How to Release a Member From an LLC

By John Cromwell

While a limited liability company might share some common characteristics with a corporation, the process of exiting from an LLC is much more difficult than leaving a corporation. Since LLCs are privately held businesses, establishing the value of the departing member’s share in the business can be quite difficult. Since the owners of an LLC are responsible for paying taxes on their share of the business’s income, there are tax reporting issues that arise from a buyout as well.

While a limited liability company might share some common characteristics with a corporation, the process of exiting from an LLC is much more difficult than leaving a corporation. Since LLCs are privately held businesses, establishing the value of the departing member’s share in the business can be quite difficult. Since the owners of an LLC are responsible for paying taxes on their share of the business’s income, there are tax reporting issues that arise from a buyout as well.

Step 1

Refer to the LLC’s operating agreement. An LLC operating agreement is the set of rules agreed to by the members at the outset of the business, and it defines how the organization is to operate and how the members interact with each other. If the operating agreement specifies how the LLC should act when a member leaves, that will govern how the transaction will take place.

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Step 2

See if a buyout agreement exists, if the operating agreement does not discuss what to do when a member leaves. A buyout agreement is a document separate from the operating agreement that dictates the rights and obligations of the LLC and its members when one person chooses to leave the business. If a buyout agreement exists and the operating agreement does not comment on buyouts, the buyout agreement will govern how the transaction takes place.

Step 3

Balance the member’s capital account. A capital account keeps track of a member’s contributions to the LLC as well as any distributions made by the LLC to the member. It also tracks any loans the member made to the LLC as well as any loans given to the member by the LLC. If the either side owes the other money, make sure that those debts are settled before attempting to execute the buyout.

Step 4

Calculate the value of the departing member’s interest in the business. Generally the operating agreement or buyout agreement will provide either a price or a means of arriving at a price for a member’s interest in the business. If there is no prior agreed-to means for valuing a member’s share, consider hiring a third-party professional to help you value the business and the member’s share of it.

Step 5

Draft a purchase agreement. The purchase agreement is a legal contract stating the terms of the transaction. The purchase agreement should conform with any prior terms that are in the operating or buyout agreement. In addition, consider adding provisions such as a confidentiality or noncompete clause to protect your business’s competitive advantage.

Step 6

Execute the purchase agreement. Have both parties review the document and sign it. The person who signs for the LLC must have the authority to do so. Depending on how the LLC is structured, either a member of the LLC or a person who was specifically chosen to represent the LLC in legal matters must sign the agreement.

Step 7

Adjust capital accounts. Distribute the former member’s ownership percentage among the remaining owners subject to the terms of the operating agreement. If the operating agreement does not state how to distribute the departing member’s share, divide the amount equally among the remaining members’ capital accounts.

Step 8

Deliver the final K-1 to the departing member. He is responsible to pay taxes on his share of the LLC’s income earned while he was still with the business. K-1s are reports prepared by the LLC that inform a member how much of the business's income and losses must be included on her personal tax return. Prepare a K-1 for the departing shareholder detailing his share of the business’s financial activity for her last year. Check the "Final K-1" box at the top of the form."

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How to Sell a Percentage of an LLC

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Legal Aspects of an LLC

A limited liability company is a relatively new form of business organization. A hybrid between a corporation and a partnership, LLCs are organized under state law. The laws regarding an LLC vary by state; there is no agreed on set of legal standards. However, there are some consistencies in how an LLC treated regardless of where the business is headquartered.

Are Former Contributions Considered in an LLC Buyout?

When an owner, known as a member, of a limited liability company wants to leave the business, he is generally bought out. This means that other members compensate the departing member in exchange for his ownership in the business. The key issue in a buyout scenario is how much the departing member gets for his stake, and how that price is determined. Generally, the contributions of a member to the LLC are considered. Which contributions are considered and how much weight those contributions carry in determining the buyout price will vary based on the circumstances.

Accounting for an S Corporation Shareholder Buyout

An S Corporation is a small business that generally protects its 100 or fewer shareholders from the business’s liabilities. Unlike most corporations, the business income is divided amongst the shareholder to include on their personal returns. This allows the business to avoid “double taxation.” To obtain this benefit, the business must conform to IRS imposed restrictions that limit who can own shares in the corporation. As a result of these restrictions, many of these businesses have established rules regarding when and how a corporation can buy out a shareholder, which ultimately defines how the corporation accounts for that transaction.

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