Adding A Member to an LLC: Everything You Need to Know
Adding a member to an LLC is an important step in many growing businesses, and there are many reasons to bring on an additional owner to your LLC.8 min read
Adding a member to an LLC is an important step in many growing businesses, and there are many reasons to bring an additional owner to your LLC, including adding a business partner, adding capital in order to expand or to reward an employee for his or her hard work and dedication.
Bringing an additional owner to your LLC means you'll have an additional business partner, so it is important to consider every aspect of it thoroughly. It is usually not an altogether difficult task, and once you've decided to do so, adding a new member is just a matter of following the procedures in your operating agreement, creating a formal record of the new ownership, and filing any required documents with the state.
What Is an LLC?
Limited liability companies, or LLCs, are business entities that provide liability protection for their owners, also called members. LLCs have quite a bit of flexibility when it comes to ownership and management structure. Depending on the purpose of the business, an LLC may choose to be taxed as a corporation or a partnership. As one of the newer entity types in the business world, LLCs are becoming increasingly popular, thanks to their flexibility.
Understand the Consequences
Prior to adding a new member to your LLC, you should fully consider the consequences and benefits. For instance:
- A new member can offer much to grow your LLC, but his presence will also lower the profit percentage of all the current owners.
- Additionally, in a member-managed LLC, a new member will add one more voice that must be heard, perhaps slowing or complicating the operation.
- Once someone becomes a part owner, it is often very difficult to remove that person if his presence turns out to not be beneficial.
If, deep down, you feel that the potential member should not be a part of your business, then perhaps you should find some other way to achieve your goals. Bringing on a new member can change your tax status as well: If your LLC is single-member, you no longer will be taxed as the sole proprietor. Instead, you will be required to pay taxes like a corporation or partnership. In order to be completely informed of the results of bringing a new member to your LLC, consulting with a business attorney is recommended.
Review Your Operating Agreement
The operating agreement that governs your LLC should lay out the process of adding a new partner, including how the members vote on the issue. If it does include this information, following the process is important, as it shows the independence of your organization and its willingness to abide by its own rules. If your operating agreement does not include this process, it may be a good idea to have an attorney draft one for you. If you would rather do this yourself, many states have forms that can be tailored to the needs of your LLC.
The rule in most states is that when a new member is considered for addition, and no operating agreement exists on how to accomplish this, the agreement of all existing LLC members is needed. Any new member will automatically become a partner equal to the current members. However, adopting an operating agreement can change such rules, allowing new members to be let in by a majority vote, with their share being less than that of the more senior members.
Remember, an LLC is a distinct business entity that protects its owners from personal liability. Following formal procedures and keeping good records helps to maintain that protection and to avoid future disputes among the owners.
Decide the Specifics
After the process for bringing on a new partner is laid out, the exact details of the arrangement should be determined. In ownership structure, LLCs have almost limitless flexibility. For instance, one could own a percentage of a business that differed from his profit percentage. Ownership percentages should be discussed with current members of the LLC and the potential member to make sure that all are in agreement. Unless state default rules apply because there is no operating agreement, each member's percentage of ownership need not correspond with the percentage of capital they invest in the company.
Once this is agreed upon, the new member's capital contribution should be collected, then the interest the new partner will own in the company and how much this will cost should be decided. In an LLC, all members need to have a capital account representing their equity contribution to the company in the form of service, property, or money.
Vote on an Amendment to Add an Owner to the LLC
Once a decision has been reached regarding the percentage of the new member's share, an amendment to bring the oncoming member into the LLC should be prepared for addition to the operating agreement. On this amendment, there should be listed the new partner's name, percentage of stake in the company, capital contribution, and percentage of losses and profits she will be allocated. Once this is done, a vote should be held concerning the amendment in accordance with the process in the operating agreement.
In voting on a new partner, one should remember that other partners cannot be forced unilaterally to dilute their own shares by bringing on a new member — the agreement must be mutual, and the vote must follow the rules of your operating agreement. If there is no agreement, then the vote has to comply with your state's LLC Act, which usually demands a unanimous consensus.
However, this vote is conducted, it should be documented in the LLC's minutes or recorded in a resolution, and all members of the LLC (along with the newest one) should sign the amendment. This document should also state:
- The voting rights,
- managerial responsibilities,
- and ownership percentage
of each member, and it should be kept in your place of business along with your other business documents.
