The ABCs of LLC Ownership Transfers
An LLC Ownership Transfer is usually completed as part of another transactions such as the sale of the company’s assets, or the redemption of an owner’s interest. However, in some instances a member or partner may be requesting to sell their ownership interest to a third party unrelated to the LLC. In those transfers, the interests must be reviewed to determine if the buyer can be admitted as a member. Assuming that the buyer is unrelated to the LLC, the selling party must still review the terms of the operating agreement to determine if restrictions are placed on new purchasers of ownership interests. If the operating agreement states that new buyers can not be admitted, the selling party may have to agree to "transfer" their ownership internally, i.e., sell the interests to other members, prior to allowing the new buyer to step into the shoes of the seller. Further, all transfers of ownership interest must be on such terms and conditions as prescribed by the operating agreement and/or by the rules of the state of incorporation.
The specific language of the operating agreement of the LLC governs the transfer of ownership and usually follows the "right of first refusal" which allows the existing members of an LLC to have the first opportunity to purchase ownership interests that one of the members wish to transfer to a third party.
For example, the right of first refusal clause will require the seller to notify all of the remaining members of its intention to transfer its interest and the terms it plans to do so. All of the remaining members will have the option to "buyout" the interest from the seller or allow the transaction to go forward , subject to whatever terms are specified in the operating agreement. The purchase price is generally determined by an independent appraisal and the other members have a specified period of time to respond to the seller after notice of its intention to sell is provided. If they do not timely respond or perform to the terms and condition of the operating agreement, the seller will be free to transfer its interest to the third party in accordance with the terms of the proposed transaction.
If the operating agreement does not contain a right of first refusal provision, or the terms of the provision are silent with respect to valuation of the interest or time periods, it may be necessary for the parties to negotiate a legal and binding resolution as to how the transaction will be performed. In addition, it may be necessary to provide additional notice to the remaining members prior to transferring or selling the interest.
Note that more complex issues may arise when the seller is protected by a buyout/life insurance policy. If that occurs, there may be a conflict as to whether the buyout/life insurance provisions control or a right of first refusal or other operating provisions control, especially if applicable time limits are permissible to run under any of the provisions.
LLC ownership transfers may also occur in the context of divorce wherein the interest is awarded to the non-owning spouse by court order, or agreed and accepted in a property settlement or agreement. In either event, the operating agreement must be reviewed to determine if the non-owner spouse can be admitted to the LLC. The terms of the operating agreement, as well as the or court order or agreement should be reviewed by the parties to determine if other provisions of the operating agreement must be followed to allow the admission of the non-owner spouse.
What to Include in an LLC Ownership Transfer Agreement
An LLC ownership transfer agreement should include several key components for the successful transfer of interest. They are:
Agreement: The agreement should clearly name the parties involved and state the type of LLC (e.g., single member, family LLC, or corporation). Other details to include with the agreement are the location of the principal office, the expiration date of the LLC, and any other definitions applicable to the document.
Transfer of Interest: This is an important section that should state the percentage of interest the departing party is transferring and to whom it is being transferred. This may be to another member of the LLC or a non-member. Also, you should have the percentage remaining after the transfer is completed to define the new ownership structure of the LLC.
Monetary Consideration: Items that may be considered when deciding on the monetary value of the interest include the following:
Payment: The payment schedule for the monetary transfer should be clearly stated in the agreement. If there are multiple payments, it should explain the amount due, the due date, and what interest is being charged.
Immediately following the agreement, both parties should sign and date the document, much like they would with any other binding agreement.
The Types of Transfer Agreement Templates
An LLC ownership transfer agreement template is an agreement that will be needed when an LLC owner leaves the business. There are several situations where the occasion for a transfer agreement may arise. For example, the business may buy out one of its owners. An owner may want to sell their share of the business to the remaining owners or give it to them. A member may pass away and the membership interest will be transferred as a result. Each of these are instances when a transfer agreement template will be necessary.
Customizing a Transfer Agreement Template
A generic LLC ownership transfer agreement template is a great way to initiate the process of transferring membership interest in an LLC, but careful customization is essential to ensure that the final product meets your specific business needs. Regardless of what the document says, an LLC ownership transfer agreement must comply with state laws, company policies, and formalities. In the event there is ever a disagreement on how to interpret the terms of a generic LLC ownership transfer agreement template, the company will likely be held accountable to any state laws or internal company policies that may not be provided for in the document, so it is important to have them in mind as you consider the provisions of your transfer agreement.
