LLC Membership Units are the ownership interests granted to individuals or entities in return for their capital investment in the LLC. These units signify the member’s share in the business and grant them the right to receive a portion of the LLC’s profits and vote on crucial decisions.
LLC membership units represent the ownership percentage in an LLC. They offer the owner a share of the profits and losses of the business, and the right to vote on important company decisions. The distribution of profits and voting rights can be customized in the operating agreement. LLC membership units represent ownership interests in a limited liability company (LLC), while stocks represent ownership interests in a corporation.
Unlike corporations, LLCs do not have shares but have LLC membership units instead. The LLC has the flexibility to assign membership units and allow members to buy, sell or transfer their LLC membership units.
If you are thinking of starting an LLC (limited liability company) for your business, it’s important to understand how membership units work.
In this article, we will discuss what LLC shares or units are, why they are important, how they are determined and allocated, as well as other considerations related to LLC membership units.
What Are LLC Membership Units?
An LLC is a type of legal business structure that provides limited liability protection for its owners while also allowing the pass-through of income taxes and increasing operational flexibility.
The members of an LLC can be individuals or businesses, but the most common choice is usually individuals because of the ease with which it is organized and managed.
The owners of an LLC are known as “members” and their financial interest in the company is represented by membership units or shares.
Basically, membership units are a way of representing each individual’s share in the profits generated by the business. They allow members to allot different amounts of earnings based on their contributions and efforts toward achieving success.
Additionally, these units can also be used as a way to assign voting rights within the company depending on state laws governing LLCs.
How are LLC Membership Units Similar to Stocks or Shares?
Both LLC membership units and Stock represent the ownership in an LLC or a corporation. The ownership in an LLC is expressed as percentage ownership interests or membership units. While the ownership in a corporation is called shares or stock.
Like S or C corporations, an LLC can establish various classes of membership interests. This grant LLCs the flexibility to allocate voting rights and profits in unique ways.
How are LLC Membership Units Different From Stocks or Shares?
LLC has the liberty to assign its ownership interests in any manner it decides. The LLC membership units are not dependent on the amount of capital, assets, or property contributed by each member.
On the other hand, stocks or shares of corporations are typically based on the amount invested.
Moreover, typical LLCs can’t go public to sell their membership units. However, members can sell their membership interests in a different way. To sell LLC membership interests, LLC owners must comply with federal and state securities regulations.
However, they are typically exempt from most regulatory requirements if they are not seeking funding from more than 35 investors and are not advertising the sale of their interests.
Issuing LLC Membership Interests
Issuing LLC membership units is a delicate process and must be handled with care. Generally, to issue membership interest correctly you must follow the following steps:
1. Determine the number of units
The first step is to determine the number of units that will be issued. This number is typically based on the total capital that the LLC needs to raise.
While capital needs are typically considered in cash, they can also be in the form of the transfer of assets or the provision of services.
The value assigned to each unit, and the ownership structure desired by the members also help in determining the number of units that the LLC needs.
2. Establish the value of each unit
The value of each unit can be determined through negotiations between the members or by using a formula that takes into account factors such as the company’s assets, liabilities, and future earnings potential.
3. Prepare the operating agreement
The operating agreement should specify the number of units being issued, the value of each unit, and any restrictions on the transfer of units.
It should also outline the rights and responsibilities of each member, such as voting rights, profit and loss allocation, and decision-making powers.
4. Record the transfer of units
Each time a unit is transferred, the transfer should be recorded in the operating agreement and any necessary state filings should be made.
For members who choose to pay in cash, it’s important to keep a record indicating that the specified amount has been deposited into the LLC’s bank account.
In cases where the consideration is not in the form of cash, a written agreement between the LLC and the member is necessary to legally bind the member to pay the agreed-upon amount.
5. Maintain the Record Book
An LLC should maintain a comprehensive record book that contains vital documents like its Articles of Organization and operating agreement. The record book should also hold information related to the membership interests of the LLC, including:
- A transfer ledger for monitoring changes in membership interests
- Any issued membership certificates (some reputed LLC formation services such as LegalZoom can make you customized LLC Member Certificate)
- A balance sheet exhibiting each member’s capital account status.
6. Comply with securities laws
If the LLC is offering its units to the public, it may be subject to federal and state securities laws. It is important to consult with a lawyer to ensure compliance with all relevant laws and regulations.
Adding New Membership Units
Your LLC can bring in new members anytime. However, you need to ensure whether it is a financially beneficial move for existing members or not.
Typically adding new membership units involves the following additional steps:
1. Review the operating agreement
Before adding new membership units, it is important to review the operating agreement to determine if it allows for the issuance of new units and if there are any restrictions or conditions that need to be met.
2. Voting on Adding New LLC Member
In order to add new members to your LLC, you must have the agreement of all current members, as their ownership stakes would be diluted by the addition of new members.
Any member has the right to veto the addition of new members to prevent further dilution of ownership. Therefore, new members can only be approved if they are seen to be of clear benefit to all current members.
Factors To Consider Before Creating Membership Units In An LLC
When considering setting up membership units within an LLC, there are some questions you should ask LLC members:
- Number Of Members: How many people do you anticipate owning a stake in your business? This will affect how you allocate membership unit shares/ownership Ownership Status: Who will own what percentage and will any ownership change over time? Do all members need equal voting power?
- Asset Value: Do all shareholders need access to shared assets like cash or property? You’ll need to define who has a claim over which assets.
- Taxation & Fees: Will there be tax liabilities associated with new ownership interests? Will any filing fees associated with creating new shares need to be paid?
Benefits Of Having An LLC With Membership Units
There are several advantages associated with forming an LLC with membership units instead other types of corporate structures:
- Limited Liability Protection: Members will generally not be held personally liable for debts incurred by the company if they hold less than 50% in ownership/shareholdings.
- Tax Efficiency: An LLC allows owners/members to pay fewer taxes due to its “pass-through taxation” status.
- Operational Flexibility: Having multiple members allows more input into operations and decision-making when needed.
- Increased Assets: As more members join a company, it typically results in additional assets for investment possibilities.
- Different classes of membership: LLC membership units can be structured to provide for different classes of membership, each with different rights and responsibilities. For example, some members may have the right to vote on company decisions, while others may not.
Disadvantages of LLC Membership Units
There are some disadvantages of LLC membership units stated below:
- Difficulty in liquidating interests: Unlike corporations, LLCs are not publicly traded and so it can be more difficult for members to liquidate their interests in the company.
- Complex tax treatment: The tax treatment of LLC membership units can be complex and may vary depending on the specific circumstances of the company.
LLC membership units are a flexible and useful tool for structuring the ownership of an LLC. However, they should be used with caution, as the tax and legal implications can be complex and should be carefully considered before implementation. It’s always best to consult with a lawyer or an accountant before making any major decision regarding LLC membership units.
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