Determining whether someone is a person with whom you would want to build a business and create a business partnership is a critical decision that can affect your life for many years to come. As such, it is reasonable to want to restrict the rights of partners or members in a startup company to sell off their interest to someone else without the approval of the other owner or owners. Transfer restrictions can help create duties and responsibilities related to passing an interest in a business to someone else. For more information on adding transfer restrictions to a business partnership or operating agreement, consider contacting an Arizona business attorney with Harrison Law, PLLC by calling (480) 320-2310 and scheduling a consultation to discuss your business needs.
LLC and Partnership Overview
The office of the Arizona Secretary of State is responsible for limited partnership registrations in the state. Limited partnerships are business structures of two or more people that include at least one general partner and at least one limited partner. Limited partnership is a legal designation that requires filing with the Arizona Secretary of State office.
In contrast, the Arizona Corporation Commission oversees limited liability companies in the state. To establish this form of business entity, you must submit Articles of Organization to the Arizona Corporation Commission. If the submitted articles meet statutory requirements, the Arizona Corporation Commission approves them for filing. In addition to these required Articles of Organization, members may optionally enter into operating agreements to establish the specific rules and responsibilities among each other.
What Is Transferability in a Partnership?
In a business partnership, transferability refers to the conditions under which a business partner may relinquish their ownership rights to someone else, thus “transferring” their share in the ownership of the company to that individual or entity. The interest transferred represents their share of profits and losses, voting rights, managerial duties, financial responsibilities, and other duties and responsibilities related to their ownership share in the business.
Whether or not a partnership interest can be transferred depends on the language included in the partnership agreement. In some situations, when a partnership interest is transferred, the original partnership may be dissolved, and a new one may need to be created.
What Is a Transfer Restriction?
A transfer restriction prohibits the transfer of a partner’s or member’s ownership interest. Transfer restrictions may prevent an owner from selling or giving away their ownership interest. Such restrictions may also set out requirements that a co-owner must give advance notice of the intent to leave the business, receive permission from a certain number or percentage of other owners before selling their interest, or follow certain directions about how to transfer ownership.
Transfer restrictions may also require that the owner give the other owners the chance to purchase their share of the business before selling to someone else. Additionally, transfer restrictions themselves may be limited by exceptions, such as allowing the transfer to closely-related people.
Importance of Transfer Restrictions
Business owners are typically very selective about their choice in partners. In many cases, business partners must work closely together in pursuit of shared goals. Therefore, it is important that they have personalities that can work well together, skillsets that complement each other, and communication styles that allow the business to operate in an efficient manner. Without a transfer restriction, business owners are typically able to freely sell or transfer their business interest to anyone they choose, regardless of how the other co-owners of the business may perceive the arrangement. This can mean that business owners can be tied to a complete stranger, without their consent.
In addition to limiting the conditions under which interest in a business may be sold, depending on how the operating agreement is written transfer restrictions can help to put a clear plan in place in the event that any of the business owners should become disabled, retires, divorces, goes bankrupt, or passes away. An experienced business lawyer with Harrison Law, PLLC can help create transfer restrictions in business agreements that clearly set out guidelines for these types of situations.
Common Types of Transfer Restrictions
There are several types of transfer restrictions that are common in business operating agreements. Some of these may include:
Complete Prohibition on Transfers
Some business agreements may state that business owners are not permitted to sell or otherwise transfer their ownership at all. This type of restriction may be more likely to appear in agreements for businesses in their early stages that require the original business structure to remain intact. Prohibitions of this type often have a time limit after which they expire.
Right of First Refusal
A right of first refusal provision requires that a business owner who has received an offer to purchase their interest in a company first give the other owner(s) the opportunity to buy their share of the business. If the other business owner or owners refuse to purchase the shares, the departing business owner can then offer their share to others.
Right of First Offer
If a business owner has decided to sell their interest in the company, they must give the other partners or members the opportunity to make the first offer for that interest. If the co-owner or co-owners pass, then the selling owner is free to solicit offers from a third party.
Buy-Sell Provisions
Buy-sell provisions may include additional provisions regarding transfers and when an ownership interest can be transferred. These provisions may state that ownership can be transferred if a business owner:
- Dies
- Becomes incapacitated
- Divorces
- Files bankruptcy
- Quits
- Gets fired
- Undergoes a change of control
These provisions can also arise if the business owners disagree about how to operate the business. Additionally, they may also identify the process to determine the value of the business interest.
Mandatory Purchase Of Stock
Another transfer provision that may apply is a requirement for the company to purchase the departing owner’s stock. This is usually only required if the departing owner attempts to sell their stock to a third party and the company denies the sale. This type of provision can give offer departing owners an exit strategy.
Drag-Along Rights
Drag-along rights mean that a certain percentage of the ownership interests are sold, which forces the remaining owners to sell their interests to a third party. This usually occurs when the whole company is sold. For example, if three partners equally own a business valued at $1.5 million and two of them negotiate a sale to a third party for this amount, this provision could require the remaining owner to sell their ownership interests for $500,000.
Tag-Along Rights
Tag-along rights are the opposite of drag-along rights and protect the interests of minority members. They require that if an owner sells their ownership in the business, each of the other owners must be able to participate in the sale and sell their interests on the same terms. If the buyer does not wish to purchase the full ownership of the business, the buyer purchases the shares on a pro rata basis.
Contact a Skilled Lawyer for Help
If you have any questions or concerns about transfer restrictions, an experienced business law attorney from Harrison Law, PLLC can help. We can review your circumstances, discuss your preferences regarding transfer restrictions, and draft provisions that meet your needs. Consider contacting us today by calling (480) 320-2310.
© 2023 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved
This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.
