What is a Buy-out Clause?
So you read our posts on The Verdict about all the different business entities that you can create. You read through them all and compared them, yet the one that struck you as the most attractive for your business is a partnership (or limited liability company/LLC). Well, now that you decided you and your business associates are going to create a partnership, you will need to, among other things, include a buy-out clause in your partnership agreement. In this post, we are going to refer to LLC’s and partnerships interchangeably, as these learnings apply to both.
What is a Buy-out Clause?
A buy-out clause is a binding contract between partners that must be placed in the partnership agreement. The clause will control future ownership of the business in the event that a partner leaves.
The clause will include a few key pieces of language that will decide how a partner’s share of the company will be divided amongst the remaining partners.
- The clause should include the price that will be paid for the interest of the departing
- What occurrences or circumstances will prompt a buyout.
- Who has the ability to buy that partner’s interest? Is it just limited to other partners or can outsiders buy the interest as well?
- Does a departing partner have to be bought out?
Thus, if you have a partnership agreement, ensure that a buyout clause is included in it and ensure that these 4 elements are explicitly considered as well.
Why do you need a Buy-out clause?
The main reason you need a buy-out clause is because a departing partner could dissolve your business. In other words, if a partner leaves, the remaining partners may be forced to divide the assets of the partnership. They can always start a new partnership, but it would be much more efficient to just include a buy-out clause.
In addition, without a buy-out clause, how will you decide who will get the departing partner’s interest? It may create serious tension if you and your partners fight over that leftover interest.
What events may trigger a Buy-out Clause?
There are a few events that may occur in a partner’s lifetime that may force him or her to leave a partnership. Here are a few to mention:
- Death, disability, or incapacity of a partner.
- A partner enters into personal bankruptcy.
- A divorce settlement that would entitle a partner’s ex-spouse to an interest in the partnership.
- Retirement or resignation of a partner.
- An offer from an outsider to purchase a partner’s interest in the partnership.
If any of these occur, you will be so happy you included that buy-out clause in your partnership agreement.
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We hope you never create or enter into a partnership/LLC without a buy-out clause in the partnership agreement after reading this. If you decide you want to create a partnership or limited liability company, let your friends at JustLaw and our highly experienced, 5-star corporate attorney’s handle the creation of your agreement.