The existing members of a LLC have great flexibility to establish the procedures for the admittance of new members. As long as the LLC operating agreement doesn´t prohibit it, new members can join the LLC on the basis of "sweat equity," rather than having to contribute cash or property to the business. This means that a new member promises to perform services in exchange for an ownership interest in the LLC.
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Check the LLC operating agreement. If the LLC has an operating agreement, it will likely include a clause that outlines the procedures for admitting new members who contribute sweat equity.
Establish terms of the new member’s interest. The LLC structure is quite flexible in that the rights of each member need not be the same. Therefore, you must reach an agreement with the prospective member as to his percentage of ownership, rights to distributions and allocation of profits.
Obtain consent from current members. If the operating agreement is silent on the procedures for admitting new members, the laws of the state in which the LLC operates will apply by default. Most states require that all current members of the LLC consent to the admission of a new member; however, the operating agreement may not require all members' consent.
Draft a contract with the new member. The new member’s promise to provide sweat equity to the LLC should be written in a legally enforceable contract. A valid contract must outline the type and length of service the new member is promising, all terms that relate to the new member’s share of profits and distributions, and the signatures of the new member and a current member or manager who is authorized to sign for the LLC.
Tips & Warnings
- Limited liability company members are free to draft the operating agreement with as many or as few terms as members deem necessary. However, there is no standard procedure that LLCs must follow to admit new members, and it may provide alternate ways to add new members who contribute sweat equity instead of cash. For example, rather than requiring unanimous consent, the operating agreement may only require a majority vote. Moreover, the agreement may even require that the contract include certain terms, such a commitment by the new member to provide services for a minimum length of time before their LLC interest vests.
- The existence of an enforceable contract that specifies the new member’s service obligations is essential for protecting the interests of current members. For example, the contract should provide some assurance to current members that profits will not be diverted to the new member in the event the promised services aren’t performed.
- It is important to remember that your state's laws governing the creation of new LLC membership interests apply only when the operating agreement doesn’t address the issue. Provided the operating agreement doesn’t include provisions that are illegal, states defer to the agreement.