Procedure for Transfer of Shares in a Private Company
Oct 07, 2022
Are you considering transferring ownership of your shares, leaving your private company, or seeking liquidity for retirement? As a shareholder in a private company, you can transfer stock to another person by written agreement. Whether you want a partial or full sale, this guide details how to transfer shares in a private company and highlights the limitations you might face.
What Rights Does a Shareholder Have to Move Shares?
All shareholders have the right to sell or transfer their shares, but a company’s by-laws or shareholder agreement may place restrictions on the process. Several court decisions have upheld the fundamental right of transferability. However, this does not mean this is an easy process or that you can sell the shares to anyone you would like.
Common restrictions that can limit your transfer options include:
- Right of first refusal on the sale
- Requiring the sale of shares back to the company
- Veto power over the buyer of the shares
Even if the company does not place restrictions on the transfer, private stock can generally only be sold to accredited investors or institutional investors, which further limits your potential buyer pool. Moreover, before the sale of private company stock, you typically must notify the company that you wish to sell the shares.
Steps for Initiating the Transfer of Shares
There are several steps to take before selling shares in a private company. These preliminary actions are part of the due diligence required to ensure the smooth transfer of shares.
- Confirm your shareholding and notify the company
Before beginning the gifting or sale of private company stock, confirm the number of shares you own and the amount you want to transfer. You can view your holding information in the stock certificate or the company’s capitalization table.
You may also be required to notify the company that you wish to transfer the shares you own. It may be a good idea to notify the company regardless of whether it is required, as they may communicate any restrictions they have for selling the shares, potentially help you locate an interested purchaser, or explain their share buyback program (if offered).
- Review articles, shareholder agreements, and by-laws
Your next step is to review company legal documents such as articles of association, operating or shareholder agreements, and by-laws to understand the share transfer process and any restrictions. Even if you have already spoken to the issuing company, it is important to review the documents yourself and make sure you agree with their interpretation. It may be helpful to consult an experienced attorney to confirm you understand the process and restrictions.
In most cases, operating agreements or shareholder agreements outline the procedure to transfer stock to another person. However, some companies have specific agreements between shareholders that regulate the sale and transfer of shares. These documents also contain procedures to be followed in case of a member’s death, divorce, bankruptcy, or retirement.
It’s essential to review shareholder agreements to identify the specific terms that dictate the conditions on how to transfer shares and how to transfer stock certificates. For instance, a right of first refusal (ROFR) provision gives priority to the company or existing members before considering outside buyers. Some agreements might explicitly prevent outside buyers from acquiring shares.
- Determine the price and find a buyer
Since private companies aren’t publicly traded, they lack a liquid market value. Therefore, you must determine the appropriate price for your stock and negotiate with your buyer directly. Coming up with a fair value also applies when you are gifting shares, as the value impacts capital gains tax. You must agree on a realistic valuation before the transfer to comply with IRS rules. If there is no process to calculate the selling price in the shareholder agreement, you can estimate the price by comparing similar business valuations in the market or contacting a broker for an appraisal.
A broker may also assist with locating a buyer for your shares and determining a market value of your ownership. In addition to a broker’s network and selling the shares back to the company itself, current employees of the company are an alternative source of potential buyers.
- Confirm the eligibility of the purchaser and company approval
Your next step in the process should be to confirm your buyer meets all eligibility requirements from the company and federal law. Follow your company’s process for receiving the necessary approvals for your share transfer to occur. Before beginning the transfer of shares, it’s essential to seek approval and determine any objections as soon as possible. The earlier in the process you learn about potential issues or requirements, the smoother the transaction will be.
Procedure for Transfer of Shares in a Private Company
After confirming your ownership records and following the process above to initiate the transfer, you’re ready to execute the transfer.
- Draft buy-sell agreement
If no buy-sell agreement exists, proceed to draft one. A qualified lawyer can help you negotiate and draft the buy-sell agreement.
A buy-sell or stock transfer agreement outlines all the terms and conditions of the transfer. The buyer and seller must sign the agreement. After that, the buyer must file a declaration consenting to the company’s terms, indicating they will comply with shareholder agreements and internal rules and regulations.
- Fill out the share transfer form
Once the transfer is approved, you can fill out the share transfer form. It is a crucial document in the transfer process, which outlines the particulars of the sale. Fill in details on the type and amount of shares transferred and the sale price. After confirming all details are correct, sign and date the form. Once the form is complete, the company directors sign the form to authorize the transaction.
- Issue a new certificate
Finally, the company issues a new share certificate reflecting the changes and outlining the new shareholders and their ownership. Consequently, the company must submit the new details to the state records office. These ownership changes must also be updated in the articles of association or operating agreement.
Limitations for Transferring Shares
The sale or gifting of shares in a private company is generally unrestricted. However, in some instances, company and state laws might impose certain restrictions that may impact your sale. Some of the standard limitations may include:
Right of first refusal (ROFR)
A ROFR gives the company or remaining shareholders the right to buy the seller’s shares at the same terms and price offered to the third party. Shareholder agreements may also include a tag-along that permits remaining shareholders to participate in the sale.
Company veto
A company, its board, or its shareholders may have the power to reject a sale to a particular third party.
Share buyback programs
A private company may offer a share buyback program that allows or even requires shareholders to sell their stock back to the company. These programs are often the easiest way to sell private company shares, but they may not result in the largest proceeds available to the seller.
Federal security regulations
According to Securities and Exchange Commission (SEC) rules, only institutional and accredited investors can typically invest in private companies. Therefore, before selling your shares, you should verify that the purchaser is an accredited or institutional investor. Also, ensure you satisfy the SEC’s standard holding period for restricted securities, usually one year, before transferring shares.
State restrictions
Some states may restrict share transfers in certain companies. For example, in Virginia, companies offering professional services in engineering, surveying, architecture, and landscaping may have share transfers denied if the transfer leaves duly licensed individuals or business entities owning less than two-thirds of the remaining shares. Make sure to consult with an attorney to confirm your transaction meets all state and federal laws.
A Successful Transfer of Shares
Understanding the potential restrictions put in place for your transaction is one of the most critical steps in the share transfer process. Perhaps equally important is finding a buyer who can meet any limitations and provide you with an acceptable valuation for your shares.
Engaging a qualified lawyer to assist in negotiations, drafting a buy-sell agreement, completing the transfer, and confirming compliance with federal and state security laws will help ensure your transaction is completed successfully and efficiently. Although the transfer of shares in a private company can be a complex process, with proper planning and an understanding of how to transfer shares, your transaction will likely be successful and provide you with the liquidity you desire.