigate disruption to the business. They also protect the company and its members by preventing unwanted or unqualified individuals from acquiring ownership or exercising control in the company. In addition, they provide clear pricing and valuation formulas, processes, and terms under which the interest can be sold which reduces disputes and uncertainty.
Whether you are forming a new company or reviewing an existing operating agreement, it’s essential to tailor buy-sell provisions to your specific needs and understand what these provisions mean. If you are interested in incorporating buy-sell provisions into your operating agreement or have questions regarding your rights under an existing operating agreement, please feel free to reach out. We’re happy to help.