Voting Rights in an LLC Operating Agreement: What You Need to Know
When you and your business partners face big decisions—like adding a new member, taking on debt, or changing leadership—who gets the final say?...
7 min read
The death of an LLC member can create legal, financial, and operational challenges if the Operating Agreement doesn’t clearly outline what happens next. Without a well-defined succession plan, the deceased member’s ownership interest might:
- Pass to their heirs, who may have no experience or interest in the business.
- Trigger state default laws, which could force the LLC into dissolution.
- Create disputes over voting rights, buyout terms, or ownership valuation.
To avoid uncertainty, an LLC Operating Agreement should include clear provisions for handling a member’s death. These provisions ensure a smooth ownership transition, prevent disruptions, and protect the business’s financial stability.
This guide explores key issues, common buyout strategies, and sample provisions that can help LLCs plan for a member’s passing.
Legal GPS Pro
Protect your business with our complete legal subscription service, designed by top startup attorneys.
- ✅ Complete Legal Toolkit
- ✅ 100+ Editable Contracts
- ✅ Affordable Legal Guidance
- ✅ Custom Legal Status Report
Key Issues to Address When a Member Dies
1. Ownership Transfer & Succession Planning
When an LLC member passes away, their ownership interest doesn’t automatically disappear. Instead, it must be transferred, bought out, or restructured.
Key questions to consider:
- Does the deceased member’s ownership pass to their heirs, or does the LLC buy back the interest?
- Can the remaining members reject an heir from joining the LLC?
- Does the LLC have a buy-sell agreement in place for member deaths?
State Law vs. Operating Agreement
If the LLC Operating Agreement doesn’t specify what happens, state default laws will determine ownership transfer. In many states:
- The deceased member’s interest becomes part of their estate and may pass to heirs.
- If no heirs claim it, the LLC may be forced to dissolve (depending on state law).
- The remaining members may have limited control over who takes over the deceased’s share.
Solution: The Operating Agreement should explicitly state whether heirs can inherit ownership and how interests will be transferred or bought out.
2. Voting and Decision-Making Rights
Once a member dies, who controls their voting rights?
- If heirs inherit the ownership interest, do they automatically gain voting rights?
- Can the estate sell the interest to an outside party without LLC approval?
- How can the LLC prevent deadlocks if a deceased member’s estate delays action?
Example
"A four-member LLC does not specify voting rights upon a member’s death. One member passes away, and their ownership interest transfers to their two adult children. The children now hold a 25% ownership stake but disagree on how to vote, creating conflicts in decision-making."
Solution:
- The Operating Agreement should clarify if heirs receive only financial rights (profits) or full voting rights.
- Consider restricting estate-held ownership interests from participating in votes.
Common Methods for Handling a Member’s Death in an Operating Agreement
1. Buy-Sell Agreement (LLC Buyout)
A buy-sell agreement is one of the most effective ways to handle a member’s death. This provision ensures that when a member passes away, their ownership interest is automatically sold back to the LLC or remaining members at a predetermined value.
Key Elements of a Buy-Sell Agreement:
- Mandatory vs. Optional Buyout – Does the LLC have to purchase the deceased member’s shares, or is it optional?
- Valuation Method – How will the LLC determine the purchase price?
- Payment Terms – Will the buyout be a lump sum, installment payments, or funded by life insurance?
Example
"An LLC Operating Agreement includes a buy-sell clause stating that when a member dies, the LLC must buy their ownership interest at fair market value, determined by a third-party appraisal. The buyout is paid over five years to reduce financial strain on the company."
Best Practice:
- Use life insurance policies on members to fund the buyout, preventing cash flow problems.
- Specify valuation methods (e.g., book value, multiple of earnings) to avoid disputes.
2. Transfer Restrictions & Rights of First Refusal
Without a buy-sell agreement, the deceased member’s ownership interest might pass to their heirs, which could introduce new, inexperienced owners into the LLC. To prevent this, an Operating Agreement can include:
- A right of first refusal (ROFR) – Remaining members get the first option to buy the deceased member’s interest before it’s transferred to heirs or outsiders.
