Before purchasing an equity interest in a limited liability company (an “LLC”), minority investors should closely review the LLC’s operating agreement and other constituent documents.  These documents govern the relationship and economic rights among the members of the LLC.  While operating agreements may be long and cumbersome (and it is important for your counsel to review the agreement in its entirety for any potential traps that lay in the agreement), below are three of the top areas that a minority investor should focus on when conducting his/her review.*

• Economics. Similar to our discussion on Top Three Business Concerns for Minority Investors Investing in Early-Stage Companies, it is critical for minority investors to understand how the economics of the LLC flow through the company’s documents.  Investors are typically well versed in creating models to determine what their expected return might be in various exit scenarios and how their (or other investors’) distributions might be impacted by the size of the exit.  However, as usual, the devil is in the details.  If one were just to focus on the waterfall in the distribution section of an operating agreement, one could easily overlook how certain company actions or consent rights could impact the otherwise expected return.  For example, without safeguards in place surrounding consent rights, companies can become overburdened by debt (the repayment of which could preempt payment of future distributions).  That is why savvy counsel know the importance of reviewing the company's borrowing regime, and considering whether any cap on the size of the permitted loans should be imposed or whether there are other needed protections relating to company debt.  Additionally, most investors are aware of the various scenarios in which their interests may be diluted (i.e., their ownership percentage in the company being reduced), but the ways in which that dilution is calculated can vary wildly (and, accordingly, the impact thereon to the investor can vary wildly as well).  It is imperative that a minority investor’s counsel review the dilution provisions and suggest potential guardrails to protect the minority investor in instances of dilution.
• Minority Member Protections. Depending on the size of an investor’s investment and the leverage that he/she may have (which may vary based on the general economic environment, as well as the specific economic outlook for the company), a minority investor’s counsel can help negotiate the inclusion of various minority member protections.  Questions that should be considered include: do you get to appoint a manager?  Are there any decisions that require unanimous consent of the managers?  If not, are there any decisions that you expect a “consent” or “veto” right on (i.e., the LLC cannot take a specified action if you do not approve)?  Consideration must also be given to what actions require the consent of the members (as opposed to the managers) and what level of member consent must be obtained for those actions.  Minority investors commonly seek approval rights for significant actions (such as the sale or dissolution of the company or entering into a new line of business) and may seek additional approval rights based on specific business concerns relating to a potential target investment by the company.  Typically, minority investors also want to ensure that the founders, as well as the employees in general, are properly incentivized.  Since those individuals play a large part in the success (or failure) of the LLC, it is important to understand whether those individuals are issued membership interests entirely upfront, or if there is an equity incentive plan in place – as having a “stake in the game” through equity often serves as a significant incentive for those individuals to help the company succeed.  In that vein, it is important to closely review the details of the vesting schedules and the size of the membership interest issuances or awards in order to gain a sense of comfort about whether the relevant individuals are properly incentivized to stay with the company for a period of time (e.g., if a founder is at the start of a four year vesting schedule, the minority investor may gain a level of comfort that the founder is likely incentivized to stay for at least the next four years in order to fully realize the benefits of the issuance to him or her).   
• Exit. As important as it may be for the minority investor to get into the company (i.e., to become a member), it can be just as important for the minority investor to understand how they can get out of the company (i.e., to recover on their investment).  Investors in private companies are often subject to very tight restrictions on when they can sell their membership interests to third parties, if at all.  Accordingly, close attention must be paid to any transfer restrictions in the operative documents, such as any right of first refusal or right of first offer in favor of the company and/or other members that must be adhered to prior to the investor's being able to sell his/her shares to any third party.  That being said, operating agreements commonly exclude certain types of transfers from the transfer restrictions (such as “permitted transfers” in connection with estate planning).  It is important for your counsel to review those exceptions and, to the extent that you have leverage, see if any additional exceptions could be inserted.  Aside from seeking to soften some of the transfer restrictions that may be imposed on the minority investor’s membership interests, your counsel can help you come up with creative solutions to potentially allow you to achieve liquidity in other ways.  For example, a minority member may want to ask for a “redemption right” or “put right,” whereby the minority member can force the company to repurchase his/her membership interests in certain circumstances.  The details surrounding those rights, including the timing and calculation methodology for the purchase price, are often highly negotiated matters that your counsel can help you navigate.

*While this article only focuses on minority investments in LLCs, similar concerns arise when a minority investor is seeking to purchase an interest in a limited partnership or shares in a corporation.  As such, this article can be a useful starting point to help investors in limited partnerships and corporations to focus on “big ticket” items of concern up front, before making an investment in a company.