At some point in your business journey, you may wish to add a member, or owner, to your LLC. Maybe you’ve found a new investor or wish to add a partner. No matter the reason, if you’re currently the sole member, you’ll need to shift from being a single-member LLC to a multi-member LLC, which takes some doing.
This handy guide lays out the process involved, as well as the implications of adding a member to your LLC.
1. Review the Operating Agreement and State Laws
The first step is to review your operating agreement. An operating agreement is not usually required by law but is highly recommended. The operating agreement specifies each owner’s percentage of ownership, their share of profits and losses, their rights, roles, and responsibilities, and what happens if a member leaves or passes away. It should also specify how to add a member and the voting process for doing so.
If you do not have an operating agreement, or your operating agreement fails to specify how to add members, you’ll need to check your state’s procedures for adding a member. Some states will require that you dissolve the LLC and form a new one. Once you’ve added a member or formed a new LLC, you should consider adopting an operating agreement. It is a crucial tool in case of member disputes and other ownership issues.
2. Decide on Terms of the Operating Agreement
The first step is to determine the ownership percentage, management roles and responsibilities, and voting rights of all members, including new members. Ownership is most often based on the members’ financial contributions to the LLC, but it can be structured any way you choose. All members should be in agreement on the specifics.
3. Amend the Operating Agreement
You or your attorney will need to prepare an amendment to the operating agreement to add the new member. The amendment should include the financial contribution of the new member, ownership percentage, and share of profits and losses. The members will then vote on the amendment, adopt a resolution agreeing to the amendment, and sign the amended operating agreement.
4. Amend the Articles of Organization
The Articles of Organization may need to be amended as well, if required by your state. If your state’s Articles of Organization don’t include member information, you will not have to do this. Every state is different, so check with your secretary of state’s office.
5. File Required Tax Forms
If your LLC was single-member and used your social security number for tax purposes, when you add a new member you will need to obtain an EIN.
EIN stands for Employer Identification Number and is like a social security number for your business, allowing the IRS to identify your business easily. It is also known as a Federal Tax Identification Number (FTIN), or sometimes for corporations a Tax Identification Number (TIN). You can request an EIN on the IRS website.
Once you’ve added a new member, your multi-member LLC will be taxed as a partnership, unless you decide otherwise. As a multi-member LLC, you can choose to be taxed as a corporation if it’s beneficial. Generally, this is done so members do not have to report all income on their personal tax returns and avoid self-employment tax. The main disadvantage is double taxation, as the corporation pays taxes on business income and shareholders pay taxes on dividends.
To choose corporation status as an LLC you need to file form 2553 with the IRS.
Consequences of Adding a Member to an LLC
Before you add a member, you should understand the impact and potential issues that could arise.
First, since ownership is now spread out among more than one owner, your ownership stake will be reduced and you will only receive a certain percentage of profits, as per your new operating agreement.
Second, if your LLC is member-managed, meaning members manage the LLC rather than third parties, your new member will have a say in decision making. Your operating agreement should specify how voting rights will work when members are not in agreement regarding an LLC decision.
Third, if your new membership structure turns out to be problematic, member removal can be difficult, as detailed in this Step By Step article.
Finally, taxation will change. If you were a single-member LLC taxed as a sole proprietorship, you’ll now be taxed as a partnership, unless you choose to be taxed as a corporation.
The process to add a member to an LLC is not difficult, particularly if you have an operating agreement that specifies the procedure. Still, you should consider speaking to your attorney before adding any new members to make sure it’s the right decision for you and your LLC. Your attorney should also be involved in amending your operating agreement to ensure all bases are covered, all potential disputes can be resolved amicably and your business remains on the road to success.