An LLC buy-sell agreement is a contract among the members that sets, in advance, what happens to a member’s ownership interest when a defined event occurs: death, disability, retirement, bankruptcy, divorce, deadlock, or expulsion. It names who has the right or obligation to buy the departing member’s units, how the price is calculated, how the deal is funded, and on what payment terms. Without one, state LLC default rules and outside parties, including heirs, former spouses, and bankruptcy trustees, determine the outcome, and nobody involved tends to be happy with it.
Why the Default Rules Produce a Bad Outcome
Most state LLC statutes separate a member’s economic rights from management rights. When an interest is inherited or awarded in a divorce, the recipient in a majority of states becomes an “assignee” rather than a full member. An assignee receives distributions but has no vote, no access to the books, and no voice in operations. The assignee holds an asset that is almost impossible to sell, and the remaining members are stuck sharing distributions with an investor they never chose. A buy-sell agreement replaces that stalemate with a defined transaction at a defined price.
Triggering Events the Agreement Should Cover
A triggering event is the specific circumstance that activates the buyout. Any event not listed is an event with no planned exit, so the catalog matters more than almost any other clause.
Death, Disability, and Retirement
Death is the cleanest trigger: the estate offers the interest back to the LLC or the remaining members at the price and terms the agreement already fixes. Permanent disability needs a careful definition, often tied to the inability to perform professional duties for a continuous period, commonly 90 to 180 days. Voluntary retirement or resignation rounds out the standard set and gives the business the right to repurchase the departing member’s units.
Bankruptcy
When a member files for Chapter 7 bankruptcy, a court-appointed trustee takes temporary legal ownership of essentially all of the debtor’s property, including LLC interests, and liquidates nonexempt assets to pay creditors.1United States Courts. Chapter 7 Bankruptcy Basics Chapter 13 presents a similar risk, with the interest falling into the bankruptcy estate while the debtor works through a repayment plan. A well-drafted agreement gives the LLC or remaining members a right of first refusal at the agreed price before the interest ever reaches the trustee.
Divorce
A state court can award part of a member’s interest to a former spouse as marital property. The same right-of-first-refusal mechanism that handles bankruptcy handles divorce: the LLC or the other members buy the interest at the agreement’s predetermined price before it leaves the member’s hands.
Management Deadlock
Two-member LLCs with equal ownership face the risk of a vote nobody can win. A “shotgun clause” resolves it by letting one member name a price and forcing the other to either buy at that price or sell at that price. The mechanism keeps the number honest: lowball offers get accepted, inflated offers get sold into. It only works fairly when both members have roughly comparable financial resources. When one side has significantly deeper pockets, the wealthier member can set a price the other cannot afford to match, and the fairness mechanism becomes leverage.
Expulsion for Cause
Some agreements let the LLC force out a member for serious misconduct. Typical grounds are a felony conviction, fraud, securities violations, or a material breach of the operating agreement. Drafting matters: a vague “material breach” catch-all invites the expelled member to sue, and the business can be tied up in litigation while the dispute plays out. Specific, objective grounds reduce that risk.
Setting the Price
The valuation clause is where buy-sell agreements most often fail in practice. A method that looked reasonable at formation can produce a wildly wrong number five or ten years later.
Fixed Price
Members agree on a dollar figure for the company’s total value and record it, sometimes in a document called a Certificate of Agreed Value. The number stays in effect until the members update it, and the standard problem is that they don’t. Many agreements include a fallback: if the fixed price has not been revisited within a set period, often 12 to 18 months, the agreement automatically defaults to a formula or an appraisal.
Formula-Based
Formulas tie the price to the company’s financial statements. A common approach uses a multiple of EBITDA. Service-oriented LLCs often use multiples of average annual net income over a rolling three-year period. Formulas work well for companies with steady, predictable earnings and distort value for businesses with lumpy revenue or significant asset appreciation that never shows up on an income statement.
