Changing Ownership Interest in Your Company
Boy, has this issue come up a lot lately. I know you’re tired of hearing me say it, but this, like many other issues in your business, is not as simple as you think. Regardless of whether you are selling interest, giving it away, or allowing someone to work for your company in exchange for ownership, you’ll want to make sure you have proper documentation.
But first, a visual. Picture your company as a bucket. The bucket is full of your company assets – bank account, equipment, intellectual property. If you have more than one owner, picture marbles that represent each owner’s interest in the company. Owners often vote according to the number of marbles they have, and they get profits based on their marbles. Go with me on this.
Let me start this discussion by saying that when you register an LLC, and you list multiple members, the presumption is that each of those members is an equal owner in the company. That presumption can be trumped by an operating agreement, which is incredibly important. Incredibly. In “partnership divorces”, I often hear “well, they’re only a 5% owner so they shouldn’t have any say in the matter.” Then I ask “where does it say they’re only a 5% owner?” “Well, we agreed to that.” Unless it’s in writing, good luck proving it, especially in a scenario where the partners are already fighting. That minority owner suddenly becomes a majority problem and unless the ownership is spelled out in some written document, it’s almost impossible to prove how many of those marbles are yours.
As long as we’re talking about LLC registration, how’s about the Common Business Registration form on SilverFlume, Nevada’s online business registration resource. The original purpose of SilverFlume was simplify the business licensing process by providing a one-stop shop for any business to get completely licensed, from start to finish, without having to deal with multiple agencies. The CBR was supposed to serve as one form that contained all the information every business licensing department needed, so that each department could separately access that info and save you the time, hassle, and carpal tunnel of repeating the same information on multiple forms for different agencies. However, despite his best efforts, former Secretary of State Ross Miller was unable to convince all the local licensing bureaus to hop on board. Now, the CBR functions only as your company’s profile sheet that 1) isn’t a requirement when registering an entity on SilverFlume, 2) is something only you have access to, and 3) is ineffective in legally changing the ownership interest of your company. Your CBR has no bearing on your marbles.
If you want to change ownership in your company, the first thing you have to do is look to your governing documents (bylaws, shareholder agreement, operating agreement) for guidance. If drafted properly, these agreements will outline the steps you have to take to change ownership interest or reallocate the marbles. If you don’t have one, or if you have a crappy one downloaded from some random website (don’t get me started), then you’ll still want to make sure the action is properly documented. This should involve a vote from each of the owners, maybe held during a special meeting called for the occasion; written documentation of such a vote; and contracts by which the ownership interest is sold to/bought by/given to/otherwise transferred.
About selling interest (marbles) in the company: Anytime, and I mean ANYTIME, you are selling ownership interest in your company, it’s a transaction that involves a security. (Each marble is a security.) Such transactions are subject to securities laws, which were developed after the stock market crash of 1929 and Great Depression to ensure vulnerable and unwitting buyers aren’t taken advantage of by wily and cunning snake-oil sellers. Though most of our clients are selling interest in their fledgling companies simply to raise money or to help with cash flow, anytime the buyer of that interest isn’t going to be an active participant in the company, you need to be mindful of securities laws. This is a complex area of the law, on both a state and federal level, with very steep penalties for noncompliance. Because it’s so specialized, we collaborate with securities attorneys to ensure no one goes to prison. (Not exaggerating).
Let’s say you’re selling interest to someone who will be actively working in the company: You’ll want to make sure you have documentation to follow those marbles from one person to another, or whatever the case may be. I recently got a call from someone who had arbitrarily changed ownership interest in his company in various registrations that had no legal bearing on actual ownership, so I am working to help him properly document the history.
In short, selling interest in a company is a bit of a minefield. Or a game of jacks that I never did learn how to play. Make sure you have the proper tax and legal advice before you take any steps or move any marbles and definitely make sure you get it all in writing.