Fact checked for accuracy by Billie Anne Grigg, a bookkeeper and Mastery Level Certified Profit First Professional.
You’re at the point where your LLC requires a new member. Congratulations! You’ve hit a significant business milestone.
You’re expanding, and it’s time to take on a new partner.
The next question in your mind will turn to the complexities involved with adding in the new member.
You should know that the process isn’t particularly hard to do. However, there are implications to taking this step that you need to know about.
In this article, you’ll learn how to add a new member to a single-member LLC and a multi-member LLC.
Understand the Implications of Adding New Members to Your LLC
Think carefully about bringing in a new business partner and LLC member. Doing so brings adjustments in the following areas:
- Taxes
- Profit distributions
- Decision making
- Personal asset protection
If you’re running a single-member LLC, consider that changing to a multi-member LLC ends the ability to get taxed as a sole proprietor. Instead, the IRS will tax the entity like a corporation or partnership. Of course, you may enjoy the tax treatment by changing your LLC’s tax status to that of an S corporation.
Adding a new member means that you’ll need to adjust profit distribution percentages. Even if you hold onto the majority of the stake in your company, you’ll see your share of profits go down after giving up some percentage to the new member.
Complexities arise when more people must give their go-ahead when making decisions. Make sure you’re 100% confident that the new member won’t create problems when crucial decisions need to be made.
The LLC structure’s personal asset protection provided to all owners is another area to think through when bringing in new members. It’s possible to lose that personal asset protection if any member:
- Mismanages the LLC by violating the operating agreement.
- Compromises the separation between the LLC and personal transactions. This can happen, for example, when a member personally guarantees a business loan.
- Commits fraud or engages in any type of illegal activity while representing the company.
Of course, many positive circumstances arise from adding new members. They might include an influx of new cash, improved expertise brought forth by the new member, or your ability to step back from managing the company’s day-to-day operations.
Can You Change a Single-Member LLC to a Multi-Member LLC?
Yes, you can change from a single-member LLC to a multi-member LLC. Consult your operating agreement for the required steps you laid out when forming your LLC. If you didn’t outline those terms in the operating agreement, follow your state’s guidelines for changing from a single-member LLC to a multi-member LLC.
Each state has different guidelines. Some states, for instance, require that you dissolve the single-member LLC and then start over with a multi-member entity.
Review Your Operating Agreement
In most cases, your operating agreement will have the requirements for adding a new member listed out for you. This is especially true if you’re already a multi-member LLC.
The central part of the process often includes holding a meeting with current members and voting the new member into the LLC.
The key to adding a new LLC member is following your operating agreement’s procedure precisely. Doing so helps prove that your LLC is a separate entity that follows its own guidelines. You don’t want to do anything during this change that might cause a judge to pierce the corporate veil at a future date.
If you don’t have an operating agreement, you should create one while adding the new member. An operating agreement is vital when running a multi-member company because it lays out the responsibilities and rights of each owner.
Hash Out the Specifics
Determine the specifics of the new arrangement between owners before finalizing the procedure. Each current owner must remain clear about how their relationship with the company changes as new members come in.
One of the critical aspects of the deal is discussing how ownership percentages change. Make sure all current LLC members talk through those percentages with the incoming member. If any discrepancies exist, you must hash out those details to the satisfaction of everyone involved before finalizing the new member vote.
Vote on an Amendment to the Operating Agreement
Once everyone involved agrees about adding in the new member and the changes that this action creates inside the company, it’s now time to amend the operating agreement.
The operating agreement amendment should list:
- New member’s full name
- The value of any capital contribution made by the new owner
- The new member’s ownership percentage in the LLC
- The percentage of income and losses that get allocated to the new owner
Hold the formal vote on the amendment to the operating agreement. This is easy if you’re the only owner of the company. Notate your decision to add a new member and mark down what you’re offering to the new owner, such as:
- Ownership percentage
- Managerial responsibilities
- Voting rights
Multi-member LLCs might require much more detailed discussions to finalize the transaction.
List the vote in the LLC’s resolution or minutes. Each LLC member must then sign the operating agreement amendment to finalize the action officially. File this signed amendment away with all of your LLC’s other important business documents.
Amend the Articles of Organization if Necessary
You’ll need to check with your state to determine whether it requires the LLC to file an amendment to the Articles of Organization. You already filed the Articles of Organization when you first set up the LLC with the state.
Some states require this amendment, while other states do not. For instance, you need to file ownership changes with the State Board of Equalization if you’re in California. You can find this information out by checking your particular Secretary of State.
File Any Required Tax Forms with Your State
The most significant tax filing change occurs when changing from a single-member LLC to a multi-member LLC. This is especially true if you previously ran the business through your social security number. Contact your Secretary of State to find out what tax form filings it requires.
Adding a new member and transforming the business into a multi-member LLC also requires an employer identification number (EIN). The IRS will give your LLC a free EIN.
It’s possible that you and your partners might want to change the way the IRS treats an already-existing multi-member LLC. For example, you might want to get taxed as a corporation. This requires that you file IRS forms to declare this new tax status officially.
You can file these tax changes on your own if you’re comfortable doing so. If you’d rather not do it yourself, then you can hire an accountant or attorney to do it for you.
The Last Word
It isn’t hard to add new members to an LLC. There are a few specific steps to take.
Your next action item from here is to discuss these changes with the new member if you’re expanding a single-member LLC into a multi-member LLC. Bring all current members and the new member together to discuss adding a new owner to a multi-member LLC.
From there, go through each step outlined above until the move becomes official.
Filed under: Advice Columns
