How to Sell Part of a Business Partnership

How to Sell Part of a Business Partnership

This month we are looking at partnership agreements. We are doing our best to make sure these concepts are not scary for you. We want you to be a part of your partnership agreement and make sure your voice gets heard in these major business decisions.

To review what key concepts we’ve reviewed so far, we recommend you check out this post.

Today we are diving into voluntary transfers. While they sound simple, there is a lot that goes into them.

The voluntary transfer you’re most likely to encounter is the sale to a third party:

Let’s say somebody comes in and is interested in buying a portion of the business or buying the partner out of the business. This would mean a change in both management and ownership of the business. Thus, all partners would need to unanimously agree to this transfer.

Let’s take a look at an example of a four-person partnership. Partner A wants to retire and live on a beach in Bali (congrats to him). “A” wants to sell his partnership share to a new third party. The third party offers a price and terms. The departing partner must advise their partners, who then in return have the opportunity to match or beat the offer on the table.

Thanks to the concept of pick-your-partner, partners have a right to refuse the sale. Often times partners don’t want to have to deal with a new guy coming in, unless they are already known and trusted. So if the other partners reject the new guy, often the new partners must buy-out Partner A who wants out.

If the partners decide that they don’t want to buy out the shares, then the sale to the third party goes forward according to the deal, and the new party comes in with all rights and obligations of being an owner/partner. Often the partnership agreement needs revisions at this point.

If the partners decide that they do want to buy out, then shares can be purchased by one sole partner, or be divided up amongst multiple partners. At the end of the day, that doesn’t really matter. What matters the most is that the partnership remains intact.

Another scenario that could happen introduces another new concept: tag-along and drag-along rights:

Drag-along involves a controlling partner that owns 51% or more of the shares. If the controlling member wants to sell the controlling interest to a third party who has made a condition of the purchase that they get the entire business. The controlling interest partner must give notice to other partners. Other partners then have the chance to join in the sale at the same terms. If the other partners do not want to be involved in that deal, then they are required to meet or beat the price that is being offered to the controlling member in order to buy-out the controlling partner.

It becomes: you either sell your partnership share or you have to buy the controlling member out. Clearly, this kind of drag-along scheme does impact the minority owners who may not want to well. This puts a big burden on minority members who might not be in a position to purchase the controlling interest. Drag-along rights need to be written and managed in a fair way. If the deal is good enough then no one will care much, but attention needs to be paid to this topic should there be a controlling member.

Tag-along rights are a little different:

Typically when tagalong rights come into play, the controlling member has received an offer on the controlling member share. The offer is not contingent on getting everyone’s shares. Notice is given to other members, who can then “tagalong” with the sale and hope that the purchaser is willing to buy their shares as well. This is less onerous on the members than drag-along rights because they are not required to buy anything.

Drag-along and tag-along rights depend upon a third party purchase offer and they can get a little onerous on the minority members in terms of ownership of the company. If the partnership is going to have unequal ownership, then the partners should very much discuss drag-along and tag-along rights.

Having a well-written partnership agreement helps to prepare for cases where part of the business will be sold or transferred to a new partner. Have questions? Let us know, we’re happy to help.