By: Robert E. Petrowsky
Over the past few months, I’ve watched a drama unfold between former friends and business owners that is fit for a soap opera.
The company at issue isn’t a Fortune 500 entity with large profits; it is merely a hunting club that owns real estate and collects a very modest income. However, the struggles of these members should serve as a warning to all business owners on the importance of planning an exit strategy early and while everyone involved still gets along.
One owner has alienated himself from his former friends by demanding a difficult ultimatum: Either the other members buy out his interest or the company is forced to dissolve in order to let him take his investment and leave. Despite owning a tiny interest with virtually no marketability, he insists on being paid full price. In his mind, his interest is worth more than a willing buyer would ever pay for it.
Unfortunately for the other members, he has developed a very convenient case of amnesia and doesn’t recall agreeing to any of the transfer restrictions contained in the operating agreement for the business. While the company had the foresight to prepare a simple agreement at the outset, they did not anticipate what kind of misery an aggrieved friend could cause.
While companies in Missouri can avoid some of these difficulties due to statutes providing the legal right to withdraw, this merely shifts the fight to one about money. For example, if a member withdraws from a limited liability company in Missouri, that member has the right to receive distributions according to the operating agreement, or, if the operating agreement is silent, up to the “full value” of such member’s interest in the LLC. Rather than determining whether to buy out a member’s interest, business owners in Missouri may instead be left wondering how to pay for such an involuntary buyout. When the company lacks cash (e.g., real estate is the only asset) or operates on very thin margins, this could mean a forced sale of assets in order to meet the obligations to the departing member.
In order to avoid these problems, it is best for all members in a business – whether an LLC, partnership, corporation or any other type of entity – to thoroughly discuss at the outset what will happen if a member wants to leave or if the majority would rather one member no longer be involved. State law gives ample flexibility to structuring an LLC and placing restrictions on transfers. The business operating agreement or bylaws are the best place to apply that flexibility and set out, with specificity, how those situations will be handled.
There are many questions that will need to be answered to ensure future headaches are avoided.
Discuss what it might cost to buy a member out unexpectedly and how to value a member’s interest in the business. Consider where that money might come from (e.g., life insurance) and what financial impact it might have on the company as a whole. Think about using a promissory note to fund the buyout payment over time rather than requiring a lump-sum payment. Is it worth paying the same amount for a member who has become a burden as it is if a member is forced to leave due to unforeseen circumstances (e.g., illness)? Should there be a discount for a minority interest? How big should that discount be? What happens if a member dies? Do family members automatically inherit the deceased member’s interest and participation rights, or is the company required to buy out the family?
The most prudent business owners will plan for all of these potential scenarios in advance, providing all members with clarity as to their rights and obligations and avoiding disputes later on. It is far easier to come to an agreement with your fellow business owners at the birth of the business when all involved are cordial and willing to negotiate. Waiting until a problem arises is guaranteed to result in an expensive court battle where only the attorneys will win.
Petrowsky, Robert. (2022, May 4). Planning your business exit now prevents stress later. Springfield Business Journal. Daily Update / posted online May 4, 2022.
Robert Petrowsky is an associate in the estate planning and transactional practice groups of Carnahan Evans PC. He can be reached at email@example.com.