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Selling Corporate Shares - Be Careful

Posted on April 4, 2020 by Charles Varma

One of the touted benefits of having a company is the ease of transferring stocks. Oftentimes, this supposed benefit is simply incorrect.

Transfer Shares

According to"experts", employing a company has one bid edge over other entities. The benefit is the ability to transfer stocks without affecting the company or viability of their corporate structure. Consider the following example.

If I have a 60 percent interest in a general partnership, I can not just sell it to somebody else. In most states, the transport of over 50 percent of an interest in a venture automatically terminates it. With a company, however, there's absolutely no such prohibition.

Instead, I'm free to move shares without limitation and the company just purrs along with no interruption.

Like many assumptions, the"free transferability" assumption runs into problems in real life. This is particularly true when the corporation has entered into contracts with other big businesses.

Accidentally Terminating Contracts

State laws govern the creation and running of the majority of business entities. These laws, however, do not violate general contract law. Rather, deference is given to the conditions two or more parties agree upon in the creation of a contract and this is where the free transferability pros fall on their faces.

In our modern economy, the vast majority of companies will need language in a contract saying that any transfer of more than "xxx" percent of stocks automatically voids the contract between the parties. The cause of this is parties would like to know whom they're doing business with constantly. Assume I need to work with a company that has three engineers that are the very best in their field. I don't wish to signal a five-year contract together only to find the 3 engineers sell their shares and leave the business during the period of the contract. In requiring the speech restricting share transfers, I'm making sure I will gain from their expertise.

Many investors in smallish businesses don't take into consideration share limitation language in contracts. Rather, they go out and sell their stocks to a third party with dreams of retirement on a snowy beach somewhere. They're more than a little surprised when served with a lawsuit by the talk buyer who's angry because several contracts for the company have been terminated. In Seinfeld terminology, "No white beaches FOR YOU!"

Before getting excited about selling your shares in a business ensure that you check the language of contracts with third parties. You don't need to need to return from that white shore.