If you’re considering forming a limited liability company (LLC) or have already done so, you may wonder how to transfer ownership of your LLC, if necessary. This may be needed if you sell your business, add or remove members from the LLC, or change the ownership structure of your LLC. The method of ownership transfer depends on the reason for the transfer, and the details of your operating agreement.
What is an LLC?
An LLC is an increasingly popular business structure for startups, offering liability protection for ownership and greater flexibility than a corporation, particularly in terms of taxes. The LLC itself does not pay taxes. As a “pass-through” entity, income passes through the business to the owner or owners, who report it on their personal tax returns. An LLC is created by filing paperwork with your state, and nominal fees are involved.
An LLC offers its owner or owners, who are called members, considerable flexibility in terms of management. You can choose your management and operational structure and decide how you want to be taxed. Your LLC can have a single member or multiple members, all of whom have personal liability protection, meaning your personal assets are not at risk if you cannot pay business debts or are involved in a lawsuit.
What is an Operating Agreement?
An operating agreement is not usually required but is highly recommended. The operating agreement specifies each owner’s percentage of ownership of the LLC, their share of profits or losses, rights and responsibilities and roles, and what will happen to the business if a member leaves.
Having an operating agreement has several benefits:
- It protects your limited liability status, particularly if you only have one member, by firmly establishing your business as a separate entity from you, and not a sole proprietorship.
- It defines your management and ownership structure clearly to help you avoid decision making issues and disputes.
- It overrides the default LLC rules of your state that apply if you don’t have an operating agreement. With an operating agreement you have control over roles and profit and loss allocation. Without one, these rules may be up in the air.
The operating agreement will clearly define the following:
- The percentage of each member’s interests in the LLC.
- How profits and losses will be allocated to each member.
- Each member’s rights and responsibilities.
- The management structure and roles of members.
- The voting rights of each member.
- Rules for meetings and voting.
- What happens when a member wants to sell their interest, becomes disabled, or dies.
It’s a good idea to have an attorney’s help when drafting your operating agreement so that you can be sure you’re covering all bases to protect all members and avoid future issues.
Buying Out a Member of the LLC
Your operating agreement should have a clear process specified for transferring ownership of your LLC in the form of a buy-sell agreement. This covers what happens when you need to buy out a member who is leaving the LLC. It will detail how shares will be valued, whether the business has to buy back shares from the member, how remaining shares will be distributed, and how the transfer must be approved by members.
If you do not have an operating agreement, the details of a member buy-out will be determined by the laws of your state. Some states require that the LLC be dissolved, which can be very complicated. This is another good reason for having a thorough operating agreement.
Adding a Member to your LLC
If you are adding a member to your LLC, the operating agreement should have specifications for how this is done as well. Generally, you and all members must agree on the specific terms for changes to the ownership percentage structure, and how this will impact LLC distributions. Usually, members will vote to add a member and on any new terms. Again, the operating agreement should outline the details.
Selling the LLC
If you’re selling your business and need to transfer ownership, the valuation will not be determined by the operating agreement. You and the buyer will need to agree on a price. You will need to draw up a transfer of business ownership agreement to finalize the transfer, and the agreement must follow your state’s laws. You should have an attorney involved in this process.
Notifications and Documentation
In any transfer of ownership, your articles of organization filed with the state will need to be amended. Each state has its own process of amendment, so check with your state for requirements. The operating agreement will also need to be amended to reflect the change in ownership.
In some states, when you sell an LLC, you cannot transfer ownership. The existing LLC would instead need to be dissolved and a new one formed by the new owner. All assets of the previous LLC would be transferred to the new one. This should be addressed in your agreement with the new owner.
The IRS will also need to be notified of the change of ownership, and the new owner may need to obtain a new tax number, or EIN.
If you’re registered as a foreign LLC in other states, you will need to follow their procedures to amend your articles of organization in those states.
Transferring ownership of your LLC may become necessary at some point, whether to add or remove a member or to sell your business. It’s best to be prepared with a robust operating agreement that will outline exactly how this will be done. If you don’t have an operating, it’s not too late – create one as soon as possible. While the process to do so is not complicated, an attorney should be involved to ensure the protection of all members and the business. You don’t want the business you have worked so hard to build to be left vulnerable due to a simple administrative or legal oversight.