October 27th, 2020
October 27th, 2020
Rating
5 - 2 votes
Owning, or being part of, a business can be great. Having a piece of the pie in any successful business, whether that means full ownership or just owning some interest, can be very financially rewarding. What happens, though, when you decide that you're ready to sell, or transfer, your ownership?
There are many different ways to transfer ownership interest in a business - and that's mainly because there are several different business model! Choosing the best legal structure for your business may be the first hurdle in owning a business, but if you've already owned one for several years and are ready to sell, what should you do?
In this guide, we'll cover several different ways to transfer the legal ownership of a business, depending on what type of business it is. Here, we'll walk you through some things to think about when deciding to let go of your ownership interest.
Please note though, this guide is for informational purposes only and shouldn't be construed as legal advice. Also keep in mind the laws on transfer of business ownership may be different in your state, so you should always check with a licensed attorney to get the best advice for you.
"Interest" in a business simply means a percentage of the ownership. Interest is different across different business models. For example, in a corporation, interest is stock. In a Limited Liability Company, or LLC, interest is just a piece of the business. In a sole proprietorship, which is just one person operating as a business, interest is the whole ownership of the company.
In this guide, we'll mention "valuation" a few different times. Valuation just means the financial value of the ownership interest at the time of sale - in other words, what the interest is worth! No sale can go forward without both parties knowing exactly what they're selling, which is why valuation is such an important concept in the transfer of business ownership.
A sole proprietorship is the least formal business structure. A sole proprietorship is, as mentioned above, just one person acting as a business. More importantly, a sole proprietorship has no formal business structure (in other words, often no formal documents filed with the Secretary of State) and in practice that often means that there isn't a lot of paperwork.
The first step in transferring ownership of a sole proprietorship is to ensure that the sole proprietor has kept their personal assets and liabilities separate from the assets and liabilities of the business. This may not always be the case because many individuals choose a sole proprietorship exclusively because the structure is a lot more relaxed than other business forms. However, any buyer will want to ensure that they can properly value the assets of the business and therefore keeping them separate is critical.
If the sole proprietor has kept the assets and liabilities of their business separate, the next step in this sale will be to get a proper valuation on these from a neutral third-party. A valuation, as noted above, is just a fancy way of saying that the buyer and the seller can properly figure out how much the sole proprietorship is worth by adding up all of the assets and subtracting all of the liabilities. Importantly here, valuation will be both of physical assets, called tangible assets, and non-physical assets called intangible assets. Physical assets are things like any office space for desks or equipment, perhaps computers, or anything else that can be seen and touched. Non-physical assets, or intangible assets, are things like the goodwill of the business, which means how consumers feel about the business, the brand name (if there is one), and anything that can't be seen or touched that adds value to the business. Liabilities are things that subtract value from the business, like perhaps credit card debt or a small business loan, or maybe ongoing financial liabilities, like a lease.
After the business is fully valued, the parties will need to agree on a price. With a sole proprietorship, even after a valuation, this is a little bit more difficult than with other business forms, but a good valuation can really help. Once the parties have agreed on a purchase price of the business, generally a written agreement will be involved to ensure both of the parties know exactly what to expect and what is being transferred over in terms of the sale.
After the written agreement is signed, the seller will need to ensure that everything the buyer needs to run the business is properly handed over. This might include things like software licenses or a vehicle, etc. Importantly, the government documents and identification that are specific to the original business owner, like a tax ID or any business licenses, are generally not transferable in a sole proprietorship because the individual is the business. Therefore, the individual that sold the business will have to stop using anything like that and the new owner will have to get tax IDs and business licenses in their own name.
Things to take into account when transferring ownership of a sole proprietorship:
1. Keep assets and liabilities separate.
2. Obtain a valuation.
3. Execute a written agreement.
Transferring ownership of a partnership depends on what type of interest is being transferred. Partnerships can have two forms: general and limited. A general partnership is generally what people think of when they think of a partnership: it involves two or more partners that have equal say, duties, and responsibilities in running the business and they share equally in the profits and losses, as well. A limited partnership is a type of partnership where there are some general partners but then there are also some limited partners who are only involved in terms of their financial investment. Limited partners don't have anything to do with the day-to-day running of the business.
Most often, the Partnership Agreement will describe exactly how the partnership interest may be transferred. In other words, there are no general state laws governing transfer of ownership in a partnership and this is something that the parties will decide beforehand, at the start of the partnership, when they're drafting the Partnership Agreement. The most common provision in a Partnership Agreement about the transfer of ownership interest will often say that the party wishing to sell must offer their ownership interest to the other partner or partners first before selling to an outside party. For a limited partner, the sale is often a little bit easier because they are only involved to the extent of their financial contribution. Therefore, limited partners are usually able to sell without as many restrictions - but again, the Partnership Agreement controls.
A general partner selling their interests will undergo the same sort of valuation process as in a sole proprietorship. The Partnership Agreement may cover exactly how the interest should be valued, or it may not. The parties may need to default to a neutral, third-party valuation expert.
Once the ownership interest has been valued, it can be sold to the buyer. For a limited partner, as noted above, often the transfer is slightly easier because of the limited financial interest. That process most often involves just an easy valuation and sale.
No matter what type of partnership interest is sold, the Partnership Agreement will have to be amended to reflect the change in ownership. The buyer and seller of the interest may choose to finalize the sale through another document, as well, specific to the sale of interest.
