In both single-member and multi-member LLCs, the owners need to have a plan for what happens in the event that a member dies. Should the LLC continue or should it automatically trigger cancellation? Who has the right to buy the deceased member’s interests? Do family members obtain voting rights or just assignment of distributions? These questions should have clear answers contained in the LLC’s Operating Agreement. Careful planning avoids headaches for both the family of the deceased member and the remaining members.
What Is LLC Membership Interest?
In short, your LLC interest is your bundle of rights and privileges defined by the LLC operating agreement. LCC membership interest is not usually held in the form of a membership certificate like corporate stock. Instead, it is usually set forth in the operating agreement under the term “units”. Like stock, the LLC can authorize a certain number of units. The units are then issued to the LLC members in proportion to their ownership percentage. There can be voting and non-voting interests and they can have other rights and classes. Usually there is just one class of 1000 voting units. Our standard operating agreement authorizes 500 voting units and 500 non-voting units. In case of your death, you should protect your LLC interest by laying out what will happen to it. You do this within the operating agreement and what you can control though your estate plan.
While it is possible to have LLC interests “payable on death” to named beneficiaries, that provision is very unusual. Instead, LLC interests can be titled in the name of your estate planning revocable trust. If the interests are titled in your own name, they will be controlled by your last will and testament. However, passing on an interest in an active business may be an unwanted burden to both your loves ones and your surviving business partners.
The Importance of a Buy/Sell Provision
For a multi-member LLC with an active business operation (not just passive asset holding LLCs), the most powerful action you should take to protect your LLC interest in the case of death is to write a “Buy/Sell” provision in your LLC operating agreement. The Buy/Sell provision is a common and effective set of instructions. It states the rules and terms upon which transfers of interest in an LLC occur. In the “Buy/Sell” provision, you may write stipulations for what will be done with the LLC members’ interest when they die. A common stipulation in the case of death is that the living LLC members have either the option to buy your LLC interest or the legal obligation to buy your LLC interest. The proceeds of the sale of your LLC interest would then go to your estate.
One advantage of this “forced buyout” at a set formula price financed over a period of time (typically a 5 year note) is that it helps business continuity. It keeps out unwanted partners, such as spouses or children of other members. Additionally, the beneficiaries of other members’ estates get a cash buy-out. This is often preferred to the burden and uncertainty of having to help own and possibly manage a business they may not be in a position to operate.
The Buy/Sell provision is not usually in standard written LLC Operating Agreements from other incorporation services. This stipulation for living LLC members to purchase your interest is useful for many reasons. One of the most important reasons is that LLC members usually do not want to be forced to go into business with the family of an LLC member. Also, the family of an LLC member usually do not want to go into business with the other LLC members either.
Your Buy/Sell provision (along with a stipulation that living LLC members have the option or obligation to purchase your interest, which can be funded with life insurance), solves this problem by keeping the business of the LLC within its original members, while automatically disposing of your LLC interest after you die. Writing forced sale within the Buy/Sell provision of your LLC operating agreement is a powerful and effective measure to ensure that your LLC interest does not become a burden to your loved ones.