Can an LLC Borrow Money From Individuals?

by Terry Masters

A limited liability company is a type of business entity that enjoys many of the same powers and protections of a corporation with the favorable management style and tax treatment of a partnership. An LLC's owners, known as members, have the same type of authority as a corporation's shareholders to enter into business transactions to benefit the company, including borrowing money from individuals. The individuals making the loans can be members of the LLC or unrelated third parties.

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Legal Authority

An LLC is organized under the business formation laws of a state in which it plans to operate. The state's limited liability company act establishes an LLC's authority under the law in the statute's powers clause. A typical powers clause will state that an LLC is an independent legal entity that has the power to do anything an individual can do to conduct its business affairs, including entering into contracts, suing or being sued, hiring employees, and buying and selling property in its own name. For example, the Uniform Limited Liability Company Act upon which most state statutes are based states that an LLC can "make contracts and guarantees, incur liabilities, borrow money, issue its notes, bonds, and other obligations..."

Operational Restrictions

An LLC's authority to borrow money from any individual or entity is a basic tenet of a state LLC formation statute. Although the law gives an LLC the basic power to borrow money, that ability can be limited by a particular company's management decisions. Many LLCs require loans from individuals to be approved by management, particularly if the loans are from members of the company. Some LLC prohibit loans from individuals entirely. These sorts of restrictions are typically outlined in an LLC's operating agreement.

Types of Individual Members

Generally, an LLC can borrow money from any individual; however, there can be ancillary restrictions and concerns if the lender is also a member of the company. Some LLC members, particularly if the company is in a start-up phase, lend money to the business to allow it to keep operating. Unlike an unrelated individual, a member has an equity interest in the company, and contributions that are intended as loans can sometimes be reclassified as additional equity contributions under the laws of certain states and the tax code. Loans must be repaid if the company has assets, while equity contributions can be lost if the company is not profitable or goes out of business.

Procedure

An LLC can borrow money from an individual under any terms that the parties negotiate. The process of borrowing money from an individual can be as formal as a loan from a bank, as in the case of borrowing money from an angel investor, or as informal as borrowing money from a relative on a verbal agreement. It is considered a best practice to put all loan agreements in writing so the terms of the agreement can be independently substantiated. It is particularly advisable to use a written agreement for loans from members because the agreement serves as proof to tax authorities or the court in case of a company dispute that the transaction was intended as a loan and not an equity contribution.