Introducing another key member to your company is in itself a neutral process and can be motivated by various aspects influencing your enterprise. That said, the procedure will likely change the fundamental nature of your company regardless of the reasons for membership expansion. So whether you are looking for new pathways to investment or need to optimize operations through additional assistance, it’s important to follow both internal and external regulations designed to mitigate the change.
What Is an LLC?
The limited liability company is one of the four main business types that combines the features of other structures which nevertheless makes it wholly unique. Participants in an enterprise of this type are called members who are distinctly separate from the identity of their entity unlike proprietors and partners of informal bodies. This is exactly what makes this business model so attractive—the ability to protect personal securities while enjoying the benefits accessible to non-corporate entities.
Another definitive feature of the LLC is its flexibility, specifically the freedom of choice it gives the ownership group in regards to the tax system. Although the default classification of the structure is that of a pass-through, it is entirely legal to change the system to a corporate one, either C- or S-corp. All members get to have a vote on this and other aspects of company management regardless of their investment share unless stated otherwise.
Steps to the Process of Adding a New Member to Your LLC
Before even considering any changes to your membership group, make sure to fully outline the benefits and drawbacks of this decision. Most of the time, bringing someone new isn’t that complicated. The risky part is successfully integrating them into the company without incurring losses or inflicting lasting damage on the entity’s internal structure. This is why it’s paramount to discuss any potential changes to the executive body with other owners and outline your action plan.
1) Refer to the Operating Agreement
The standard business practice recommends that this procedure be outlined in the internal regulatory documents, in this case, the Operating Agreement. While the drafting of one is not mandatory by any form of corporate law, it is nevertheless a step that companies rarely wish to skip. In addition to outlining key regulations in regards to the company’s leaders, staff, and important procedures, the document makes the removal and addition of participants almost seamless. After all, avoiding internal conflicts is in your best interests.
2) Negotiate the Conditions of the Amendment
Writing someone out or bringing in a new member both require you to make relevant changes in your amendment. These changes can only be settled on by discussing them with all current members that have a stake in the company. When the original membership group (as it appears in the first version of the agreement) is altered, the overall percentage interest must be adjusted based on the new circumstances.
This business structure is inherently flexible, meaning that you don’t always have to divide interest equally. There are multiple ways to assign asset distribution which is normally agreed upon during the formation. By bringing another person, all participants must settle on the new terms of distribution which largely hinges on the role the new member will play in the company.
3) Draft the Proposal
Before any changes can be officially signed, you should put the amendment in writing. The document must cover every essential, including the name of the new participant, the size of their contribution to the entity’s assets, their stake in the company defined through their percentage interest, as well as the exact portion of allottable profits and expenses.
4) Approve the Amendment
Once the official proposal is made, it should then be settled by each member casting their vote. This process is typically recorded in meeting minutes or through a resolution. The newly amended agreement is then authorized by all current members, as well as the newcomer who is now officially part of the ownership group.
5) Make Relevant Tax Filings
This step might not apply to everyone, but it’s always a good idea to keep your documentation as relevant as possible even if you don’t make any drastic changes in your taxation.
One of the most common reasons for making additional filings of this nature is the need to change the actual classification of the company. In other words, when a single-member LLC brings on a new partner or several, it must go through the process of changing its status to multi-member.
Most sole owners tend to stick to their SSN for tax purposes. But once you expand the membership group, it’s vital you obtain a tax ID also called federal employer identification number or EIN. Thankfully, it’s a free procedure, so you don’t need to pay the IRS any fees to get this number.
Another possible reason for filing is to authorize the change of your taxation method. As a structure, the LLC grants its owners the choice of the preferred tax system. If you’ve been sticking to the default pass-through system but now the members want to change it to a corporate one, the company must file Form 8832 to officially elect another classification.
Considerations for Adding Members to a Single-Member LLC
When your starting point is a company that was classified as a multi-member entity from its launch, altering its operational dynamics can feel considerably less dramatic than how the same process could come across for sole owners.
With the former, the procedure can even grow into a more or less automated mundane process if the company in question is fluid with its approach to ownership. The same can’t be said for single-member entities that decide to take on one or more new members, thus partially altering their base structure.
As the only owner of your enterprise, you have a huge responsibility to yourself and your company’s future when making any fundamental decision. Even if the new partner is someone you know closely, like a spouse or family member, the amendment process must be taken seriously. The consequences of changing this entity type to a multi-member one include:
- Dividing the percentage interest among all members instead of allocating all profits to the single owner;
- Having to negotiate every decision in regards to the company;
- Possibly obtaining a federal tax identification;
- Changing the tax classification from a sole proprietorship to a partnership.