If you own a business with someone else, you already have a plan for what happens when one of you leaves. You may have written it yourselves in your operating agreement or shareholder agreement. If you didn’t, California wrote one for you, and in my experience it is rarely the plan either side would have chosen.
Owner exits are not edge cases. Founders burn out. Partners retire, relocate, get divorced, get sick, or simply want different things in year seven than they wanted in year one. Over more than a decade of advising founders and closely held companies, I have learned that the departure itself almost never destroys value. What destroys value is discovering, at the worst possible moment, that your documents are silent, vague, or written for a company you no longer are.
The California default: you can leave, but you may not get paid
Start with the rule that surprises LLC owners most. Under California’s LLC Act, a member has the power to withdraw at any time. But under the default rules, a voluntary withdrawal before the company winds up is treated as wrongful, and the departing member can be liable for the damages their departure causes.
Here is the part almost everyone misses. Unless the articles or a written operating agreement say otherwise, walking away does not entitle the departing member to be paid for their interest. They lose their vote and their role in management. They keep their economic interest only as a transferee, which means they receive distributions if and when the remaining owners decide to make them. If the departure was wrongful, the company can offset its damages against those distributions.
Think about what that means for both sides. The departing owner has capital locked in a company they no longer control, and if the LLC is taxed as a partnership, they may still be allocated taxable income without receiving cash to pay the tax. The remaining owners have a former partner who shares in every future distribution and every dollar of an eventual sale, indefinitely, while contributing nothing. Nobody wins that arrangement. A well drafted buyout provision is not just protection for the company. It is the door both sides need.
If you end up in court, the statute picks the price
When owners reach an impasse, the pressure valve is often a petition for judicial dissolution, which California permits when management is deadlocked or the business can no longer reasonably be carried on under the operating agreement. The other members can stop the dissolution by buying out the members who filed. The price is fair market value, set by three court appointed appraisers, measured as of the date the lawsuit was filed.
That phrase, fair market value, does real work. In Cheng v. Coastal L.B. Associates, the Court of Appeal affirmed a 27 percent minority discount on a 25 percent LLC interest in exactly this kind of buyout. Corporations are treated differently. A shareholder buyout in a corporate dissolution case is at fair value, built from liquidation value while accounting for a possible going concern sale, and courts have not permitted a minority discount.
So the same dispute, over the same business, can produce a materially different check depending on whether you formed an LLC or a corporation. A minority LLC member who files for dissolution to force a payout may be bought out at a discount, on a valuation date they did not strategically choose. The lesson is not to avoid LLCs. It is to decide your standard of value in the agreement, including whether discounts apply, how appraisers are selected, and what happens when appraisals diverge, before anyone has a reason to fight about it.
For venture backed startups: different documents, same problem
Most venture backed companies are Delaware corporations, and founder exits are governed less by a traditional buy sell agreement than by the financing document stack: the founder’s stock purchase agreement with vesting, the right of first refusal agreement, the voting agreement, and the bylaws.
Vesting does most of the work, but only for unvested shares. When a cofounder leaves, the company typically has the right to repurchase unvested stock at cost. Vested stock generally stays with the founder. A cofounder who leaves at month 30 of a four year schedule can walk out owning well over half of their original grant with no ongoing role. Investors call this dead equity, and a lead investor will either price it into your next round or ask you to clean it up before closing.
Three issues deserve attention at the moment of departure, not after.
The first is the board seat. Check whether your voting agreement ties a director seat to the CEO role or to a named founder. If it names the founder, they may keep the seat long after they stop working at the company.
The second is intellectual property. The most expensive founder departure problem I see is usually not equity. It is discovering that a technical cofounder never signed an effective invention assignment, or wrote core code before the company existed. The separation agreement is your last easy chance to fix that.
The third is tax. If the company buys back vested shares for cash, the redemption rules under Section 1202 can put qualified small business stock treatment at risk, and not only for the departing founder. Company repurchases above a 5 percent threshold within a two year window around a stock issuance can disqualify the stock issued in that window. There is an exception for repurchases tied to a bona fide termination of services, but it turns on the facts, so structure and time the buyback with your next financing in mind.
