Limitation on lines of business: Overview, definition, and example
What is a limitation on lines of business?
A limitation on lines of business is a contractual provision that restricts a company from engaging in certain types of business activities beyond its core operations. This clause is often used in loan agreements, investment contracts, and shareholder agreements to ensure that a company remains focused on its primary business strategy and does not take on excessive risks by expanding into unrelated industries.
For example, if a tech company secures venture capital funding, the investors may include a limitation on lines of business clause to prevent the company from shifting into non-tech industries, such as real estate or manufacturing, without prior approval.
Why is a limitation on lines of business important?
This clause is important because it helps investors, lenders, and business partners ensure that a company maintains its strategic direction and financial stability. It prevents businesses from making risky or unrelated expansions that could negatively affect their financial health or divert resources from their core operations.
For businesses, this limitation provides clarity on permitted activities, ensuring that all stakeholders are aligned on the company’s growth strategy. It also protects creditors and investors by ensuring that the company does not take on excessive risk beyond its intended scope.
Understanding limitation on lines of business through an example
Imagine a healthcare startup receives a $10 million investment from venture capitalists to develop medical software. To protect their investment, the investors include a limitation on lines of business clause stating that the company cannot expand into unrelated industries, such as consumer electronics or e-commerce, without investor approval.
In another scenario, a manufacturing company secures a bank loan, and the lender includes a clause restricting the company from engaging in financial services or other industries that could increase risk exposure. This ensures the company stays within its core business of manufacturing and does not enter speculative markets.
An example of a limitation on lines of business clause
Here’s how a limitation on lines of business clause might appear in a contract:
“The Company shall not engage in any business activities outside its current line of business as described in this Agreement without the prior written consent of [Investor/Lender/Board of Directors]. Any expansion into new business lines shall require an amendment to this Agreement and approval by the necessary parties.”
Conclusion
A limitation on lines of business clause helps protect investors, lenders, and business partners by ensuring that a company remains focused on its core operations and does not take on unnecessary risks. It is commonly used in investment agreements, loan covenants, and shareholder contracts to preserve financial stability and strategic direction.
By clearly defining permitted business activities, companies can align stakeholder expectations, maintain investor confidence, and ensure long-term growth within their intended industry.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.