How to Sell or Transfer an Interest in an LLC to a New Owner
Under most state LLC laws, an LLC owner is called a member, and an ownership interest in an LLC is called a membership interest. Although there are default laws that govern transfers of membership interests, most states allow an LLC’s members to decide how ownership interests in a company can be transferred. Members establish the rules for interest transfers by including transfer provisions in an LLC’s operating agreement (also called a company agreement).
Transferring Limited Liability Company Interests
An ownership interest in an LLC typically includes both economic rights (often called a transferable interest) and membership rights. A transferable interest consists of the interest holder’s right to participate in the allocation of profits and losses and to receive distributions from the LLC. Rights of a member allow the member to be involved in the company’s management and internal affairs—such as by voting on important matters.
This distinction allows an LLC owner to transfer his or her economic rights without necessarily transferring the owner’s status and rights as a member. LLC operating agreements and state laws often have different rules for transfers of economic interests and transfers of membership status. In most cases, a transferee acquires full membership rights only after being admitted as a member with all other members’ consent under the operating agreement’s terms.
LLC interest transfers may occur as part of another transaction. For example, a relocation of an LLC to a new legal home state (a process called LLC domestication or conversion) sometimes involves transfers of membership interests. An LLC domestication is a statutory procedure that requires careful planning and creation of different documents than an ordinary interest transfer.
Documents Created for LLC Interest Transfers
A member who decides to sell or transfer an LLC interest must carry out the transaction in compliance with state law and with the LLC’s operating agreement. Sales and transfers involve several key documents that establish the terms and conditions of an interest transfer:
An assignment of an LLC interest is a document that declares that the current member is transferring an LLC interest to the transferee. An assignment should specify which rights are being transferred (e.g., all rights or just economic rights). And it should observe the operating agreement’s conditions, requirements, or limitations on transfers. A member can deliver an assignment (sometimes titled assignment and assumption) that transfers some or all of the member’s interest.
An LLC joinder agreement is a document that officially adds a new member to the LLC. A joinder agreement is needed when the person who receives an LLC interest is becoming an actual member with membership rights—not just a transferee with economic rights. A transferee or purchaser who signs a joinder agreement acknowledges that the LLC has an operating agreement and agrees to be bound by the operating agreement’s terms.
A purchaser or transferee must be officially approved as a member in compliance with the LLC’s operating agreement before joining the company as a member. A joinder agreement is not ordinarily needed when a purchaser receives an economic interest only and does not receive rights as a member.
A purchase agreement is a contract between an existing LLC member (as seller) and a purchaser acquiring the member’s interest in the company. A purchase agreement sets forth the terms and conditions of the sale and may include warranties from the seller and the purchaser. A seller often agrees within the purchase agreement to deliver an assignment and a joinder agreement as a term of the sale.
A charging order is a document entered by a court and is not created by the LLC’s members. Members who wish to voluntarily transfer an LLC interest to a creditor typically use an assignment.
Transfer Restrictions in Operating Agreements
Operating agreements can (and often do) place restrictions on members’ right to sell or transfer interests in the company. Transfer restrictions define when, how, and to whom interests may be transferred. The limitations protect other members and avoid a situation where business owners lose control of their company.
There are a variety of ways an operating agreement can limit sales or transfers—such as:
- Prohibition on transfer. An operating agreement can completely prohibit sales and transfers unless all other members (or a percentage of other members) provide their written approval of the terms of the transfer.
- Prohibition on harmful transfers. An operating agreement can prohibit transfers that cause harm to other members or to the company—such as transfers that change an LLC’s tax classification or impair other members’ right to manage the business.
- Limitation on transferees. An operating agreement can allow members to make transfers only to certain classes of transferees—such as other members or transferees who are closely related to the member (such as immediate family or affiliated entities).
- Right of first refusal. An operating agreement can guarantee other members the right to match a purchase offer received from a potential third-party buyer.
- Right of first offer. An operating agreement can require a member to give other members the right to purchase the interest before it is offered for sale to third parties.
- Buy-sell provisions. An operating agreement can include buy-sell provisions that require or allow other members or the LLC to purchase a member’s interest upon the happening of certain events—such as retirement, death, or divorce. Buy-sell provisions often include a precise method or formula for establishing the sale price for a member’s interest.
Members can tailor their operating agreement to their specific situation and objectives. When a transfer occurs, it is important that the transfer terms and documents comply with the LLC’s operating agreement, formation document, and with state law.