Idaho Business Law how to Manage Transfers of an Owner's Interest in the Business

By Lane V. Erickson, Idaho Business Attorney

Whether it is a small family-owned business or any other type of small business operation, the owners of the business want to make sure they always know who they are in ownership with. In other words, you do not suddenly want to be an owner of a business with strangers. This may sound funny, but it actually happens all the time when the owners of the business have failed to put a good business plan in place that would control or manage the transfer of an owner’s interest in the business.

The purpose of today’s article is to describe how you can manage the transfer of an owner’s interest in the business especially when unforeseen events take place. Keep in mind that this article is just a short summary of the things that you should understand about how this actually works. If you are concerned about what could happen with your business, you should speak with a qualified business attorney who can answer your specific questions and help you with your particular business needs.

At Racine Olson, our team of Idaho business lawyers includes partners Lane Erickson, TJ Budge, and Nate Palmer and of-counsel attorney Dave Bagley. Our attorneys have decades of experience, knowledge, and skill in helping business clients deal with all of their business needs. We help move our client’s businesses forward successfully. This includes creating a plan that controls the transfer of the ownership interests in the business, especially when unforeseen events occur.

It may seem strange that there could be unintended transfers of an owner’s interest in a small business. However, this happens all the time. The main events that caused these unintended transfers would include things such as the death of an owner or an owner’s divorce. Additionally, the owner could also file a personal bankruptcy. While there are many more events that could also occur, these are the most common and will be the focus of today’s article.

A person’s ownership interest in a business is legal property that is owned by that person. It does not matter whether its shares in a corporation, or units in an LLC. The fact that that person has a recognized ownership interest in the business is all that is needed to evidence that this is the personal property of the owner.

If that person dies, their ownership interest becomes property that can be transferred through their estate plan, or if they do not have an estate plan then through the laws of intestacy. In other words, the ownership interest is much like a car or a home or a bank account. It is an item of intangible property that belongs to the owner who died.

For example, let’s say that there are three friends who decide to go into business together. Each of those friends owns a one-third interest in the business. If one of the owners dies and has a written Will that says that their “property” goes to their surviving spouse, or to their children, then that is who will “own” all of the decedent’s property, including the decedent’s one-third ownership interest in the business. So now, the two surviving friends are in business with the decedent’s spouse or children depending on who they gave their property to.

The same circumstances could be true in a divorce. If one of the three friends gets a divorce, it is possible that their spouse could receive all or a portion of that owner’s interest in the business through the divorce proceedings. Similarly, in a bankruptcy, the bankruptcy trustee would have the ability to become the new owner of the bankrupt partner’s interest in the business.

In any of these circumstances, without some protections being in place, these new owners would have the same rights as the original owner. This means they can vote, and they may have a right to manage the ongoing operations of the business.

So, what is it that business owners can do to protect themselves from these types of situations? They can use the business documents to control what happens when an owner’s interest is transferred to someone else through a triggering event such as death, divorce, or bankruptcy.

Bylaws are the documents that are used to control a regular corporation. In the bylaws, the owners have the ability to create a system or a plan on how the corporation will be managed, and how an ownership interest is handled. Specifically, in the bylaws there can be protective provisions providing a process or procedure that would kick in if one of the owners were to die, become divorced, or file bankruptcy.

The first thing that can happen is that the bylaws can control the actual ownership interest itself. In other words, even though the bylaws cannot stop the transfer from occurring through a death, divorce or bankruptcy, they can provide a right to the corporation or the other business owners to buy that ownership interest back so that they can control who actually owns an interest in the business. This includes setting the price and terms for the purchase of that ownership interest.

If the corporation and the other owners elect to not purchase that ownership interest, the bylaws can still help. They can state specifically that the new owner has a right to the ownership, but they do not have a right to vote, or manage the affairs or operations of the business. This is true even if that transferred ownership interest holds a majority of the ownership in the company.

An LLC is similar but the controlling document here is an operating agreement rather than bylaws. It is common for an operating agreement to set out specific provisions dealing with unexpected or unforeseen transfers of an ownership interest in the business such as death, divorce or bankruptcy. It is also common for the operating agreement to control what happens to those ownership interests if any of these events happen.

As described above, the terms of the operating agreement often give a right to the other owners or to the LLC itself to purchase the ownership interest after the unforeseen event occurs. Alternatively, the operating agreement can limit the control the recipient of the transferred ownership interest has in the ongoing operations of the LLC. In this way, the original owners can retain management and control of the business even when an unforeseen event causes a transfer of an ownership interest in the LLC.

If you hold part of an ownership interest in a corporation or an LLC in Idaho, and you are concerned about what may happen if one of your partners passes away, gets divorced, or files bankruptcy, we can help. As mentioned, this article is just a short summary of the rights that are available to the remaining owners if the proper clauses are in the business documents. We have helped numerous business owners come up with a plan that serves their business operations. If you have questions, we are confident that we can help you too!

Our team of Idaho business lawyers can help you with any of your business structure or operation needs. Whether you are seeking to create a new business or review a current business, we are available to discuss your options and answer your questions at an initial free 30-minute consultation. Call us toll free at 877-232-6101 or 208-232-6101 for a free consultation. You can also email us directly at lane@racineolson.com or stop by our office at 201 East Center Street, Pocatello, Idaho 83201. We will answer your questions and help you solve your Idaho business problems.