One of the reasons why entrepreneurs find the Limited Liability Company business structure attractive is that it gives them flexibility in dividing ownership among the LLC’s members. How you determine LLC ownership percentages can be based not only on members’ financial stakes in the company but also on the expertise they bring and the time and effort they spend managing and working in the business.
While LLC members can have different ownership percentages, the ownership interests of all members in total must add up to 100%.
For example, a multi-member LLC with three members might apportion its ownership as follows:
35% (Member 1) + 35% (Member 2) + 30% (Member 3) = 100%
If any member leaves the company (e.g., retires, dies, sells their interest) or the owners decide to bring on another member, the ownership percentages must be changed so that the combined interests equal 100%.
For instance, using the scenario above, if the company adds a fourth member.
In this case, the multi-member LLC ownership percentage breakdown might look like this:
30% (Member 1) + 30% (Member 2) + 20% (Member 3) + 20% (Member 4) = 100%
Four Steps for Changing Ownership
1. Abide by the LLC Operating Agreement
An LLC Operating Agreement, the company’s governance document, should disclose the LLC’s members and their ownership interests. It should also describe the procedure for changing ownership percentages under various circumstances, such as:
- Adding new members
- Death of a member
- A member wishing to sell their ownership interests
- Owners want to divide their interests among themselves differently
- Securing a business loan from a financial institution that requests ownership shares to be apportioned more equally
Typically, the business owners must write a resolution to amend the LLC Operating Agreement to change the ownership percentages and then have the owners sign it to document their approval.
If an operating agreement exists but does not include membership percentages or provisions for changing them, members can vote to amend it to include the information. If no operating agreement exists, members may need to create a separate buy-sell agreement for changing ownership interests. Another option is to follow the state’s rules for transferring or changing ownership interests.
2. Issue New LLC Membership Certificates
LLC members should relinquish existing ownership certificates after changing ownership percentages. They should then issue new LLC member certificates with the correct information to their members.
3. Inform the State
Although states don’t typically ask a multi-member LLC to include ownership percentages in its formation document (Articles of Organization), some states do ask for members’ names and addresses. If changing ownership shares has occurred because new members were added or existing members were removed, the LLC must notify the state by filing Articles of Amendment to update the company’s public record.
4. Inform Other Parties and Stakeholders
LLC members should consider whether they must notify other individuals or companies about changes to the LLC’s ownership — particularly if a change in ownership percentage has affected individual members’ authority or responsibilities. For example:
- If the LLC’s registered agent lists a departing member as the contact person for the LLC, the members should let that registered agent services provider know who the new point of contact will be.
- Likewise, the IRS will need to know (via Form 8822-B, Change of Address or Responsible Party) if an LLC member who served as the responsible party for the entity no longer has ownership interests.
- If the individuals authorized to access the LLC’s bank and credit card accounts will change, the LLC’s members should notify the financial institutions per those organizations’ policies and procedures.
Also, LLC members may need to notify customers and vendors if the company has added new members or existing members are leaving. Whether this is required depends on the LLC Operating Agreement, contractual obligations, and state laws.
How You Divide LLC Ownership Matters
The percentages that each member owns affect various aspects of their business involvement:
- Their share of business profits – Unless otherwise stated in the operating agreement, a member’s distribution of profits will correspond to their ownership percentage.
- Their voting rights – An LLC member’s ownership interest affects their voting power in the organization. Unless the operating agreement states otherwise, votes by members with higher ownership percentages weigh more than those with lesser ownership percentages.
- Personal liability for business loans – If the LLC takes out a business loan that requires the members to guarantee it personally, members with higher ownership percentages will bear more personal responsibility for that debt.
The division of LLC ownership has legal and tax implications, so it’s essential to understand how any changes to the balance of power will affect the business and its owners. Consulting an attorney and tax advisor for guidance can help LLC owners make informed decisions and avoid unwelcome surprises that could put them at risk of non-compliance with their internal governance documents and their state’s laws.
For a deeper dive into what’s involved when transferring ownership interests, check out my recent article on transferring LLC ownership.
