Many states do not require limited liability companies to have an operating agreement, but they are a wise decision, especially for sole owners of LLCs who must underpin their claim to limited liability. Operating agreements regulate decision-making procedures, codify the members' percentage interests, head off disputes, and override default state LLC rules. When a member wants to sell his interest, operating agreements offer exit routes, one of which is the put option.
What's a Buyout Agreement?
A buyout agreement can be a stand-alone agreement or a provision within an operating agreement which sets out what happens when an LLC member wants to leave the business, retire, goes bankrupt or dies. Essentially, it mandates who can buy a departing member's share and at what price. Without appropriate buyout provisions, the LLC might face dissolution when one member leaves, forcing the business to be sold prematurely.
Read More: Can an LLC Operating Agreement Be Amended?
What's a Put Option?
Operating agreements typically contain rights of first refusal (ROFR) when it is important to keep the ownership of the LLC within a certain class of people, for example a family. ROFR provisions require that if any member wishes to sell his share and receives an offer from a third-party purchaser, he must first give the existing members the option to buy out his share on the same terms. The departing member can sell to the third party only if the existing members decline. A put option is a fallback provision for any member who wishes to leave, but cannot find a third-party purchaser. It "puts" a contractual obligation on the remaining members to buy out the departing member's share.
How Does It Work?
The language of your put option clause can be as simple or as complex as you wish. However, the operative provisions are fairly simple. The departing member serves a put notice specifying that he wishes to dispose of his share of the business. As soon as he serves that notice, the receiving members are obligated to purchase the offered share at either a predetermined price or at the value determined by an appraisal mechanism set out in the operating or buyout agreement. The receiving members have a limited time to complete the purchase.
What Else Do I Need To Know?
The opposite of the put option, and equally effective, is the call option. Call options come into play on certain trigger events, such as the death, incapacity or retirement of a member, or divorce within a family-owned LLC. Under the call option, the remaining owners have the right to "call" for the affected member to sell his share, creating a binding contract which forces the outgoing member to cleanly depart the company, severing all ownership claims.
A former real estate lawyer, Jayne Thompson writes about law, business and corporate communications, drawing on 17 years’ experience in the legal sector. She holds a Bachelor of Laws from the University of Birmingham and a Masters in International Law from the University of East London.