In entrepreneurship, change is a constant factor that is bound to happen. Business owners who were once passionate about their endeavors may face new opportunities or life situations that lead them to prioritize other things. In the case of members of a Limited Liability Company (LLC), what happens if they want to transfer ownership interests? This article will review some factors that can impact this process.
You Have Options
There are essentially two ways to transfer LLC ownership: full and partial transfers. Partial transfers are less complicated than complete transfers, which have significant tax consequences. A partial transfer occurs when only a portion of the ownership is transferred, while a complete transfer occurs when one or more LLC members sell all their ownership interests to someone else.
Create an Operating Agreement
An LLC operating agreement outlines the rules and procedures for transferring ownership interests. Ideally, it should describe what happens when a member dies, retires, leaves the company, or is involuntarily removed. Some agreements require departing members to offer their interests to other members before selling them to an outside party. They might also have requirements for handling the valuation of a member’s ownership interests.
Create a Buy-Sell Agreement
Many multi-member LLCs have a buy-sell agreement in their operating agreement, a contract between the LLC owners that defines various conditions related to selling LLC membership interests. These documented conditions include what events trigger the sale of membership shares, who may purchase LLC membership interests, how to determine the selling price of the interests, and how to fund the sale. LLCs that don’t have a buy-sell agreement can add one by drafting an amendment to their operating agreement and voting to approve it. Usually, the LLC operating agreement or buy-sell agreement will state how to determine the value of the ownership percentage being sold. Valuation steps might include having a third party assess the company’s net worth so the price for ownership interests can be calculated. When adding new LLC members, the sum of all members’ ownership percentages in the LLC must equal 100%. The percentage of ownership might be determined by the members’ initial financial and property investments in the LLC, their degree of involvement in managing the LLC, or other factors.
Transferring ownership of an LLC has tax consequences that may be confusing and complicated. Therefore, it’s essential to consult legal counsel and a trusted tax expert for guidance. Whether an LLC is taxed as a Sole Proprietorship, Partnership, S Corporation, or C Corporation will affect the tax liability when transferring LLC ownership interests. The type of sale (entity sale or asset sale) also affects taxes. There is no universal formula for transferring ownership of an LLC because every scenario is unique. However, the steps involved include:
- Reaching out to an attorney and tax advisor for guidance.
- Reviewing the LLC operating agreement and buy-sell agreement.
- Determining the asking price for the ownership interests.
- Creating a purchase agreement.
- Filing any necessary documents with the state.