Last Updated on April 22, 2023 by Ewen Finser
If your business is going from strength to strength, it might be time to add another member to your LLC to unlock the extra funding and resources you need to thrive and take your company to the next level.
While it’s true that adding a new member to your LLC opens the doors to a wealth of benefits, no business decision comes without its risks. From operating agreements to tax implications, you’ll have several factors to consider before you proceed.
However, adding a new LLC member doesn’t have to be complicated. With the proper knowledge, assistance, and resources, you can face this task confidently and give your business the boost it needs to flourish.
Let’s get started.
What’s an LLC?
Put simply; an LLC stands for a Limited Liability Company. This is a private limited company operating from the US. LLCs can be created by those looking to own or operate a business and exist to provide business owners liability protection, tax benefits, and a more flexible management structure.
LLC’s are similar to corporations, except they provide the same amount of limited liability at less expense. The flexibility of LLCs is what makes them so popular. They can be formed by almost any business of any size. Also, depending on your business’s nature, you can choose to be taxed as a corporation or a partnership.
Why Might an LLC Add a Member?
An LLC might choose to add a new member for several reasons, including:
- To reward a respected employee with an equity stake in the business.
- To gain a capital contribution from a new investor.
- To allow a current LLC member to sell some, or all, of their membership interest to someone else.
- To offer membership interest as a part of your compensation package to a new employee.
- In the event you’re purchasing a new business and paying part of the price by issuing a membership interest, or equity, to the seller.
How to Add a New LLC Member
Now that we’ve covered the what and why let’s look at the how:
Look Over Your Operating Agreement
Your LLC’s documentation should include an operating agreement detailing various aspects of your company policy, including responsibilities and obligations. In addition, each LLC member should have their respective duties described in the agreement.
Your operating agreement will also detail the protocol for adding new members and outline the process you and existing members should follow. Before adding a new member to your LLC, you’ll also need to check LLC laws in your state. These laws differ depending on whether you’re a single or multi-member LLC and regulations generally vary across the country.
If you don’t have an operating agreement, this is particularly important. If new members are added to the LLC, some states will require the LLC to be dissolved and rebuilt under new ownership. If in doubt, please refer to your state’s laws on LLCs.
Suppose you don’t have an operating agreement or your existing one needs tweaking. In that case, it may be worth seeking legal advice to update your operating agreement before adding a new member to your LLC.
Establish The Particulars
Once you’ve reviewed your operating agreement and established the process for adding a new member, you’ll need to determine the specifics.
Typically, the admittance of new members is dependent on a capital contribution. However, this doesn’t have to be paid in full. Instead, it can be laid out in a capital commitment or a promise to make future contributions or investments if the company requires funds.
However, there’s currently no legal requirement for new members to make a capital contribution to gain interest. In cases where the new member is an existing employee, the value of the service they provide (e.g accounting services) can take the place of a purchase price.
You’ll also need to discuss and determine ownership percentages. Unless state law says otherwise, the ownership percentage of each member doesn’t have to equal the capital they invest.
You’ll also need to establish the amount of interest the new partner will own in the company and how much this will cost.
Remember: All LLC members need a capital account that represents their equity contribution. Capital accounts are theoretical accounts that track each member’s equity in the LLC, and their contributions can either be in the form of money, property, or services.
Each member should contribute enough to cover the LLC’s initial expenses until company earnings are high enough to cover the business’s outgoings. If there’s not enough capital, members may be held personally liable for any debt that’s incurred.
Consider The Tax Implications
Adding a new member to your LLC could affect your tax status. For example, suppose your LLC only consisted of one member before bringing in a new member, and you’re not being taxed as a corporation. In that case, your LLC will shift from a disregarded entity to a partnership once the new member is bought in.
Bringing in a new member and becoming a partnership will mean that, for tax purposes, you must complete your annual tax return and provide each member with a Schedule K-1. This will detail each member’s profits and losses for the year. The Schedule K-1 makes up part of the Partnerships Tax Return (Form 1065), which documents the total net income of the partnership.
If your new LLC member is admitted in the middle of the fiscal year, you’ll need to adopt a method approved by the IRS of allocating profit and loss for the partial year. Typically, this will be either the interim closing method or the proration method.
Under the interim closing method, the partnership closes its books on the date the partnership interest changes. The tax items from the beginning of the tax year up to this date are then totalled together. In contrast, the proration method simply allocates your share of income or loss based on the number of days you’ve been a partner in the fiscal year. This is otherwise known as the proration period.
If you’re unsure and you want to double-check that you’re fully compliant, consult an accountant.
Take it To a Vote
Once you’ve established the specifics, you’ll need to take this decision to a vote.
A vote to add a new LLC member should be conducted amongst existing LLC members, and an amendment needs to be created to vote on. The amendment should include the partner’s name, percentage of their stake in the company, capital contribution, the percentage of profits and losses allocated, ownership percentage, managerial duties, and voting rights.