- Approval requirements for new members – Heirs must be approved by a vote before gaining full membership rights.
- Profit-sharing without voting rights – Heirs may receive financial distributions without decision-making power in the LLC.
Example
"A three-member LLC has a right of first refusal clause. When one member dies, their spouse inherits the interest but cannot vote unless the remaining members approve. The LLC then exercises its right to purchase the interest instead, ensuring business continuity."
Best Practice:
- Clearly state whether heirs receive voting rights or only profit distributions.
- Define the timeline for members to exercise the right of first refusal (e.g., 60 days).
3. Designating a Successor Member
Some LLCs allow members to pre-designate a successor who will inherit their membership interest. This can be a:
- Family member (e.g., child, spouse).
- Business partner or co-founder.
- Trust or estate representative.
This method ensures that ownership transitions smoothly and according to the deceased member’s wishes. However, the LLC may still require:
- Approval of the successor by a majority or supermajority vote.
- Restrictions on who qualifies as a successor (e.g., only family members).
Example
John, a co-founder of an LLC, designates his son as his successor. However, the Operating Agreement requires at least 75% approval from remaining members to admit a new member. When John passes, the LLC votes to approve his son, ensuring a seamless transition."
Best Practice:
- Include a successor approval process to prevent conflicts.
- Allow members to update successor designations as their circumstances change.
Legal GPS Pro
Protect your business with our complete legal subscription service, designed by top startup attorneys.
- ✅ Complete Legal Toolkit
- ✅ 100+ Editable Contracts
- ✅ Affordable Legal Guidance
- ✅ Custom Legal Status Report
Valuing a Deceased Member’s Ownership Interest
Determining the value of a deceased member’s stake is crucial for fair buyouts and avoiding disputes. Common valuation methods include:
1. Pre-Determined Valuation Methods
- Fixed Price – Members agree in advance on a set buyout price.
- Book Value – The value is based on the LLC’s financial statements at the time of death.
- Fair Market Value (FMV) – An independent appraiser determines the current market value.
- Earnings Multiplier – The LLC’s past revenue or profits are multiplied by an agreed factor (e.g., 3x net earnings).
Example
"An LLC Operating Agreement states that ownership stakes will be valued at 3 times the average net income of the last three years. When a member dies, an accountant calculates the valuation to determine the buyout price."
Best Practice:
- Use an independent valuation expert for neutrality.
- Update valuation terms periodically to reflect changes in the business.
2. Funding the Buyout
A buyout can place financial strain on the LLC if not planned properly. Common ways to fund a buyout include:
- Life Insurance Policy – The LLC takes out policies on members to fund buyouts.
- Installment Payments – The LLC buys out the interest over time, preserving cash flow.
- Reserves & Profits – The LLC uses its own retained earnings to fund the buyout.
Example
"An LLC with three members purchases life insurance policies on each owner. When one member dies, the policy payout covers the buyout, ensuring the business isn’t financially burdened."
Best Practice:
- Consider a cross-purchase agreement, where members buy policies on each other.
- Define buyout payment schedules (e.g., lump sum, 5-year installment).
Legal and Tax Considerations
When an LLC member passes away, there are important legal and tax implications that need to be addressed. Without proper planning, the transfer of ownership can result in delays, estate disputes, or unintended tax liabilities for both the LLC and the deceased member’s heirs.
1. Estate & Probate Issues
If an Operating Agreement does not specify how ownership interests are handled, the deceased member’s share may become part of their estate and go through probate. Probate can:
- Delay the transfer of ownership, potentially disrupting business operations.
- Introduce unintended heirs as LLC members.
- Complicate buyout negotiations, as estate executors may seek higher valuations.
Example
"An LLC member dies, and their ownership interest passes to their three children. Since the Operating Agreement is silent on succession rules, the LLC is now forced to deal with multiple new co-owners who have no business experience."