Things to take into account when transferring ownership of a partnership:
1. Review the partnership agreement.
2. Obtain a valuation.
3. Decide whether to use an interest sale agreement.
4. Amend the partnership agreement.
Just like in a partnership, the terms of the Articles of Organization or LLC Operating Agreement (the two main governing documents of the LLC) will most often control exactly how (and if) the LLC interest can be transferred.
For a single-member LLC the practice of sale is very similar to that of a sole proprietorship. The reason for that is because in a single-member LLC, although this structure is generally more formalized than a sole proprietorship, very often the sole LLC member only has the assets and liabilities of the business to be concerned with. As in a sole proprietorship, any potential buyer would want to get a valuation on those assets and liabilities before purchase and ensure that the assets and liabilities have been kept separate.
To complete the purchase, a Business Sale Agreement can be used, along with LLC Membership Interest Assignment. These documents evidence the sale and the change in ownership.
After the purchase goes through, the documents filed with the Secretary of State, such as the Articles of Organization, may need to be changed.
Transferring ownership in a multi-member LLC is different based on whether the entire LLC is being sold or just one member is transferring their interest.
If just one member is transferring their interest, usually the Articles of Organization or LLC Operating Agreement will govern exactly how the transfer needs to happen. LLC members own parts of the LLC, which together add up to 100% ownership interest. One of the LLC documents will usually state that for any member that wants to transfer their interest, they must offer it first to the other members, called a "right of first refusal."
A valuation may be needed if there is no information contained within the LLC documents on how to value the member interest for sale.
Even if one of the LLC documents does not contain a provision requiring the first refusal, it will usually cover any other conditions required for an interest transfer. The documents might offer restrictions on who can become a new member or how any sale of interest is approved.
If all of the LLC documents are entirely silent on how to transfer interest, individual state laws will apply. Usually, membership interest can be sold through an LLC Membership Purchase Agreement and then the buying party becomes a new member.
The Articles of Organization and LLC Operating Agreement may need to be amended.
For a multi-member LLC that wishes to sell the entire business, a Business Sale Agreement would be used. A valuation would need to be obtained for the whole of the business, instead of just one part, and the assets and liabilities would be transferred over, rather than just a percentage of the interest. In these cases, generally all LLC members need to consent.
Things to take into account when transferring ownership of an LLC:
1. Review the LLC Operating Agreement and/or Articles of Organization.
2. Obtain a valuation, if needed.
3. Execute the proper sale documents.
4. Amend the Articles of Organization and LLC Operating Agreement, if needed.
A C Corporation is that which most people think of when they think of corporations - the big businesses of America. In these types of business, transferring ownership is usually the easiest of all organized businesses, even though they are often the biggest and most complicated structures. The reason is that ownership in a C Corporation lies with the shareholders, also known as stockholders. These are individuals that are given stocks, or shares, in exchange for a piece of the ownership of the company.
To transfer ownership of a C Corporation, all that is needed is a sale of stock. Since C Corporations are such big business, they usually have free buying and selling of shares. Sometimes, the Shareholder Agreement or the Corporate Bylaws will restrict how the shares can be sold: for example, they may need to be offered to existing shareholders first. If that's the case, then the terms of the Shareholder Agreement will control and any new shareholder, if a new one comes in, will need to execute and abide by that Shareholder Agreement, as well.
A Share Sale and Purchase Agreement might also be used, depending on the parties. Shares are usually valued by their current market-value for C Corporations, meaning what they are currently going for on the open market, and they are "transferred," with the transfer of Stock Certificates, which are hard copy documents evidencing who owns the stock.
One thing to consider is that there may be different classes of stock, that come with different voting privileges. The buyer will need to ensure they are buying the appropriate class of stock for their needs, if it is applicable.
Things to take into account when transferring ownership of a C Corporation:
1. Find a buyer.
2. Execute a Share Sale and Purchase Agreement, if needed.
3. Transfer the stock certificates.
An S Corporation is similar to a C corporation in that there are shares, or stocks, but these are often "closely held," meaning that only a small group of pre-determined individuals can hold stock in the S Corporation. Because of this, there tend to be more restrictions on the sale of stock here than in a C Corporation.
The Corporate Bylaws or Shareholder Agreement might restrict what types of individuals can hold shares or whether businesses can hold shares, or even sometimes whether anyone outside of a family can. Therefore, one of these two agreements must be checked before any sale of S Corporation stock can be made.
If the Corporate Bylaws or Shareholder Agreement say that the prospective sale is permitted, then the stock will need to be valued, generally by a third-party, often with the assistance of an attorney. If the buyer and seller both decide to proceed with the purchase, a Share Sale and Purchase Agreement can be used to finalize the terms.
Finally, the S Corporation should ensure its books are updated to reflect the new ownership.
Things to take into account when transferring ownership of an S Corporation:
1. Ensure the sale is permitted under the Corporate Bylaws or Shareholder Agreement.
2. Have the stock valued.
3. Execute a Share Sale and Purchase Agreement.
4. Transfer the stock certificate, if any.
The many different structures available to business owners mean that there are many different ways to transfer ownership interest - which is often a benefit to owners! Most transfers of ownership, as noted above, require valuations and written agreements. It's important to keep in mind that the details of the transaction should always be clear between the person giving up their interest and the person obtaining it. Besides that, a licensed attorney in your state can help you with any business ownership interest transfers.
Things to take into account for all transfers of ownership interest:
1. Ensure the business documents permit the transfer.
2. Obtain a valuation, if needed.
3. Utilize the relevant written agreement for the sale.
About the Author: Anjali Nowakowski is a Legal Templates Programmer at Wonder.Legal and is based in the U.S.A.