LLC Change of Ownership: Everything You Need to Know

An LLC change of ownership is a process whereby one of the LLC owners transfers ownership to a new member. An LLC, or Limited Liability Company, is a business structure that operates as a hybrid between the corporation and partnership. It provides limited liability protection similar to that of a corporation and pass-through taxation similar to that of a partnership. Pass-through taxation means that the profits and losses are divided among members and reported on their personal tax returns as opposed to the business reporting it.

Since the business doesn’t report income, it will still need to file an informational tax return to simply indicate the percentage of profits, losses, and expenses that each member is required to report. Keep in mind that different states have different rules and regulations for LLCs. For that reason, there is a lack of uniformity in terms of the LLC structure. The Revised Uniform Limited Liability Company Act has attempted to unify such standards countrywide. The Act is endorsed by the American Bar Association and has been adopted in five states.

Ownership Transfer: An Overview

Many LLCs have a change of ownership at some point during their lifetime, as some LLCs want to continue operating even after one or more members leave the business. Such ownership changes can happen for many reasons, including the following:

• Member leaving the company
• New member joining the company
• Member dies or becomes disabled
• Member obtains a divorce in which the spouse retains ownership over the business
• Members sell the business entirely

Keep in mind that there is a procedure that must be followed when transferring ownership, particularly when transferring the full ownership in the LLC. Whatever the reason may be for choosing to transfer ownership, whether fully or partially, you should be mindful of the potential consequences of such a transition. This could include having to draft additional paperwork, increased tax implications, or even financial burden for the company.

Setting Forth Procedures in the Operating Agreement

The LLC might not be transferred in its entirety. As noted above, perhaps only one LLC member might want to transfer his or her interest in the business, or maybe a new LLC member is joining the business. The important thing to remember is the process that you will go through when transferring ownership.

First and foremost, when you initially form your LLC, you should draft an operating agreement. This agreement will specifically identify what must be done in order to properly transfer interest rights to another.

Absent this agreement, any potential transfer of interest could in fact cause a default termination of the LLC. Therefore, absent such buy-sell provisions, the entire business could be shut down.

Therefore, it is crucial to create this agreement when forming your business. All members should be present when the agreement is drafted, as all members will need to agree upon what is identified in the agreement. Once the agreement is finished, all members will sign it. Now it becomes a legally binding document which can be used in court to prove that a decision-making process or procedure should stand since it is mentioned in this agreement.

If you choose not to draft this agreement, you should draft a buy-sell agreement at the very least. This agreement will identify what happens when someone sells or subsequently purchases additional membership interest in the business.

The agreement itself might also place restrictions on who can become a member, i.e. any new member must be approved by all existing members of the LLC; no new members permitted as members wanting to sell his or her interest must sell to an existing member. Keep in mind that some states require you to dissolve the LLC if you don’t have an agreement in place for ownership transfers.

Before you choose to transfer interest in an LLC, you should first speak to an attorney to ensure that your LLC operating agreement or buy-sell agreement is valid and legally binding to prevent any potential legal issues that might arise if a member tries selling his or her membership interest in the business.

If you need help learning more about the ownership structure of an LLC or if you need help drafting an LLC Operating Agreement or LLC buy-sell agreement, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law, and average 14 years of legal experience, including work with, or on behalf of companies like Google, Menlo Ventures, and Airbnb.