When two or more people go into business together, there’s always a risk that one or more owners will want out. And when that happens, it’s not only because the owners get into an irreconcilable dispute. If the business goes on long enough, life circumstances, such as the deteriorating health or death of an owner, will dictate a departure from the business.
While it’s not an eventuality that business owners want to contemplate, it’s critical that they do. If the members of a limited liability company (LLC) in Michigan don’t spell out how to deal with a member who wants out, such as in the provisions of an operating agreement, then they’re putting themselves and the business at risk.
Common Reasons Why Members Leave an LLC
A member who leaves an LLC can have a significant impact on the remaining members and the business as a whole. Understanding the reasons why a member may depart can help the remaining members anticipate and plan for this possibility. Here are some of the most common:
- Disagreement with the other members over the direction or management of the business. This may include disagreements over financial decisions, strategic direction, or the allocation of responsibilities. These disagreements can lead to a lack of trust and communication among the members, making it difficult to continue working together.
- Change in personal circumstances. This can include retirement, health issues, or a desire to pursue other business opportunities. In these cases, the member may decide to sell their interest in the business to the remaining members or to an outside party.
- Financial difficulties. This can include the member experiencing financial strain or the member being unable to contribute financially to the business.
- Lack of alignment. In some cases a member will disagree about the company’s goals and vision, or experience a lack of motivation or interest in the business.
To minimize the potential negative impact of a member leaving an LLC, it is important for the remaining member(s) to have an operating agreement in place that addresses the possibility of a member’s departure. As discussed below, some of the key provisions that help address a situation involving a departing member include a buy-sell agreement, a non-compete clause, a dissolution provision, a successor member provision, and a dispute resolution provision.
Key Operating Agreement Provisions to Deal with a Departing Member
An operating agreement is a legal document that outlines the structure and operation of an LLC, including the rules and procedures governing the departure of a member.
One common way to address the departure of a member is through a buy-sell agreement, the terms of which are incorporated into an operating agreement. This type of provision outlines the process and terms for a departing member to sell their interest in the business to the remaining members, or to an outside party. The buy-sell agreement should specify the purchase price, the method of payment, and any contingencies that must be met before the sale can occur. This provision can help to prevent disputes and ensure a smooth transition of ownership.
An operating agreement may also require that members enter into a non-compete clause. This type of provision prohibits a departing member from competing with the business for a certain period of time after their departure. The non-compete clause should specify the geographic area and type of business activities that are prohibited, as well as the length of time that the restriction will be in effect. This provision can help to protect the business from unfair competition and maintain customer loyalty. However, it should be noted that the Federal Trade Commission recently proposed a broad ban on noncompete agreements, so it’s unclear whether noncompetes will be allowed in these types of circumstances should the ban take effect.
Additionally, an operating agreement should define if, when, and how the business should be dissolved in the event of a member’s departure. This provision should outline the steps to be taken to wind down the business, including the distribution of assets and liabilities, and the process for dissolving the business entity.
An operating agreement may also include a provision for the appointment of a successor member. This provision should outline the process for appointing a new member in the event of a departure, including any qualifications that a potential new members must meet, and any approval rights of the remaining members.
Finally, an operating agreement should address how disputes between should be handled. This includes the means and progression for resolving disputes, such as mediation, arbitration or legal action. This provision can help to prevent disputes from escalating and, ideally, avoid full-blown litigation.
Take Control of Your LLC’s Future with an Effective Operating Agreement
Business owners in Michigan must expect—and plan for—the unexpected. One important step that every business should take, particularly businesses with multiple owners, is having a well designed buy-sell agreement in place. Without an operating agreement, an LLC and its members are left to deal with the default rules under the Michigan Limited Liability Company Act, such as when a member departs. This may, and often does, result in an unintended and unwelcome outcome.
At Dalton & Tomich, we help Michigan small and medium-sized businesses and their owners create effective operating agreements which include buy-sell agreements. If you require helping in incorporating a business, creating an operating agreement, or have questions about your existing operating agreement, please contact Zana Tomich, co-founding partner of Dalton & Tomich.