Buying into an LLC: Everything You Need to Know
If you're thinking of buying into an LLC, you'll need to buy membership interest.3 min read
If you're thinking of buying into an LLC, you'll need to buy membership interest. An LLC offers its members/owners the legal protections of a corporation but the management of a partnership. State laws give members the right to govern the business by agreement among themselves.
Buying an LLC: Introduction
There are things to consider when buying into an LLC. If you are buying someone's LLC membership there are tax benefits. There's less risk when buying an existing company which can give you more immediate returns than a start-up. There's a tax reform where LLCs receive beneficial tax treatment.
You can take the option of making a Section 754 election with future members. This election allows you to claim additional tax on assets within the LLC to deduct depreciation and/or amortization of income taxes. An LLC commonly has depreciated assets in the business so that the tax basis of the company's assets is less than the LLC's value.
Steps to Buying an LLC
- Identify an LLC to Buy
- Operating Agreement
- Framework of the Deal
- Buy-In Terms
- Due Diligence
- Written Agreement
- Capital Account
Identify an LLC to Buy
Consider how you will finance your purchase, who will operate the LLC after buying it, how this affects your personal finances, and what is the long-term chance of the company's success.
Once you have figured out which LLC is best, you have to contact the owners(s) to know if they're interested in selling. If they're positive then you can think about the details.
Get the okay from the LLC members to continue. The existing members hold all of the ownership interest and if they bring in a new owner then they would have to decrease their ownership percentages.
No member can be forced to reduce his/her ownership interest. Without a written agreement stating otherwise, state law usually requires unanimous consent from everyone to allow a new member.
If there's an operating agreement available which goes over the possibility of a new member it has contract force and takes precedence over state law.
You have to figure out what kind of rights you'll have as a member. Do you only receive profits with no say? The operating agreement specifies these rights.
Framework of the Deal
Do you want to buy the whole LLC or just a piece of equity? Parties will agree to the keys of the deal and write them down. The document to do this is named memorandum of understanding or term sheet which will be used for the purchase document.
If the members will allow a new member then they have to determine a buy-in price. Members can determine the value to be what they think a certain portion of the company is worth since there are no restrictions.
The members value of the LLC is determined by many things such as growth potential and current health, and it can be difficult to determine.
Due diligence is where the buyer, attorneys, and accountants review the LLCs overall finances before ending a sale. The buyer's attorney will create a due diligence checklist where the seller has to provide information to the buyer to review such as employee contract and financial statements. If there's any intellectual property this should be provided too. The attorney reviews the documents while the accountant reviews the LLC's taxes and bank accounts.
The transaction details have to be written as the agreement. The buy-in price and rights of the new owner have to be specified. Once the agreement is signed and the money exchanged, the agreement has to be updated to reflect the new member's participation.
The sale is legalized and the terms are set in the agreement. Once the purchase agreement is final, the buyer's attorney prepares a final checklist to give to the seller's attorney. The checklist will list the documents that have to be done before signing the deal.
Ask the LLC to open a capital account which is used to keep track of member contributions. These accounts will help members divide profits in case the company closes.
Typically the closing is the end of the transaction unless there are post closing matters. Be careful and seek professional help to make sure buying a business turns out for the best.
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