With a limited liability business, the options are virtually limitless (LLC). These rather informal corporate forms offer protection from personal liability, tax advantages, and ease of creation. To safeguard their personal assets, owners of general partnerships and sole proprietorships frequently decide that the work of incorporating an LLC is worthwhile. The good news is that you may always make adjustments to your ownership structure over the course of the company. We’ll guide you through the LLC member addition process.
Overview of LLC Membership
LLCs are created under state law, so rules may vary depending on where you form your business. Generally, an LLC can have one to an unlimited number of members. Members can consist of individuals or other legal entities, including corporations, other LLCs and foreign business entities.
At formation, your initial members will be listed in the documents filed with the applicable state agency (usually the secretary of state). The formation document is typically called the articles of organization or certificate of formation depending on the state. Some states require members or initial organizers to be listed in the formation documents, and some don’t.
Every LLC should have an operating agreement drafted at formation which details how the business will run, however, only a handful of states require such an agreement by law. In any event, your operating agreement should list your LLC’s members and their individual ownership interests.
Ownership interest is often based on the size of capital contribution to the business initially, which can include financial contributions or other forms of labor or capital, like real estate. An operating agreement also spells out decisions on voting rights of current members and management structure.
Process for Adding New Members to Your LLC
The process for adding members to your LLC will be different depending on how many members your LLC currently has. If you’re currently the only member of a single-member LLC (SMLLC), that means you’re the sole decision-maker and can add any members you want (though you should still carefully vet new business partners in any situation). If you’re part of a multi-member LLC (MMLLC), adding a new member will include extra steps.
Adding Members to an SMLLC
If you’re the single owner of a small business, it’s your prerogative to add any member you want. Upon growing your membership, you’ll need to do the following:
- Update your operating agreement to include new members, their ownership percentage, duties and responsibilities, distributions, share of profits and losses and voting rights
- Update your contact information with the state by filing articles of amendment with the same state agency where you filed your formation documents
- File any necessary tax forms with the Internal Revenue Service (IRS)
- Obtain an employer identification number (EIN) from the IRS (if you don’t have members or employees, you can use your Social Security number as identification unless you’re opening a bank account for your business)
Unless you’ve elected either S-corp or C-corp tax status with the IRS, your LLC will go from being taxed as a sole proprietorship (or “disregarded entity”) to being taxed as a partnership. These are essentially the same — the default tax status for any size LLC is a “pass-through” entity, meaning income passes through to the owners’ personal income for tax purposes.
Adding Members to an MMLLC
If there are multiple members of an LLC, they’ll vote on the addition of new members. Depending on your operating agreement, existing members’ votes may depend on ownership percentage or may all be weighted the same. Your operating agreement could require a unanimous vote to add a member, or simply require a majority vote. If you don’t have an operating agreement or it doesn’t spell out the process for voting on new members of the LLC, your state’s LLC laws will apply.
The same post-addition steps will apply whether you’re transitioning from an SMLLC to an MMLLC or adding members to an existing MMLLC. You’ll need to update your operating agreement, agree on distribution of profits and losses, update your contact information with the state if necessary and file necessary tax forms with the IRS.
Tips for Vetting and Negotiating With New Members
Before formally forming an LLC, it is advisable to get advice from a company attorney or other small business expert (such as a tax accountant), unless you have known your new member for a considerable amount of time and you trust them completely. Here are some actions to take before choosing to admit a new member, before we discuss the repercussions of doing so.
- Make a background investigation. For a fair price, several background check businesses will do this job. Ask the prospective new member to complete an application, then compare the answers with the background check findings. Make sure they are honest about everything that could come up, or else you might not be able to trust them.
- Speak with previous associates and coworkers. How well does this person work with you? When it comes to making difficult judgments, are they reasonable? Are they dependable workers?
- Verify again and again! To ensure the accuracy of the information, try to obtain it from many sources. Make sure your choice is sound because it’s more harder to delete a member than to add one.
Implications of Adding New LLC Members
There are a few other things business owners need to consider when adding new members.
Changes to Your LLC Operating Agreement
If you’re the sole owner of an existing LLC and are considering adding a member, you’ll be changing from a SMLLC to a MMLLC, and your operating agreement will need to reflect that changed structure. Even if you already have multiple members, you’ll need to reconfigure the share of profits each member receives from the income of the LLC, as well as their voting rights, duties and responsibilities.
Once you amend your operating agreement, ideally with the help of a legal or business professional, keep a new copy on file signed by all of the members. If you live in a state that requires an operating agreement, file the new copy with the state.
Management Implications
If you’re transitioning from a single- to multi-member LLC, you’ll need to decide whether the members are responsible for day-to-day operations (member-managed LLC) or whether you’ll hire a third party to manage (manager-managed LLC). Your operating agreement, often the state formation documents on file, will need to reflect this designation.
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Tax Implications
The new organizational structure of your company and any resulting adjustments to recognized income will be included in your tax filings. For instance, distributing the profits across several members may momentarily lower each member’s tax obligation. It’s also possible that adding a commercial organization or a non-resident individual as a member will prevent you from choosing S-corp status. See a tax professional to ensure you are aware of all the consequences.
Frequently Asked Questions
How do I add a new member to my LLC?
If you’re the sole member of your LLC, you can add a member by updating your operating agreement and formation documents to reflect changed membership. If you’re part of a multi-member LLC, you’ll need to discuss additional members with current members and hold a vote before proceeding.
Can you change members in your LLC?
Changing membership in your LLC is governed by the terms of your operating agreement or, if you don’t have an operating agreement or it’s silent on transferring membership interests, the laws of your state will apply.
How do I add multiple members to my LLC?
Adding multiple members to your LLC is accomplished the same way as adding a single member, it only requires more paperwork. Make sure to be diligent in vetting your members, no matter how many you plan to add.
Is it better to have more than one LLC owner?
For decision-making purposes, it’s helpful to have more than one perspective on business plans and operations. However, more than one member, and especially having many members, can slow down the decision-making process if you find it difficult to come to an agreement.
Is it possible to alter an LLC’s ownership percentage?
Yes, it is possible to update your operating agreement and change the proportion of ownership held by each member of an LLC, provided that the necessary number of members agree (by majority or unanimous vote).
How do I change the ownership of my LLC with the IRS?
You don’t necessarily need to report ownership changes to the IRS unless you’re changing your tax designation. Most of the changes are relevant at the state level.
Can I give someone a percentage of my business?
The laws of the state in which your LLC was established, or your operating agreement if you don’t have one, control the transfer of ownership interests.
Can LLC members take unequal distributions?
Yes, provided that the distribution plan is specified in the operating agreement and does not manifestly discriminate against any member, LLC members may accept uneven dividends. Otherwise, if a member chooses to file a lawsuit to recover a fair portion, the court may not uphold an unjust operating agreement.
Does adding a new member to my LLC incur any fees?
The filing fee for changing your formation documents plus the cost of any legal counsel you seek prior to changing your operating agreement make up the majority of the costs connected with adding a member to your LLC.
