Considering Transferability of Ownership Interest When Choosing a Business Type

Sole Proprietorship

A sole proprietor transfers ownership of the business by transferring the assets of the business to the new owner. The prior proprietorship is terminated and a new proprietorship is established under the new owner.

Partnership

The transfer of a partner’s economic interest in a partnership is determined by the partnership agreement, or by statute if there is no partnership agreement. No person may become a partner without the consent of all of the partners. If a partner attempts to transfer his or her interest in the partnership without such an agreement, the transferee does not become a partner but instead becomes entitled to receive the profits which the transferring partner otherwise would receive. A properly drawn partnership agreement will address the conditions under which an ownership interest may be transferred, and the consequences to the transferee and to the partnership.

Corporation

Ownership in a corporation is transferred by sale of stock. A change in ownership does not affect the existence of the corporate entity. Technically, shares of stock in a corporation are freely transferable. As a practical matter, however, the market may be limited for shares of stock in a small corporation that is not publicly traded. In addition, shareholders in a new venture often will want to prevent unrestricted transfer of shares and thus may provide in the articles of incorporation or bylaws for transfer restrictions or buy-sell and redemption agreements, further limiting transferability. In an S corporation, shares of stock are also freely transferable, in theory. The S corporation election may be inadvertently terminated if the entity to which the shares are transferred does not qualify as an S corporation shareholder.

Limited Liability Company

Under Minnesota’s LLC act, chapter 322C, a member’s economic stake is a “transferable interest”: the right to receive distributions from the company (Minn. Stat. § 322C.0102, subd. 28). A member may transfer a transferable interest, and the transferee then has the right to receive the distributions to which the transferor would otherwise be entitled (Minn. Stat. § 322C.0502). The transfer does not by itself make the transferee a member, entitle the transferee to participate in the management or conduct of the company’s activities, or give the transferee access to company records. A transferee becomes a member, with voting and management rights, only as provided in the operating agreement or with the consent of all the members (Minn. Stat. § 322C.0401, subd. 4). The operating agreement, not the articles of organization, is the governing instrument on these questions, and it may restrict transfer: a transfer made in violation of a restriction in the operating agreement is ineffective as to a person with notice of the restriction.

CREDITS: This is an excerpt from A Guide to Starting a Business in Minnesota, provided by the Minnesota Department of Employment and Economic Development, Small Business Assistance Office, Twenty-eighth Edition, January 2010, written by Charles A. Schaffer, Madeline Harris, and Mark Simmer. Copies are available without charge from the Minnesota Department of Employment and Economic Development, Small Business Assistance Office.

This is also part of a series of articles on How to Pick the Right Business Entity Type. These articles help you select the right business type for your circumstances.