This is a legal document laying out how the members’ interests can be bought and sold. It is important to check that your membership agreement contains suitable wording regarding the sale and purchase of members’ interests to ensure that the protection agreement is valid; legal assistance is recommended.
The most common agreement used is a cross option agreement, which is also known as a double option agreement. This gives the remaining owners the option of buying a deceased owner’s stake (the “call option”), and the beneficiaries of the deceased’s estate the option to sell them (the “put option”). If either party wants to exercise their option, the others are legally obliged to allow them to do so. Usually the agreement will stipulate that the remaining owners have three months to decide if they want to buy, whilst the family is given six months for their decision.
You can also incorporate plans for a member leaving due to a critical illness; if you arrange insurance to cover this event, it is common (but not mandatory) to use a single option agreement for this benefit, rather than a double option. This means that if a member of the LLP is diagnosed with a critical illness covered by the insurance policy, the rest of you do not have the right to force them to sell their stake. However, the ill owner does still have the right to sell their interest and it could be seen as a good time for them to obtain a cash sum without damaging the financial stability of the firm.
The agreement should also specify in what proportion the deceased or outgoing member’s interest should be purchased by the remaining members.
This is the most popular type of share agreement, as the non-binding nature of the sell and buy options means that each member’s stake in the business will still qualify for full Business Relief for Inheritance Tax (IHT) purposes, provided the individual held them for at least two years prior to death.