Appraisal-Based
An independent business appraiser produces a formal valuation report. Costs run from a few thousand dollars for a straightforward business to considerably more for complex operations. Some agreements call for a single appraiser chosen by mutual agreement. Others have each side hire its own, with a third appraiser brought in to break any significant gap. Appraisals are the most expensive option and the hardest to challenge, which makes them the default when the stakes justify the cost.
Why Book Value Usually Undersells the Business
Some agreements default to net book value: total assets minus total liabilities on the balance sheet. It’s simple, cheap, and almost always wrong for a going concern. Balance sheets reflect historical cost, not current market value. Real estate purchased a decade ago at $400,000 might be worth $1.2 million, but the books still show the depreciated original cost. Brand value, customer relationships, and proprietary processes never appear on a balance sheet at all. A member who accepts book value usually leaves real money behind.
Valuation Discounts
Even after fixing a fair market value for the entire LLC, the price for one member’s interest can be reduced by discounts. A minority interest discount reflects the fact that a less-than-50% stake carries no control over business decisions. A lack-of-marketability discount reflects that LLC interests cannot be sold on a public exchange. Applied together, these discounts can cut the buyout price by 30% to 50% compared to a straight pro-rata share. The agreement should state whether discounts apply and which ones. Silence here is an invitation to fight.
Who Writes the Check: Cross-Purchase, Redemption, or Hybrid
In a cross-purchase, the remaining members personally buy the departing member’s interest. Each buyer’s ownership percentage grows, and the total number of outstanding units stays the same. It works cleanly for two or three members. In a five-member LLC, each member needs a separate insurance policy on every other member, producing 20 policies to manage.
In a redemption, sometimes called an entity purchase, the LLC itself buys back the departing member’s units using company funds or financing.2U.S. Securities and Exchange Commission. Membership Interest Redemption Agreement The units are typically retired, which proportionately increases every remaining member’s stake without anyone writing a personal check. One buyer, one transaction, regardless of how many members remain.
Many LLCs use a hybrid: the entity has the first option to redeem, and if it declines or cannot fund the purchase, the remaining members have a secondary right to buy on a cross-purchase basis. This preserves flexibility to pick the better structure when the triggering event actually happens.
Funding the Buyout and the Connelly Problem
Life insurance is the most common funding mechanism for death-triggered buyouts. In a cross-purchase arrangement, each member personally owns a policy on the other members and collects the proceeds to buy from the estate. In an entity-redemption arrangement, the LLC owns the policies, pays the premiums, and collects the proceeds to fund the redemption.
Which side owns the policy now carries major estate-tax weight. In Connelly v. United States (2024), the Supreme Court held that life insurance proceeds payable to a company to fund a stock redemption must be counted as a company asset when calculating the business’s fair market value for estate tax purposes.3Supreme Court of the United States. Connelly v. United States The Court rejected the argument that the obligation to spend those proceeds on the redemption offsets their value as a company asset. In practice: if an LLC owns a $5 million policy on a member with a 50% interest, the proceeds inflate the company’s value at the moment of death, and the estate’s 50% interest is worth more because the LLC now holds $5 million in cash, even though that cash is earmarked to buy the estate out.
The Court explicitly noted that a cross-purchase structure avoids the problem. When surviving members personally own the policies, the proceeds never land on the LLC’s balance sheet and do not inflate the company’s value for estate tax purposes.3Supreme Court of the United States. Connelly v. United States For LLCs where a member’s estate could approach or exceed the federal estate tax exemption of $15,000,000 in 2026, the structural choice can mean hundreds of thousands of dollars in estate tax.4Internal Revenue Service. What’s New — Estate and Gift Tax Any LLC currently using an entity-owned policy to fund buyouts should revisit the structure.