Assuming there are no unusual provisions under state law governing transfers of membership in your state (consult an attorney licensed in your state for more information), the first step in customizing your membership interest transfer agreement template is to replace any language referring to "selling" or "selling out" membership interest. For the purposes of an LLC, "selling membership interest" is not likely to be an accurate characterization of the transaction because any transfer of membership interest in an LLC is without any promise or attempt to sell a product or service. An LLC ownership transfer could also refer to a gift or inheritance of membership interest. Use of the name of the transferring member and the company in Section 1 of the LLC ownership transfer agreement template shows the intent of the parties to transfer ownership interest in the company by gifting, selling or inheriting it.
Section 2 will identify the interest being transferred. This section will likely refer to the "membership interest" in the company. Be sure to research how ownership of the company is reflected in your company’s books and records, and insert those terms into Section 2 . Insert the membership interest percentage owned by the transferring member in Section 2 of the LLC ownership transfer agreement template, but do so in accordance with the company’s operating agreement. Section 2 may also refer to other terms used in the operating agreement to identify membership interest (i.e., "units," "full units" or "partial units").
Section 3 will refer to the "effective date" of the transfer. Section 3 can also provide for a vesting schedule if the parties do not want transferring membership interest to be owned equally by the transferee immediately upon the effective date of transfer.
Section 8 of the LLC ownership transfer agreement template outlines the general representations and warranties that are required of the transferor and transferee. Your operating agreement or other agreements between the parties may require additional representations and warranties, or you may want to add to or modify the representations and warranties in Section 8 of the generic LLC ownership transfer agreement template to suit your needs.
If the transferring member is to receive something in exchange for membership interest, Section 5 can be modified to reflect that. Be sure to use precise terms to avoid any ambiguity between the membership interest and the compensation offered for the transfer. Also, Section 5(M) of the LLC ownership transfer agreement template, and any other provision of the agreement that restricts the members’ future actions, insulates the company from having to address the issue of whether the transferring member has authority to relinquish membership interest for the purposes set forth in those provisions despite any potentially conflicting language set forth in the company’s operating agreement.
Once you have modified the generic LLC ownership transfer agreement template discussed above to reflect your own company’s needs, all that is left to do is to arrive at an agreement on the terms with the other transacting party and enter into the agreement.
Who’s Responsible and for What: Legal Implications
It’s not just a matter of signing an agreement and handing over the keys. Such a transfer would technically not be compliant with state LLC regulations, and non-compliance leaves parties vulnerable to liability. An ownership transfer can impact your LLC’s standing as an independent business entity, as well as affect the rights and responsibilities of other members and managers.
Most states require that resignation, additions and other membership changes be submitted to the state authorities in the form of an amendment. Generally, this is done by filing a new registration with the state Secretary of State’s office, and often a fee for processing and publication of the new Certificate of LLC is also required. The new Certificate includes facts about the company, such as its name and address, and its purpose, as well as details about the members and managers, their respective interests and contributions, and restrictions on the ability to transfer any interest in the future. If the LLC is not up do date on filing its taxes, or there are outstanding debts owed to state or federal agencies, the transfer may be held up until requirements are met or payments made.
Best Practices to Ensure Smooth Transfer
Efficient management of an LLC ownership transfer is paramount to maintaining operational integrity and shareholder trust. Every transfer of ownership interest requires careful oversight to ensure that all parties involved are not only on the same page, but also that they remain in agreement throughout the duration of the transfer process. The most important factor when handling a transfer of ownership interests within an LLC is to ensure that all potential stakeholders are promptly informed of all transactions that affect their investment. Any time someone attempts to alter the shareholder dynamic, both internal and external communication must take place to avoid any issues. This includes but is not limited to all interested parties, such as shareholders, executive staff, and the board of directors of corporations and associations. To maintain a cohesive relationship with stakeholders , it is best practice to require that the transferee provide notice to both the LLC board of directors and all limited partners, keep accurate records of such communications, and provide request fulfillment in a timely manner. Additionally, it is recommended that the transfer agreement be created and signed before any money or shares change hands. It is also best practice to have both parties and any other current or prospective owners notarize the agreement. A notarized document further protects the agreement and helps avoid potential fraud. Notarization, notification, and accurate recordkeeping are just a few ideas to consider when managing an LLC ownership transfer. These methods, when used effectively, promote effective communication, reduce the potential for mistakes or miscommunication, and ensure all parties are aware of all terms and conditions associated with the acquisition of membership interests.