You’ll need to record this voting process in the meeting’s minutes, and all members of the LLC (including the new member) should sign the amendment. Recording your voting process will act as a necessary paper trail for your company; in the case of dispute or miscommunication, you’ll have these documents to fall back on.
If your LLC doesn’t have an operating agreement in place before the vote, seek legal advice. An operating agreement acts as a governing document for your LLC, detailing the procedures, rules, and regulations that your LLC operates under. As such, ideally, you should have your own operating agreement in place before conducting a vote.
As we’ve already hinted at, if there’s no agreement, you’ll need to comply with your state’s LLC act regulations, which usually require a unanimous consensus.
Draft Transaction Documents
Suppose your LLC’s operating agreement requires a specific manager or member’s consent to add a new LLC member. In that case, this approval must be documented, and the transaction and vote of each member or manager must be included. However, te.g.his may not be necessary (see the voting process above) if you don’t have a current operating agreement.
These transaction documents and procedures may differ depending on the nature of your LLC.
For example, if you’re using a multi-member operating agreement, and the new member will receive identical terms to the existing members, the documentation for a new member must include:
- An addendum where the new member agrees to be bound by the contract (usually called a ‘signed joiner’ to the existing agreement)
- A schedule detailing the capital contributions and commitments of each member
Or, suppose your LLC has a complicated operating agreement or multiple levels of membership interest. In that case, the new member may need to sign a separate membership agreement. Or, perhaps a new member intends to purchase an existing member’s interest. In that case, the company needs an assignment of the current membership interest and joinder to the operating agreement.
Alternatively, if admitting a new member to the LLC means a single-member LLC will convert into a partnership, the company should draft amendments to the operating agreement detailing the required changes. Amended or restated operating agreements can also be drafted to integrate all the changes and replace the old document.
As you can see, the documents you need to draft and the changes you need to make will differ depending on your LLC’s individual circumstances. Therefore, to ensure accuracy and compliance, you may need to consult a lawyer who can draft all the necessary paperwork and make any required changes to your articles of organization.
Update Articles of Organisation
When you created your LLC, you needed to submit Articles of Organisation to your state. These articles are used to develop and outline your LLC’s liabilities, powers, duties, obligations, and members. Once you’ve admitted a new member to your LLC, you may need to update your articles of organization. However, this isn’t always necessary. Certain states will require you to submit paperwork to amend these articles, but some won’t. So, check your state’s LLC regulations to ensure compliance.
However, if your business structure is changing, you may need to update your articles. For example, suppose you’re switching from a manager-managed LLC to a member-managed LLC. In that case, you will need to amend this information.
Other Things to Consider
On top of everything else we’ve already mentioned, here are some other things to consider:
Amendments May Need to Go to The Secretary of State
Suppose your articles of the organization need updating. In that case, the amendments must be filed with the secretary of state or another state agency that handles business filings. In contrast, as operating agreements do not need to be filed with the state, amendments to this document can be made without the need for filings.
However, suppose your state allows you to file your operating agreement, and you choose to do so. In that case, you should file your amendments to your articles of organization with this, too. This can usually be done online, but sometimes, paper forms are required. Again, check with your secretary of state’s office for clarification.
If Your Company’s Name Changes, You May Need to Register It
If adding a new member to your LLC changes the company’s name, you may need to register this with federal and state authorities. You’ll also need to file documents with the IRS and the Secretary of State.
To file the appropriate business name change form with the Secretary of State, you may need to pay a fee of up to $200. In addition, the IRS will require the street address where the return is to be filed, and all business partners must sign this.
Question: Does a Lawyer Need to be Present when I Draft, Edit, or Make Changes to My Documents?
Answer: It’s recommended. Without a legal professional, mistakes can be made that can invalidate your paperwork and slow down the process.
Question: Can Taxes be Filed as a Sole Proprietorship when two Different Owners or Partners are in An LLC?
Answer: No, this isn’t possible.
Question: Will Bringing in a New Member Split the Ownership of My LLC?
Answer: Yes. An additional membership will spread out the ownership of an LLC between all its members.
Question: Do Members Gain Financial Interest in the Company?
Answer: Yes, they will. This is why it’s essential to admit new members carefully. If a new addition to your LLC doesn’t work out, it can be challenging to reverse the decision. It’s not as simple as firing a problematic employee, so ensure the new member is a good fit before making any hasty decisions.
Are You Ready to Add a New Member to Your LLC?
As you can see, there are lots to consider as you go about adding another member to your LLC. The benefits can be astounding for your business, and it can be the push you need to take your success to the next level. However, the process also requires careful consideration, knowledge, and sometimes, professional assistance.
If you need help considering the tax implications for your company or sorting out the relevant paperwork, consider contacting an accountant or a lawyer for further advice. We hope this blog post helped! Let us know what you decide to do in the comments box below.