Description of LLC Ownership

by Jeff Franco J.D./M.A./M.B.A.

The laws governing the formation and operation of a limited liability company are created by state governments. However, most jurisdictions adopt the principles of the Uniform Limited Liability Company Act (ULLCA) to create uniform standards across all states. The ULLCA creates the minimum rights a member of an LLC receives solely by virtue of obtaining an ownership interest in the business.

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Membership Interest

The members of an LLC are the rightful owners of the business. As an owner of the business, you have a financial interest that entitles you to a share of the LLC’s earnings. As a member of the LLC, you can transfer the financial interest to another individual that entitles him to your share of profit distributions. However, the transfer does not provide the new owner with all membership rights such as the right to actively participate in business operations. Members of the LLC also enjoy limitations on personal liability for debts and obligations of the business. For example, if the LLC enters into a contract with a third party and breaches that contract, members are not responsible for fulfilling the terms of the contract. However, if the breach results in a civil lawsuit, the plaintiff has access to all LLC assets and earnings.

Management

The ownership interest of a member includes a right to manage and participate in the LLC’s business affairs. If the LLC is member-managed, all management responsibility vests with the members. Each individual member has an equal voice or vote in how the business is run. However, the operating agreement of the LLC may require alternate forms of management to which all members must adhere. Commonly, this results in the hiring of non-members to manage the business. Although active participation by members is limited, the members can actively monitor employees and vote on their selection.

Fiduciary Duties

Members who obtain ownership interests in the LLC must not engage in any activity that breaches their fiduciary duties. Fiduciary duties include a duty of loyalty to the LLC. This requires that members put the interests of the business as a whole before any personal interests when conducting LLC matters. A breach of this duty that results in damage or loss to the LLC imposes personal liability on the member. For example, a member who directly competes with the LLC breaches the duty of loyalty and is responsible for usurping LLC profits.

Tax Implications

The federal tax law allows all multi-member LLCs to choose between corporate or partnership taxation, and single-member LLCs between corporate and sole proprietorship taxation. If the LLC does not elect corporate treatment, the individual members are solely responsible for reporting and paying all tax on the business profits that flow-through to them. The failure of one member to comply with the tax law has no consequence to the LLC or to the other members.