You want to leave an LLC. You may be nervous about divorcing, in a business sense, from your friends and business partners. Often, LLC members start out as close friends or co-workers with a great business idea. Those relationship may turn sour during business operations. Do not worry. Your LLC is unlikely to be akin to indentured servitude and you likely have a way out.
First, Check your Operating Agreement
Many members of LLCs have no idea where their operating agreement is or what it says. They downloaded a form from legalnonsense.com and signed it several years ago because it was on a “Start a Business” checklist. Many members never read it or have not looked at it in years. They may have never followed the operating agreement. If this is you, rest assured you are in common company. You will likely do things differently in your next business endeavor.
If you cannot access your operating agreement and your fellow members do not have it or are not being cooperative, we can make a demand for it under Wis. Stat. 183.0405. You have the right to collect an extensive amount of information from the LLC, including information about membership interests, the Articles of Organization, financials and tax returns, the Operating Agreement, the history of each member’s contributions, and other important information.
Transfer Clauses in Operating Agreements
Every prudent operating agreement should have one or more clauses that explain how and when a member can dissociate (the LLC term for ending your ownership rights). You may be restricted on when you can leave and who can take your place. Many transfer clauses require the ownership interest be offered to existing members first. They sometimes require existing members to have a right of first refusal, meaning they have the right to match any offer the member obtains from a third party. The transfer clause may have notice provisions that, if ignored, could expose the dissociating member to liability. It may also restrict a member from receiving a distribution upon dissociation for a period when the company is new.
A prudent operating agreement should also have a valuation clause. There are many ways to value a small business. All methods provide challenges and may or may not be fair to certain members. I have seen clauses that tie the value to profits or distributions of the prior couple years. An advantage to this valuation is that its likely very easy to calculate and reduces transactions costs for leaving (think attorneys fees and CPA fees). Transfer provisions may provide that the LLC can be responsible for a debt to the exiting member.
If There Is No Operating Agreement…
Wisconsin’s LLC laws provide direction. A member may voluntarily withdraw from a limited liability company at any time by giving written notice to the other members. If the withdrawal does not cause the LLC to dissolve, a dissociating member is entitled to receive a distribution in complete redemption of the “fair value” of the member’s interest in the limited liability company as of the date of dissociation based on the member’s right to share in distributions from the limited liability company.
Determining “Fair Value” of Your Ownership Interests When Leaving an LLC
This is a difficult question for most small businesses and will be fact dependent. If there is no operating agreement, this question can be messy. The Wisconsin statute is clear that the dissociating member’s interest is the same as its right to share in distributions. For example, if the dissociating member contributed $100K and has a 30% interest, the rights to distribution will be based on 30% of the business value, not the initial investment. A backstop to valuation is that a distribution cannot cause the LLC to fail to pay its debts.
If there is no operating agreement, it might be preferable for a member to simply collect distributions until the other members are tired of paying them, and then make a reasonable offer. When a company is worthless, then your distributions will be zero. If you are receiving distributions, then your ownership interest is likely worth something. Attorneys fees and costs of a dispute may drive the parties to be reasonable and come to a conclusion.
Draft a Prudent Operating Agreement
Leaving an LLC can get messy. It is often best for all involved to have a prudent operating agreement that explains how a member can leave. Maybe most importantly, thoughtful consideration should be given to valuation of the LLC upon dissociation.
Most LLC members have the business acumen to properly read and execute sophisticated contracts. However, leaving an LLC is a little different. There are many traps for members leaving an LLC. I do not recommend a member leave an LLC without proper legal advice.
