The limited liability company (LLC) is a popular business structure for new businesses because it provides unique opportunities for customization. But what does it really mean to own an LLC? Here is what you should know about LLC ownership.
The owners of LLCs are generally called members. If a single person or a single business entity owns an LLC, it is called a single-member LLC. If multiple people or entities own an LLC, it is called a multimember LLC. LLCs can have an unlimited number of members. When ownership is established, the membership interests are usually expressed in one of two ways:
- by percentage, or
- by membership units similar to corporate shares.
The terminology a business owner chooses to use for a membership interest typically corresponds to their vision for the company. For example, if the business is owned primarily by a family, identifying the membership interests by percentages may keep things clear and straightforward. However, if the owner intends to seek funding from individuals outside of the family, they 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; however, the contribution need not be cash, otherwise known as a capital contribution. 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 percent of the capital in an LLC, that member and the other LLC members may still choose to split profits fifty-fifty.
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 are generally established by state law; however, they may also be customized through contractual agreements. The contractual agreement that typically governs LLC ownership rights is an operating agreement. Operating agreements 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 an owner intends to transfer membership units to investors, it would be wise to first engage a professional to evaluate whether the transfer triggers federal securities law.
LLC members can choose to be managed either by the LLC members (a member-managed LLC), or by nonowners, or by certain members designated as managers (a manager-managed LLC). Regardless how an LLC is managed, it is vital to identify and articulate which decisions will be made by members, versus those which will be made by managers. If the decision-making authority is not clear, the resulting uncertainty can hinder effective management and operation of the LLC.
LLC members can pay themselves in several ways, such as:
- receiving income in the form of distributions of annual profits;
- receiving periodic payments (e., draws) based on the estimated annual profits; 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 remember 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 as it would for any other employee. Conversely, when members pay themselves based on profits, they must pay self-employment taxes. Either way, LLC members must be mindful of the tax consequences of the payment methods they choose.
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.