Payment Terms When There Is No Lump Sum
Few buyouts close with one check. A typical structure calls for a down payment at closing, often 20% to 30% of the total, with the balance paid through a promissory note over three to five years at a reasonable interest rate specified in the agreement. Disability buyout insurance plays a parallel role to life insurance, paying a benefit when a member becomes permanently impaired, and those proceeds can cover part or all of the price. When installment payments do most of the work, the agreement should state whether the interest rate is fixed or variable and what index it tracks.
Protections for the Departing Member
A seller holding a promissory note is an unsecured creditor unless the agreement says otherwise, which is a weak position. Strong agreements restrict the buyer from selling, pledging, or transferring the purchased interest until the note is paid in full. Some go further, prohibiting the LLC from selling major assets, issuing new membership interests, or admitting new members without the seller’s written consent while the note is outstanding.5U.S. Securities and Exchange Commission. Sale of LLC Interest Agreement On default, the agreement typically lets the seller accelerate the full remaining balance and pursue enforcement in court or arbitration, with the losing party covering attorneys’ fees.
Security Interest in the Units
The most concrete protection is a security interest in the membership units being sold. The seller keeps a lien on the units as collateral for the note and perfects that interest by filing a UCC-1 financing statement with the state’s Secretary of State. If the buyer defaults, the secured seller has priority over other creditors with respect to the membership interest. The statement must include the debtor’s name, the secured party’s name, and a description of the collateral. Filing fees vary by state and are generally modest. Skipping this step leaves the seller with an unsecured IOU.
Specific Performance
Because LLC membership interests are unique assets with no ready market substitute, courts can order specific performance when a party tries to back out of a buy-sell agreement. Rather than awarding money damages, the court compels the reluctant party to complete the transaction on the original terms. The remedy is available when monetary damages would not adequately compensate the non-breaching party, and including a specific-performance clause in the agreement makes it easier to obtain quickly.
Tax Treatment of the Buyout
How the deal is structured affects what the departing member nets and what the remaining members’ ownership costs going forward. For an LLC taxed as a partnership, payments to a retiring or deceased member’s successor generally fall into two categories under federal law. Payments made in exchange for the member’s share of LLC property are treated as distributions and typically taxed as capital gain or loss to the recipient.6Office of the Law Revision Counsel. 26 U.S. Code 736 — Payments to a Retiring Partner or a Deceased Partner’s Successor in Interest Payments that exceed the member’s share of LLC property, such as amounts attributable to goodwill when the operating agreement is silent on goodwill or to unrealized receivables, may be treated as ordinary income to the departing member and deductible by the LLC. Capital gains rates are lower, so how the agreement allocates the price between these categories directly affects the tax bill on both sides.
After the buyout, the LLC can file a Section 754 election with the IRS. The election adjusts the tax basis of the LLC’s assets to reflect the price actually paid for the departing member’s interest, rather than carrying forward the old basis.7Internal Revenue Service. FAQs for Internal Revenue Code (IRC) Sec 754 Election and Revocation Without it, the remaining members may end up paying tax on gains already baked into the buyout price. The election must be attached to the LLC’s timely filed return, including extensions, for the year of the transfer. Once made, it applies to all future transfers and distributions and cannot be revoked without IRS permission. If the LLC misses the deadline, an automatic 12-month extension is available under Treasury regulations, and later relief is possible but requires the Commissioner’s approval.
Keeping the Agreement Current
A buy-sell agreement drafted at formation and never revisited is almost guaranteed to produce a bad result. Business values change, members’ personal circumstances shift, and tax law moves. Review the agreement whenever a member joins or leaves, after any significant change in business value, and in response to major legal developments like Connelly. The fixed-price method in particular needs annual updates; a stale number either shortchanges the departing member or overcharges the buyers. After a change in membership, most states require amending the LLC’s articles of organization, which typically costs between $25 and $150 in filing fees. The real cost of neglect is not the filing fee. It’s the litigation that follows when a triggering event arrives and the agreement no longer matches reality.