One of the most important steps when forming a limited liability company (LLC) is determining who owns it. Fortunately, when it comes to managing your business, LLCs offer great flexibility with minimum requirements in terms of organizational structure.
But what if you suddenly need to transfer your LLC ownership to someone else? Is that possible? It’s a bit complicated but doable – and this guide details how to transfer LLC ownership and when are the best times to do so.
What is an LLC?
An LLC is a popular business structure for startup companies due to its many benefits. An LLC provides personal liability protection, for example, so your assets are not at risk if your business is sued or cannot pay its debts.
Also, an LLC is a “pass-through entity” in taxes, meaning that the LLC itself is not taxed. Instead, income passes through the company to the LLC owners or members, who report it on their tax returns.
LLCs also offer flexibility in management, as there are few requirements regarding organizational structure.
What is an Operating Agreement?
Most states do not require an operating agreement, but it’s a very important document. We highly recommend creating an operating agreement, as it renders significant benefits and advantages:
- Liability protection: Unlike a sole proprietorship, an LLC is a separate entity from its owners or members and thus has its assets and debts. As a result, your assets are protected, which is especially beneficial to LLCs with only one member.
- Transparent organizational structure: A clearly defined management and ownership structure reduce the potential of future issues or disputes related to decision-making or how to execute a process– like transferring ownership.
- Overrides state-default LLC operational rules: LLCs that choose not to create an operating agreement is subject to the state’s default rules in which they’re registered. An operating agreement gives LLC members control over management roles and profit allocations.
What Does an Operating Agreement Define?
An operating agreement should address the following:
- Management structure and member roles
- Each member’s percentage of interest in the LLC
- How to allocate profits and losses to each LLC member
- Rights and responsibilities of each member
- Voting rights of each member
- Rules and protocols for LLC meetings and votes
- Steps to follow when an LLC member:
- Sells their interest
- Leaves the business
- Transfers ownership
- Becomes disabled
The language of an operating agreement is crucial and often helps determine how member disputes will be resolved and how to transfer ownership of the LLC.
Approaches for Transferring LLC Ownership
1. The Member Buy-Out
Your operating agreement should define and clearly outline the procedure for transferring ownership via a buy-sell agreement.
When a member leaves the LLC, the buy-sell agreement details what needs to take place to properly and effectively buy them out. Your LLC’s buy-sell agreement should specify the following:
- How to value the departing member’s ownership share or percentage
- Whether the LLC must purchase the departing member’s ownership stake
- How to distribute the remaining ownership units
- LLC members’ process to approve an ownership transfer
Keep in mind that a buy-sell agreement plan detailed in your operating agreement will override your state’s existing member buyout laws and regulations. For instance, some states mandate that the LLC be entirely dissolved, which can be discouraging and complicated.
You can find free operating agreement templates online, but it’s best to have them drawn up or reviewed by an attorney. Creating an operating ag
2. Add a New LLC Member
Your business’s operating agreement should provide detailed information on how to add a new member to the LLC.
During an LLC meeting, all members typically need to agree on any decisions and actions taken on behalf of the business. This extends to any changes made to the LLC’s management and ownership structure and the related implementation process.
Additionally, all members must agree on a protocol to change the LLC’s ownership percentage structure and the corresponding impact on member distributions.
Your business’s operating agreement should detail the process, but LLC members typically vote on adding a new member.
3. Sell Your LLC
If you’ve decided to sell your LLC, this will also require you to transfer ownership. But it’s important to note that in this situation, you won’t find instructions or steps detailing how to conduct the process in your operating agreement.
This is because your operating agreement cannot determine ownership valuations – mainly determined by the market. LLC members will thus need to agree on a price with the buyer and draft a transfer of business ownership agreement, preferably with the advice of an attorney.
Amend and Update Ownership Documents
Once LLC ownership is transferred, it’s essential to go back and amend the associated ownership details provided in the articles of organization filed with the state.
Also, alert the IRS of any change in ownership, and note that the new owner may need to acquire a new tax identification number, or EIN. Every state has its amendment process, so check with your state to ensure you meet the requirements for legal compliance.
If your business is registered in other states as a foreign LLC, you’ll want to review and comply with each state’s amendment process. Be warned that some states prohibit the transfer of ownership.
LLCs registered in states that do not allow the transfer of ownership are usually required to dissolve the business, then the new owner forms a new LLC. In these cases, the buy-sell agreement should address whether the assets of the original owner will be transferred.
To Sum it Up
Business is often unpredictable, and at some point, you might find yourself seeking to transfer the ownership of your LLC. Therefore, it’s in your and your business’s best interest to be prepared for these eventualities with a robust operating agreement.
You can find free operating agreement templates online, but it’s best to involve an attorney in drafting an original document specific to the needs of your LLC. Expert guidance helps ensure that the agreement protects all your LLC members and the business.