Owners in a Delaware limited liability company (LLC) are known as members. And while forming and managing your business is easier with an LLC, there is one issue that can complicate things. LLC members aren’t permitted to freely transfer their membership interests.
Because LLCs aren’t bound by corporate formalities, the sale and transfer of membership interests can be more complicated. It is critical to draft a detailed Operating Agreement that describes the process for transferring membership interests in your LLC.
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Delaware refers to Operating Agreements as limited liability company agreements. While Delaware law doesn’t require LLCs to have an Operating Agreement, the document can help you outline the rights and obligations of the members of your LLC. Without an Operating Agreement, your LLC operations are dictated by Delaware’s default LLC laws. The Operating Agreement can include important details about your LLC, including:
After completing your operating agreement, all the members of an LLC sign the document as a form of consent.
Transfers of ownership go more smoothly if your Operating Agreement details a procedure for buying out and selling the LLC’s membership interests. If you don’t have an Operating Agreement, the transfer and sale of membership interests in the LLC are governed by Delaware law. Under Delaware law, LLC members are permitted to assign their LLC interests to another party. However, that doesn’t automatically make the person receiving the interest, known as the assignee, a member of the LLC. After transferring the LLC interest to the assignee, the assignee is entitled to share in the profits and losses of the LLC, to receive distributions, and to receive allocation of income, gain, loss, deduction, or credit similar to that of the former member. However, the assignee can’t become an actual member of the LLC unless every member of the LLC consents. This means that they can’t exercise any of a member’s rights or powers to manage the business. However, if and when all of the other members consent, the assignee becomes a member and has the rights and powers of the other LLC members.
Having an Operating Agreement for your LLC allows you to set your own procedures for the transfer and sale of membership interests rather than relying on state law. Additionally, sometimes an Operating Agreement is required before your LLC can complete other business activities, like opening a bank account. Even though drafting an Operating Agreement might seem like a hassle, it can save you from extra work down the road. Don’t know where to start? We provide Operating Agreement Templates to help you draft an Operating Agreement that fits your needs.
There are two common methods for transferring an LLC membership interest without dissolving the LLC entirely: (1) a partial sale, also referred to as a buyout; and (2) a full entity sale.
Sometimes an LLC member may wish to leave the LLC. When that happens, the other members of the LLC can make a deal to purchase that member’s interest in the company. Then, the membership interest can be redistributed between the remaining LLC members.
The procedure for buying out the membership interest of one of the LLC’s members should be clearly outlined in your Operating Agreement. The buyout provision details:
Having a thorough and comprehensive Operating Agreement that outlines the process for transferring ownership interests in your LLC is the best way to avoid disputes among LLC members.
Alternatively, you may want to sell the entire LLC. A buyer might ask you to purchase your entire business or just the assets of the LLC. Again, your Operating Agreement will govern the rules and procedures for selling the LLC. If you don’t have an Operating Agreement, the sale of your LLC is governed by Delaware law. Under Delaware law, sale of the entire LLC must be approved by all of the LLC’s members.
When transferring full ownership of your LLC, draft and execute a buy-sell agreement with the individual or entity seeking to purchase the business. This document details the terms of the sale by naming the assets being sold, the timescale for the sale, and other important information. Selling your entire LLC is a complicated process, so consult an attorney if you plan on heading down this path.
There are other situations where transferring ownership interests in your LLC might be necessary, including any circumstances outlined in your OA triggering a sale.
Depending on their estate plan, a member’s ownership interest in the LLC will pass to their spouse or children after they die. However, whoever receives the ownership interest will be considered an assignee, meaning they can collect profits and other benefits from the LLC. However, the assignee doesn’t have the right to participate in running the company like a member does. It’s typically recommended that the LLC buy out the assignee’s interest through the process outlined in the Operating Agreement for partial transfers.
If you have several members seeking to leave or join the LLC at the same time, doing multiple partial transfers of ownership interests can be tedious and stressful. In these situations, dissolving the LLC entirely and reforming another LLC provides a simpler option. By reforming a new LLC, you can easily add new members while the former members wanting to leave can do so.
Delaware does not require LLC members to be named in the Certificate of Formation when creating the business. Thus, there is no requirement to file an amendment advising the state of Delaware of membership changes. Following the transfer of all or part of your LLC, the new Operating Agreement needs to be amended to reflect the name(s) of the new member(s). LLCs aren’t required to file their OA with the state of Delaware. If you end up selling the LLC entirely, you’ll also need to fill out the right IRS forms to confirm the transfer of ownership.
A partial or full transfer of your LLC can be frustrating, especially when you’re forced to rely on default state laws. A well-drafted, detailed Operating Agreement is the best way to simplify the process and document the procedure at the outset of your business. Whether you’re just starting your business or are seeking to update your internal procedures, ZenBusiness’s Operating Agreement template is the best place to begin. If you run into issues completing a full or partial transfer of your LLC, consult a Delaware attorney familiar with business contracts for professional advice.
Disclaimer – The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
The terms of an LLC’s Operating Agreement can outline the process for members seeking to sell their membership interests. Consult your Operating Agreement for the procedures surrounding the sale of a membership interest.
Subject to the terms of its Operating Agreement, LLCs can issue new membership interests with the consent of all members of the LLC.
The IRS doesn’t recognize LLCs as a form of business entity, and requires LLCs to be classified as either corporations, partnerships, or sole proprietorships. If you transfer your entire LLC, file a Form 8822-B, Change of Address or Responsible Party – Business, with the IRS within 60 days of the sale.
Having an ownership interest in an LLC is what makes someone an LLC member. Members have management and decision-making authority over the business. Assignees can have only a financial interest in the company without having “ownership” interests that allow them to manage the operations. However, LLC members can hire officers to manage the day-to-day affairs of the LLC who do not possess an ownership interest in the company.
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