Amend the Articles of Organization, If Necessary
When your LLC was formed, you were required to submit articles of organization to the state. When you add a new member, certain states will require you to submit a form amending your articles, while others do not. Such state requirements can be checked through the agency that handles business filings, which is usually the secretary of state.
One should also be aware of any deadlines if an amendment is necessary. Additionally, if your business management structure is being changed from a manager-managed LLC to a member-managed LLC or vice versa, you will need to amend the articles of organization, as well.
File Required Tax Forms
Although having a single-member LLC allows you to use your Social Security number for your federal tax identification number, you will be required to get a federal Employer Identification Number (EIN) when you change to a multimember LLC. You can get this by completing a free form on the IRS website, and it will act as your LLC's tax number for both state and federal filing.
Generally, if your LLC's structure or ownership changes, you will need to get a new EIN; however, if you are adding a new partner and already are a multimember LLC, you most likely will not need to change your EIN. If in the past, your LLC was classified for tax purposes as a partnership or sole proprietorship, additional forms will need to be filed with the IRS in order to elect corporate status. A tax accountant or lawyer can inform you of the best way to have your LLC taxed.
Check Your State's LLC Act
If you lack an operating agreement, the state in which you set up your LLC has rules outlining the required steps for bringing in another member, as well as the documents that need to be submitted or amended by law.
Hold a Meeting of the LLC Members
If your LLC is multimember, set up a meeting for the members concerning the possible new partner before voting. At this meeting, you should show the financial resources, qualifications, and business experience of the member under consideration, similar to a job interview. It is possible that the other LLC members will wish to speak with the candidate.
The LLC's current members must reach a consensus regarding the candidate's capital interest, along with how it will affect the worth of the capital investments from the current members. Should the interests of current members not be updated after the candidate is brought on, the new candidate could gain a disproportionate share upon dissolution of the business.
Amend Your Operating Agreement
When bringing a new member into your LLC, numerous parts of the operating agreement will need updating. At the least, the sections covering the percentage of shares of each of the company's members, the dispensation of losses and profits, the member's capital contributions, and the voting capacity of all the members must be updated. Because an oncoming member will receive a stake of the corporation, the shares of current members' distributions, losses, and profits will be changed, and any rules in the operating agreement related to the current members' fiscal interests must be adjusted.
Submit the Amendments to the Secretary of State
If amending the articles of your organization is deemed necessary, this amendment must be filed with the secretary of state or other state agency that deals with business filings. Because operating agreements do not need to be submitted to the state, the agreement can be amended without any filing being done, although there are some states that do allow you the ability to file your operating agreement. If you do choose this option, your amendment should be filed with it, too.
You should also check in with your secretary of state's office to see if it is possible for the amendments to be filed online or if paper forms are required. Don't forget to ask how much you must pay for the filing, although it is usually about $100.
Either the business filings agency in your state or your secretary of state will be able to tell you what the fees are and what they include. Should a certified copy of the filing not be included in the fee, then you also must pay for that in order to obtain a copy for your business records.
File the Entity Classification Election Form With the IRS, If Needed
Bringing a new partner to your LLC can result in the LLC's classification being changed. If it does, an Entity Classification Election Form must be filed with the IRS. Unless a different election form is made using Form 8832, your LLC will be classified by the IRS in accordance with the default rule.
By default, multimember LLCs are regarded as partnerships for tax purposes, so if you want your LLC to be classified as a corporation, you must file Form 8832. Usually, as long as your LLC has two members prior to a new member being added, the income tax status of the LLC will not change by bringing on a new partner, and there will be no need to contact the IRS.
Register the Name Change With Federal and State Authorities, If Needed
Sometimes when a new member is added, the company's name is changed. For instance, let's say you and a friend ran “Jim and John's Jukebox, LLC.” Then, a mutual friend named Jake joined the business, and thus you wanted to change the name to “Triple J Jukebox, LLC.” To accomplish this, documents would need to be filed with both the IRS and the secretary of state.
The secretary of state will require the appropriate business name change form to be filled out along with a fee that could be up to $200. The IRS would require notice of the street address where your return was to be filed, with said notice being signed by all business partners involved.
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