Best Practice:
- Include a clear succession plan in the Operating Agreement to avoid probate.
- Use a buy-sell agreement to ensure ownership stays within the business.
2. Tax Treatment of the Buyout
If an LLC buys out a deceased member’s interest, the transaction can have significant tax implications for both the LLC and the heirs.
Capital Gains & Taxation on Heirs
- When an heir inherits LLC ownership, their tax basis in the business is stepped up to fair market value, reducing capital gains tax if they later sell.
- If an heir sells their inherited LLC interest, they may owe capital gains tax on any appreciation beyond the stepped-up value.
Deductibility for the LLC
- If the LLC purchases the deceased member’s interest, the buyout is not deductible as a business expense (it’s a capital transaction).
- If the LLC uses installment payments, the seller’s estate may spread out taxable gains over multiple years.
Example
"A deceased member’s ownership is valued at $500,000. The LLC buys out the estate in five annual payments. Since this is an installment sale, the estate pays capital gains tax only on the portion received each year, reducing the immediate tax burden."
Best Practice:
- Consult a tax professional to structure the buyout in a tax-efficient manner.
- Consider using installment payments to reduce tax liabilities.
Sample LLC Operating Agreement Provisions
1. Buyout Clause for a Deceased Member
Sample Provision:
"Upon the death of a Member, the Company and/or the remaining Members shall have the option to purchase the deceased Member’s Interest. The purchase price shall be determined by [agreed valuation method], and the purchase shall be completed within [X] days of the Member’s passing. Payment shall be made in [lump sum/installments] over a period of [X] years."
2. Right of First Refusal for Heirs
Sample Provision:
"If a deceased Member’s ownership interest passes to their estate, the Company and/or remaining Members shall have the first right to purchase such Interest before it may be transferred to any third party. The purchase price shall be based on [fair market value/book value], and the Members shall have [X] days to exercise this right."
3. Successor Designation Provision
Sample Provision:
"Each Member may designate a successor who shall inherit their Membership Interest upon death, subject to approval by a vote of [X]% of the remaining Members. If no successor is designated, the interest shall be subject to the buyout provisions of this Agreement."
Conclusion
Planning for a member’s death is critical to maintaining business stability, preventing disputes, and ensuring smooth ownership transitions. Without clear provisions in an LLC Operating Agreement, the company may face legal, financial, and tax complications that could disrupt operations or force unintended ownership changes.
Key Takeaways:
- Define ownership transfer rules to prevent probate delays.
- Use a buy-sell agreement to structure a fair and enforceable buyout.
- Set valuation methods to avoid disputes over pricing.
- Consider tax implications to protect both the LLC and the heirs.
To ensure your LLC is protected, check out our customizable LLC Operating Agreement template with built-in provisions for succession planning.
Do I need a lawyer for an Operating Agreement?
The biggest question now is, "Do I need a lawyer for an Operating Agreement?” For most businesses and in most cases, you don't need a lawyer to start your business. Instead, many business owners rely on Legal GPS Pro to help with legal issues.
Legal GPS Pro is your All-In-One Legal Toolkit for Businesses. Developed by top startup attorneys, Pro gives you access to 100+ expertly crafted templates including operating agreements, NDAs, and service agreements, and an interactive platform. All designed to protect your company and set it up for lasting success.
Legal GPS Pro
Protect your business with our complete legal subscription service, designed by top startup attorneys.
- ✅ Complete Legal Toolkit
- ✅ 100+ Editable Contracts
- ✅ Affordable Legal Guidance
- ✅ Custom Legal Status Report
Tag-Along and Drag-Along Rights in an LLC: What They Are and Why They Matter
When an LLC owner decides to sell their interest in the company, it can create challenges for both majority and minority members. What happens if a...
What Are Considered Material Decisions in an LLC Operating Agreement?
Running an LLC involves countless decisions, but not all of them require approval from the entire membership. Material decisions are the high-impact...