The limited liability company (LLC) is a popular business structure for new businesses, but what does it really mean to own an LLC? LLCs provide unique opportunities to customize business ownership to fit the particular needs and circumstances of the owners. Here is what you should know about LLC ownership.
The owners of LLCs are called members. If a single person or a single business entity owns an LLC, it is called a single-member LLC. Conversely, if multiple people or entities own an LLC, it is called a multi-member LLC and there can be an unlimited number of members. When ownership is established, the membership interests are usually expressed in one of two ways:
● by membership units similar to corporate shares or
● by percentage.
The terminology you choose to use for a membership interest should correspond to your vision for the company. For example, if the business is owned primarily by your family, identifying the membership interests by percentages may keep things clear and straightforward. However, if you intend to seek funding from individuals outside of the family, you may find that labeling the ownership interests as membership units facilitates the easy transfer of ownership rights.
Establishing Ownership Rights
To be an LLC member, some form of contribution is required, which is called a capital contribution. The contribution need not be cash; LLC members can also contribute property or services. Additionally, unlike contributions to a corporation, when an LLC member makes a capital contribution, the concomitant ownership rights and distributions can be customized. For example, if one member were to contribute 40% of the capital in an LLC, that member and the other LLC members may still choose to split profits 50-50.
Generally, LLC members are entitled to share in the company's profits and losses, vote regarding key LLC matters, inspect and review the books, and enjoy a host of other rights. These rights stem from default state laws; however, the rights may be customized through contractual agreements. An Operating Agreement is the contractual agreement that typically governs LLC ownership rights and may include the following common customizations:
● distributing profits and losses in a way that does not match the members' capital contributions;
● creating different classes of ownership to reflect passive investor rights; and
● mandating member meetings.
Transferring Membership Interests
Death, incapacity, and sale are the primary events that trigger transfers of membership units. However, if you intend to transfer membership units to investors, be sure to evaluate whether your interest is a security under the federal securities law. If you offer your interest to less than 35 investors, your interest likely qualifies for an exemption that allows you to bypass the federal disclosure requirements and some state securities law.
LLC members can choose to be managed either by the LLC members (a member-managed LLC), or by nonowners or certain members designated as managers (a manager-managed LLC). When an LLC is managed, it is vital to identify and articulate the decisions for which the members bear responsibility and the decisions the managers must make. If the decision-making authority is not clear, the resulting uncertainty can hinder effective management of the LLC and confuse third-parties that may deal with the LLC.
LLC members can pay themselves in several ways, such as:
● receiving income in the form of distributions of profits at the end of the year,
● receiving draws, which are periodic payments based on the estimated profits for the year, or
● receiving periodic payments as employees of the business.
These three methods are not mutually exclusive—a member can take advantage of more than one option. However, members must always bear in mind that each option has unique tax consequences. For example, when LLC members pay themselves as employees, the LLC is expected to withhold Social Security and Medicare taxes just as it would for any other employee. Conversely, when members pay themselves based on their profits, they must pay self-employment taxes.
If you are considering creating an LLC, our team of experienced attorneys can help you develop the right ownership structure for your business. Call our office to schedule a virtual meeting soon.