And if you and your cofounder each own exactly half of a Delaware corporation, know that Delaware law gives either 50 percent stockholder of a two stockholder joint venture a statutory path to seek dissolution when you cannot agree on whether to continue, unless your charter or a written agreement between you provides otherwise. Preserving or waiving that right should be a deliberate choice.
For midsize businesses: the price is only half the problem
In established companies, owners spend most of their negotiating energy on valuation. The buyouts I see actually fail usually fail on funding.
A company funded buyout is a distribution, and California’s statutory limits on distributions can prevent the company from paying even when the agreement says it must. Your senior lender’s credit agreement almost certainly restricts redemptions, so a mandatory buyout the bank will not permit is a promise you cannot keep. If the price will be paid over time, the note needs security, a clear subordination arrangement with the bank, and acceleration if the company is sold. And the departing owner will reasonably want a release from personal guarantees on the credit line and the lease, which the landlord and lender have no obligation to grant simply because your operating agreement says so.
Insurance funding deserves a fresh look as well. In Connelly v. United States, decided in June 2024, the Supreme Court held that when a corporation owns life insurance to fund the redemption of a deceased owner’s shares, the redemption obligation does not offset the insurance proceeds in valuing the company for federal estate tax. For owners whose estates may face estate tax, an entity redemption structure can increase the taxable value of the very shares being bought back. If your agreement relies on company owned insurance and predates that decision, review it with your estate planning and tax advisors. A cross purchase or another structure may now fit better.
If you are an S corporation, your transfer restrictions must keep shares away from ineligible shareholders, because a single transfer to the wrong owner can terminate the S election for everyone.
Not every exit should be priced the same
The most common drafting shortcut I see is a single buyout price that applies no matter why someone leaves. Death and disability are usually best handled as mandatory purchases at full value, ideally insured, so the family is paid and the business continues. A planned retirement with notice might justify full value paid over several years. An abrupt departure in year two might justify a longer payout or a modest discount. A departure following a material breach might justify a lower price still, though in California a financial penalty tied to competing with the company can run into the state’s strong restrictions on restraints of trade.
On that point, California generally voids noncompetes, but the statute carves out owners. An LLC member exiting the company, or an owner selling their entire interest, can agree not to compete within the area where the business operates. Those protections belong in the exit provisions of your governing documents, where they can be enforceable, rather than in an employment agreement, where they generally are not.
Divorce deserves its own provision in a community property state. Spousal consents, paired with a purchase option if an interest is awarded to a spouse, can keep a former spouse from becoming your newest owner.
Deadlock: choose your mechanism with open eyes
For 50/50 companies, the popular solution is a shotgun clause: one owner names a price, and the other must either buy or sell at that price. It is elegant on paper. In practice it favors the owner with more liquidity and the owner who runs daily operations and knows the numbers best. If one of you is the operator and the other is the capital, a shotgun may not be the fair mechanism it appears to be. Alternatives include defined escalation and mediation, a tiebreaking independent director for specified decisions, or put and call rights that open only after a cooling off period.
A quick stress test
Here is the exercise I suggest to every client with more than one owner. Assume your partner resigns tomorrow morning. Without opening a file, can you say who has the right to buy their interest, how the price is calculated and under what standard of value, where the money comes from and whether your lender will allow it, what happens to their board seat and personal guarantees, and how the transaction is taxed on both sides? If any answer is “we would figure it out,” the statute will figure it out for you, and you may not like its answer.
The Farukhi Law Takeaway
The best exit provisions are negotiated while everyone still likes each other, and revisited whenever the company changes: a new financing, a new lender, a new owner, a meaningful jump in value. At Farukhi Law, we help founders and business owners build operating agreements, shareholder agreements, and founder equity arrangements that work for the company you are today and the transitions you will eventually face. If you have not read your exit provisions in the last two years, now is a good time.
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This article is for general informational purposes only and does not constitute legal or tax advice. Reading it does not create an attorney client relationship.