How to Add a Member to an LLC CompanyBy Tom Speranza, J.D.
How to Add a Member to an LLC CompanyBy Tom Speranza, J.D.
A limited liability company (LLC) operates more like a partnership than a corporation, so its members, or owners, must agree when it comes to major decisions such as adding new members. LLCs often have operating agreements that detail how the business should handle such procedures. In the absence of an operating agreement, the company would turn to state law for guidance.
Reasons an LLC might add a member include:
- Receiving a capital contribution from a new investor
- Purchasing another business and paying part of the purchase price by issuing equity (a membership interest) to the seller
- Granting a key employee an equity stake in the company
- Providing compensation to a new employee in the form of a membership interest
- Selling all or part of a member's interest to a third party
Before admitting a new member into the LLC, the company must first make sure it is adhering to protocols set forth by its founding documents among other considerations.
1. Review the LLC's formation document and current operating agreement.
Articles of organization—called a certificate of formation in some states—serve as the operating agreement of an LLC and may spell out how the company admits a new member. That process could include a required vote or approval of the managers or existing members. If neither document provides any guidance, state LLC laws often require unanimous approval of the existing members for admittance of a new member.
If the situation requiring a new member is the sale of an existing member's membership interest to a third party, the operating agreement may require several steps before allowing the sale. Typical transfer restrictions include an obligation of the selling party to first offer the interest to the other members or to give the company the option to redeem the membership interest at an agreed-upon purchase price, which usually comes with a long payment period.
2. Calculate the member's capital contribution.
Admittance as a new member to an LLC usually requires a capital contribution. Often, the purchase price is not paid all at once but instead takes the form of a capital commitment, or a contractual promise to make capital contributions in the future if the company needs funds. The obligation to contribute capital can be part of the operating agreement or appear in a subscription agreement containing the terms of the purchase.
When an LLC determines a new member's capital contribution amount, it places a value on the company. For example, if the existing members believe the business the LLCis worth $3 million before the new member buys in, a $1 million capital contribution or commitment would entitle the new member to a 25 percent interest in the company.
It's important to remember that state law does not require a new member to make a capital contribution to obtain an interest. If the new member has worked for the company or will work there in the future, either as an employee or owner, the services provided often function as the purchase price.
3. Figure out the tax implications.
If the LLC has only one owner before admitting the new member 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 an annual partnership tax return and issue to each member an annual Schedule K-1 setting forth that member's allocation of profits and losses for that fiscal year.
If the LLC admits the new member in the middle of the fiscal year, the company must choose an IRS-approved method of allocating income and loss for the partial fiscal year. The LLC can use either the interim closing method or the proration method. The company's operating agreement may designate an allocation method for use when admitting a new member or when a member withdraws during the year. If the agreement includes such a provision, the company should follow its guidance.
Existing members or managers of an LLC facing these considerations should consult the company's accountant so that the company's tax filings are fully compliant.
4. Draft the required transaction documents.
If the operating agreement of an LLC mandates certain manager or member approvals, a written consent of the managers or members must be prepared containing resolutions describing the transaction and reflecting their votes.
If the LLC already uses a multi-member operating agreement and the new member will receive a membership interest with identical terms as those held by the existing members, the admission of a new member requires:
- A signed joinder to the existing operating agreement (a simple addendum in which the new member agrees to be bound by the contract)
- A revised schedule showing each member's capital contributions or commitments and their modified percentage interest of the LLC
If the LLC has many investors, multiple classes of membership interest, and a complicated operating agreement, it may make sense to have the new member sign a separate subscription agreement.
If the admittance of a new member converts a single-member LLC into a partnership, the company needs to draft an amendment to the existing operating agreement reflecting the various required changes. It may also draft an amended and restated operating agreement that integrates all the changes and completely replaces the old document.
If the new member buys an existing member's membership interest, the company needs an assignment of the existing membership interest and a joinder to the existing operating agreement.
An experienced corporate lawyer can draft all of the necessary closing documents and any necessary amendments to the LLC's articles of organization.
This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.