A limited liability company, or LLC, is a popular type of business association that offers small business owners flexibility and simplified formalities. An LLC is not required to have multiple owners or a board of directors, and LLC owners can determine how their LLC will be structured and operated by executing an operating agreement. However, LLCs cannot issue stock.
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LLCs and Stock
While state LLC statutes vary slightly, no state permits an LLC to issue stock. Only a corporation, whether it is a C- or S-corporation, may issue stock. However, while state laws prohibit an LLC from issuing equity instruments such as stock, no state LLC statute prohibits an LLC from issuing a debt instrument, such as a bond. While issuing bonds in the LLC achieves the same purpose of issuing stock, which is to attract financing, the process of issuing bonds is significantly more complex than issuing stock. The decision to issue debt instruments in an LLC may require the expertise a firm that specializes in issuing debt instruments, such as an investment bank.
LLC Ownership Structure
While state LLC statutes vary to some extent, a common requirement found throughout state LLC statutes is that members in an LLC must have equal rights. Typically, LLC members receive an ownership stake commensurate with their investment in the LLC. An LLC member does not necessarily need to invest financially in the LLC to receive an ownership stake, and may instead provide “sweat equity” by providing the LLC with services such as legal or other professional representation.
Preferential LLC Ownership
A corporation has the option of issuing both preferred and common shares. Preferred stock generally carries the rights of a dividend preference as well as a preference in receiving company assets in the case of liquidation. Additionally, preferred stock may also carry special voting rights. Because an LLC cannot issue stock, an LLC cannot issue preferred shares. However, by executing an operating agreement, LLC members may agree to assign rights and benefits to some LLC members but not to others. For instance, a particular LLC member may be granted veto power over issues that call for a vote of LLC members.
Preferential LLC Dividend Structure
An operating agreement may also be used to simulate other benefits to preferred stock. The terms of an operating agreement may specify a means of liquidating the LLC that provides a greater share of proceeds of liquidated assets to a particular LLC member. Additionally, an operating agreement may be used to assign LLC income to LLC members at a percentage different from the proportion of LLC ownership. The IRS must approve this type of assignment of income, which is called a special allocation.