A limited liability company, or LLC, is a business entity that is formed under state law. It combines the limited liability of a corporation with the operating flexibility of a partnership. Like a partnership, an LLC can be governed by a binding operating agreement between the partners, called members in the LLC context; however, the adoption of an operating agreement is optional in most states. Without an operating agreement, the default provisions of a state’s limited liability company act will govern the relationship between the members.
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Follow the provisions of the LLC's existing operating agreement for adding new members. A typical operating agreement establishes voting procedures for adding new members and determining their percent of ownership in the business. It is advisable -- though not required by law in most states -- to adopt an operating agreement at the outset of the business. A duly adopted operating agreement has the power of an enforceable contract, and is binding on all current members.
Draft an operating agreement if the LLC doesn't already have one, or amend the existing operating agreement if it doesn't adequately provide for the addition of new members. An LLC that conducts business without an operating agreement is subject to state-mandated default provisions. Most states provide that a new member added to an LLC shares equally in profits and losses as all other members. This default provision places all members on equal footing and makes it impossible to add a member with a lesser share of the business than the existing members. It is only through an operating agreement that an LLC can establish that a new member's share could be a percentage that is less than existing members -- for example, a 40-40-20 ownership interest distribution.
Vote to add the new member. Any addition of a new member dilutes the ownership interests of the existing members. Ownership interest in an LLC, like in a partnership, is not freely transferable. Adding a new member requires the consent of all existing members before any type of ownership dilution can take place.
Collect the new member's capital contribution and establish his capital account on the company's books. The new member must contribute cash, goods or services to the LLC to establish his ownership basis in the business. This amount can be based on the capital accounts of the existing members -- for example, if two existing members have each contributed $50,000 to the business, a new member with an equal share of the business must also contribute $50,000 -- or can be an amount set by the members in advance as a distributive share -- for example, for $75,000 a new member will have 10 percent of the business, regardless of how much money the existing members have contributed in the past.
Change the LLC's IRS tax classification, if needed. An LLC is classified by the IRS based upon the number of its exiting members. If the LLC has one member and is adding a new member, the LLC must alert the IRS that it is changing from a single-member LLC to a multi-member LLC. A multi-member LLC can choose to be classified as a partnership or a corporation. Fill out and send in IRS Form 8832, Entity Classification Election, to make the change. The form can be downloaded from the IRS website (see Resources).
Amend the LLC's articles of organization. A few states require that an LLC's articles of organization list the company's members. Refer to your copy of the LLC's articles; if the names and address of the members are listed, you may need to file an amendment. Check the website of the state office where the articles of organization were filed for requirements and procedures.
File an updated list of members. A few states require an LLC to provide an annual list of members. If the state where the LLC is registered has this requirement, make sure to provide the state with the necessary information on the new member.
- Operating agreement
Tips & Warnings
Adopt an operating agreement before adding a new member, even if it's a single-member LLC. New members are subject to existing rules, and these rules trump a state's default provisions. Establishing the rules in advance prevents an automatic 50 percent dilution of your ownership interest under the default provisions, and enables you to determine how the business will operate without having to get the approval of a new member first.
References & Resources
- Business.gov: Limited Liability Company
- FindLaw: Making LLC Operating Agreements
- Citizen Media Law Project: Operating Agreement
- Penn Law: Uniform Limited Liability Company Act
- American Bar Association: Adding a New Member to an LLC
- SCORE: Business Tools
- U.S. Small Business Administration: Small Business Planner
- ABA Family Legal Guide: Forming and Operating a Small Business
- The 'Lectric Law Library: Business Entity Forms
- FindLaw: Start-Up Toolkit
- IRS.gov: Form 8832
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