Can You Give Away Equity for your LLC
There are several reasons to give up your LLC’s equity. First, you may decide to do away with your membership in the company. You could choose to sell off the company. Members could also recruit a new member and add them to the ranks.
Whatever may be your rationale, you want to know if it is something you can do with your Limited Liability Company; and the answer is yes. Therefore, you can give away your LLC’s equity. However, you need to consider factors and challenges that affect this decision.
The equity transfer must follow the law, be appropriately done, and not lead you into a legal mess. In this article, we discuss the steps in transferring your equity. In addition, we will examine the types of equity transfers and the variables you need to consider during the process.
First, just in case, let’s make sure we fully understand what an LLC and its Equity is.
What Is an LLC?
LLC stands for Limited Liability Company. An LLC affords the business owners (referred to as members) the privilege of separating their personal and corporate finances. LLC members (owners) also choose their preferred taxation structure.
With this freedom, the members can choose to make the company free from any tax responsibilities. How? Instead of the business, members of the LLC will bear the tax burden personally when they receive profits. This pass-through is the default setting that the IRS classifies your LLC’s tax structure as upon formation. If there is one member/owner, it will be a pass-through entity; if there are 2+ member/owners, it will be taxed as a partnership where each owner attaches their share of the businesses profit or loss to their personal tax filing via a Schedule K-1.
Another prominent feature of a limited liability company is that members enjoy immunity from any debts incurred by the company. The law protects the members of the LLC from forfeiting personal finances in the event of company losses. A limited liability company could have single ownership. In this kind of ownership, the member maintains full business ownership. There is also multiple ownership where members share rights, liabilities, and decision-making responsibilities.
What Is Equity?
Equity is the contribution of LLC members to the company. Limited liability companies do not operate with or sell shares. Instead, members will hold a percentage of interest in the business depending on their agreement. Sole owners or single-members control 100% equity or company interest.
Transferring Your Equity
Almost every significant action you take as an LLC member will have legal implications, and transferring your equity isn’t exempted. So when moving LLC equity, you need to take great caution. The process involves many taxes, financial, and legal implications. Also, there are several wrong turns you can take in the process.
If you intend to discontinue your involvement with the business, you can sell your interest to the other members. The other members can then share your interest equally among themselves.
There is also the scenario where you and other members of the LLC may decide to sell your collective interests to an external party. Ensure that every member of the LLC is on the same page and agrees with the sale, usually majority rules or 50.1%. Members should prove their willingness to sell by being signatories to the transaction.
In either case, draw up a buy/sell agreement with the other party with the help of a lawyer. The decisions of the LLC members must adhere to the state laws. For example, Texas LLC laws won’t be the same as those of other states. Hiring the services and seeking guidance from a licensed attorney is one way to make sure you are on the right track every time.
To change ownership, you’ll make an amendment to your Company Agreement or Operating Agreement. This can be a simple fill in the blank form that states Member A, Member B, and Member C each sell x amount of their ownership to Party Z for $XX. All Members and purchasing Party’s sign the document and it is complete. Some other examples are that Member A could sell ownership to Member B, Member A and B sell all their ownership to Member C, or Member C sells 30% of their ownership to Member A and 70% of their ownership to Member B. The great thing about LLCs is that they are flexible.
The Operating Agreement
To avoid confusion and complexities, every LLC member must document their desire to work together. This document is called an operating agreement, and this document should be set up when the business is formed with the state. Any number of changes can be made later through Amendments or even adopting an entirely new Operating Agreement (can also be called a Company Agreement). However, not all states make operating agreements compulsory, and Texas is one example.
The absence of an operating agreement can produce sharp disagreement among members. The operating agreement contains every guideline that governs the operation of the LLC. Therefore, every member must accept all the terms and conditions stated in it to be binding.
The operating agreement acts as a constitution, spelling out how the company should run in as much detail as possible.
Your operating agreements should spell out:
- The rights and privileges of every member
- What percentages of interest belong to each member
- The procedure for new membership
- The voting rules among members
- The sharing formula for profits and losses
- Buy/sell provisions for LLC equity
An essential component of the operating agreement is guidelines on sales and acquisition of the company. Members are to consult the provisions of the operating agreement that govern the transfer of equity. A thorough adherence to the operating agreement will produce a hitch-free transfer.
What if There Is No Buy/Sell Provision in the Operating Agreement?
Many LLCs neglect to spell out buy/sell guidelines in their operating agreement. The absence of this clause is a famous obstacle to equity transfer. This is why it is essential to hire the services of intelligent lawyers before starting a limited liability company. If you’ve made this mistake, there is just one option available. Members have to agree to dissolve the LLC.
Dissolving the LLC, in this case, might sound like a far-reaching measure, but it is the safest and the only way out. After dissolving the LLC, parties can restart the process with the new membership.
Contact BetterLegal Today!
What if you don’t have to meander through the equity sales/transfer process maze? How about allowing us to save you the stress and do an excellent job on your behalf? Yes, all these are possible.
With BetterLegal, you can set up your company formally and have an Operating Agreement with the appropriate buy/sell provisions included. We handle any and all administrative challenges while you focus on other responsibilities.