Like any business entity, a limited liability company (LLC) might add an owner, also known as a member, for a variety of reasons:
- Admitting a new investor making a capital contribution
- Buying a business and issuing a membership interest as part of the purchase price
- Rewarding a valuable employee with an equity stake in the company
- Hiring a new employee and granting a membership interest as part of the overall compensation package
- Allowing an existing member to sell all or part of its membership interest to a third party
Whatever the reason for the new member, the LLC must take certain steps to correctly complete the transaction.
1. Review the articles of organization and operating agreement.
The LLC's articles of organization or operating agreement might include a process for admitting a new member and explain any required vote or approval needed by the managers or existing members. In the absence of such guidance, state LLC laws often require unanimous approval from the existing members to add someone new.
If the reason for the additional owner is an existing member's sale of a membership interest to a third party, the operating agreement might require the fulfillment of several conditions before the sale can go through, including an obligation of the selling party to first offer the interest to the other members.
2. Determine the new member's capital contribution.
A new owner of an LLC typically makes a capital contribution to the company to purchase a membership interest. Sometimes the new member doesn't pay immediately but makes a capital commitment, or a contractual promise to make capital contributions in the future if the company needs funds.
Determining a capital contribution amount involves valuing the LLC. For example, if you think the LLC's business is worth $2 million before the new member buys in, a $1 million capital contribution or commitment would entitle the new member to a one-third (or 33.33-percent) interest in the company.
Keep in mind that law does not require a new member to make a capital contribution of cash to obtain an interest. If the member has worked for the business or will in the future, either as an employee or partner, the services provided often function as the purchase price.
3. Understand the tax implications.
If, prior to admitting the new member, the LLC has had only one owner and has not elected to be taxed as a corporation, it will convert from a disregarded entity to a partnership when it admits its second member.
Once an LLC is a partnership for tax purposes, it must file a partnership tax return and issue an annual Partner's Share of Income, Deductions, Credits, etc., Schedule K-1 (Form 1065) to each of its members that reflects the member's allocation of profits and losses.
If the LLC adds the new member in the middle of the company's fiscal year, members must decide which IRS-approved method of allocating income and loss to use for the partial fiscal year. The choices are the interim closing method and the proration method. If the LLC's operating agreement designates an allocation method to use after a member joins or withdraws during the year, the company should follow the operating agreement's guidance.
Consulting the company's accountant is another important step in making sure the LLC's tax filings are fully compliant.
4. Document the deal.
Admitting a new member requires the drafting of some legal documents.
To reflect any manager or member approvals needed for the transaction, obtain written consent from the managers or members with resolutions that describe the transaction and reflect their votes.
If the LLC already has a multimember operating agreement and the new member will receive the same class of membership interest as the existing members, the addition of a new member requires both of the following:
- A joinder to the operating agreement signed by the new member
- A revised schedule showing each member's capital contributions/commitments and their modified percentage interest of the LLC.
If the LLC has many members and multiple classes of membership interest, you might also want a formal subscription agreement for the new member.
If admitting a new member turns a single-member LLC into a partnership, you will need one of the two following:
- An amendment to the existing operating agreement to reflect the various changes
- An amended and restated operating agreement that integrates all the changes and completely replaces the old document
If the new member being admitted to the company purchases an existing member's interest, you will need both of the following
- An assignment of the existing membership interest
- A joinder to the existing operating agreement.
An experienced corporate lawyer can prepare the necessary closing documents and any necessary amendments to the LLC's articles of organization.
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