If you are considering forming a limited liability company (LLC) or already have, you may wonder if your LLC can issue stock. Unfortunately, the short answer is no – only corporations can issue stock. But this does not mean you can’t raise money from investors.
You’ll just have to do it a bit differently. This handy guide explains all you need to know about the differences between a corporation issuing stock and an LLC raising capital.
LLC owners are called members, and their share is a percentage that often dictates how members’ profits and losses are allocated.
Usually, members have invested capital in the company or gained an ownership share for other contributions, such as contributing work for equity. Members’ ownership shares are generally based on the amount of their contribution, but they can be proportioned in any way the members choose.
All members get a share of profits, usually based on their ownership percentage, voting rights, and other rights defined in the operating agreement. Members can be individuals, corporations, or other LLCs. An LLC must have at least one member, and the number of members it can have is unlimited.
The exception is when an LLC chooses to be taxed as an S-Corp. In that case, the LLC can have no more than 100 members.
A corporation is created when it is incorporated by a single shareholder or group of shareholders who hold ownership in the form of common stock. Shareholders pay for the common stock but have no further financial responsibilities to the company. They do, however, share in the profits.
Shareholder stock can be sold or transferred to someone else. New shares of stock can also be issued if approved by the board of directors, which a corporation must have. When new stock is allocated, the value of the shares of the current shareholders is proportionately reduced.
LLCs are pass-through entities, which means income passes through to the member or members. If the LLC has only one member, it’s taxed as a sole proprietorship. If the LLC has more than one member, it’s taxed as a partnership.
However, LLCs are unique because they can elect to be taxed as a corporation if the members decide it makes financial sense. This is done by filing an election form with the IRS. In addition, you can choose to be taxed as a C-Corp or an S-Corp.
C-Corp status means income is taxed at the current rate for corporations (21% as of late 2022), which is lower than the usual individual taxpayer rate. But keep in mind that C-Corp shareholders – who are members in the case of an LLC – must also pay taxes on their distributions. This is called double taxation.
However, members are subject to self-employment tax in an LLC that is taxed by default as a sole proprietorship or partnership. Once such LLC switches to being taxed as a corporation, self-employment taxes no longer apply.
Similarly, self-employment taxes do not apply to members with S-Corp status, which is the main advantage of electing S-Corp status.
With S-Corp status, members are generally paid as company employees, which means more accounting and payroll expenses. Therefore, S-Corp status is only beneficial when the self-employment tax savings are more significant than those additional expenses.
It’s important to note that electing to be taxed as a C-Corp or S-Corp only applies to taxation and DOES NOT enable an LLC to issue stock.
Raising Capital for an LLC
First, it’s crucial to have an operating agreement in place for your LLC. An operating agreement will define how an investor can be added as a member.
If you have an investor for your LLC, you’ll structure the deal as a capital contribution made in exchange for a certain percentage of ownership, also known as equity, in the LLC. You’ll need to negotiate with the investor to determine their role in the company and their voting rights.
If the investor is a professional, they will likely want some control in the company, so you’ll probably be sacrificing some control and ownership. Generally, existing members will reduce their ownership in equal amounts that add up to the investor’s ownership percentage.
The operating agreement will need to be amended, which requires member approval.
If you have an operating agreement, or the existing one needs to outline how to add a new member, the process becomes much more difficult. State laws will apply, and if they are unclear, all parties will have to somehow agree on the process and terms of the deal.
This explains why investors are often hesitant to invest in an LLC. Corporate ownership is much easier to transfer.
The answer to the original question is no; an LLC cannot issue stock. But it can raise investor capital – it’s a slightly more complicated process.
If you are just starting your business and hope to raise capital, you should consult with an attorney and tax advisor about the right business structure for you.