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How to Add New Members to Your Limited Liability Company

April 16, 2019

Posted in Corporate Law, Uncategorized

You may be in the situation that your company is thriving, but you need more resources or funding to expand, to grow, to take your company to the next level.

So you are looking for investors to inject additional funding into the company by selling a portion of your company formed as an LLC.  So how do you do it?

1.  Knowing what you are getting into

The first thing that you need to do is, you need to understand both the positive and negative consequences of having a new partner.  One benefit is that you’re going to attract additional funding for growth; obviously, new members are going to come in, and they agree to provide a certain amount of money in exchange for a certain percentage of ownership of the company.  Another benefit is that this partner might have additional resources that you don’t have. They might have new connections, unique insights, the latest knowledge, or new skills, which you currently don’t have and which is what your company needs to expand and to grow.

On the other hand, what are the potential downsides?

Well, since you have another partner coming in, you have an additional partner to divide the profit with.  In other words, if the amount of profit remains the same, and there are more people to share, the percentage will be reduced.  However, this scenario may not happen if the company’s revenue increases due to its growth in capacity. The percentage of distribution may be reduced, but the actual amount may be the same or more.

Now another potential downside is changing the dynamics of a company. The new partner is coming into the company; he or she has a different personality, different energy, and different ideas, and different ways of getting things done. The presence of a new member may contribute to a different working environment or change the company culture.  

One thing is sure, the working relationship has a new dynamic, and that’s something that you need to consider about whether or not this investor who is interested in being admitted as a new member is a good fit for your current company culture and is compatible with the core value of your company.

Now, having a new member in your company is like a marriage. Tying the knot is easy. Getting out may be difficult and always comes with consequences. Positive or negative, depending on how the relationship ended.  So, think carefully before you decide to have a new partner in your company.

Also, there may be some tax consequences if you choose to have new members join in, and that’s something you should always consult with a qualified CPA.

2.  Review the Operating Agreement

Now, the second thing that you need to do is, you need to review the operating agreement. An excellent operating agreement should describe the procedure that you must follow to add new members. Most importantly, you need to follow the process to the letter.  

If your operating agreement mentions nothing about the procedure for admitting new members, you need to call our office right away, and we will discuss how you can do it by the statute.

Now, at this point, it is a good time to review and update your current operating agreement.

Documenting the voting process:

So the final step is that you need to take a vote among the existing members and then record that voting process and the results in the form of meeting minutes. It will serve as a paper trail. In the event of misunderstanding or dispute, later on, you have the documents to fall back on, and see what was agreed what went on.

Now, if your LLC does not have an operating agreement, call our office right away.  It’s very, very important to have an operating agreement for your LLC. It’s an operating agreement and is a governing document of your LLC.  It’s an opportunity for you to write down the rules, regulations, procedure, and process that your LLC needs to operate under.

If you don’t have an operating agreement and in the case of dispute, the court is just going to say, “You know what, we allowed you to write your own rules, and you didn’t. Therefore we’re going to apply the rules according to the California Corporations Code which may or may not suit your needs.” If it doesn’t work for you, you cannot complain at that time. Your complaint, unfortunately, will most likely not work.

3.  Decide on the specific terms agreed on with the new member

Now, the third thing you need to decide on is the specifics of the arrangement. What do I mean by that? For example, what is the percentage of ownership? How you’re going to distribute the profit -When, how, and how much?  Whether or not the members or owners are going to have two different classifications of ownership interest – Class A or Class B?

Each class of ownership interest may have different rights and responsibilities. So you have to decide on that.

Also, what are these new members going to do? What are they contributing? Are they contributing different assets than the money? What is he or she going to provide to the company? What are the rights and responsibilities of these new members? Whether it’s going to be the same as the original members or going to be slightly different, or being modifying one way or the other?

Like I said, LLC is a flexible business entity. There are rules and regulations you need to follow of course but it is a flexible business nevertheless.  In other words, the law provides a boundary, and within that boundary, you have the flexibility to tweak it to the way that you like.

4.  Prepare the documents

The fourth step is to prepare the documents.

There are three documents that you need at a minimum:  Operating Agreement (revised or restated), Joinder Agreement, and Written Spousal Consent.   

Now, every transaction is different. There might be a situation where you need more than these three documents to complete a process.  If so, give us a call, and we will let you know whether or not you need additional documents drafted.

(a) Operating Agreement:

Again, the operating agreement, it is a governing document of LLC. It should state the percentage of the ownership interest, the rules of management, the rights and responsibilities in the business, the rules of selling, closing, or having one or more owners leave the company, and distribution of the profits.

It should be reviewed and updated. My recommendation is to review the operating agreement once a year and update the document accordingly.  Business evolves all the time, and so should the operating agreement. It should be updated all the time as well, and once a year is a good rule of thumb.

(b) Joinder Agreement:

Joinder Agreement has the following purposes:

[copy from the slide]

Everybody’s going to be fully bound by this operating agreement. That’s why I said that if your company does not have an operating agreement, you should pick up the phone and call us right away. You have to have an operating agreement for your LLC.

If you consult with our firm, we will customize all the documents for your specific situation. So the one that we presented here is a general framework of what documents you need to admit a new member to your LLC.

(c) Spousal Consent.

It is a written document, it needs to be notarized.

All members of the LLC should sign it. So I’m assuming that all existing members have one signed, so therefore if anybody wants to join in as a new member, he or she needs to sign to have their spouse sign one as well.

Of course, no one can force a spouse to sign this document and no one can force the spouse to do things that he or she does not want.  However, you can make this a condition for the new member to join the company.

The written spousal consent serves the following purposes:

•The new member’s spouse or partner may have a community property interest.

•Agrees to sell the community property back to the new member or the company at fair market value at the time of divorce.

•Agrees not to will, gift or lien the community property interest at any time.

For example, an investor wants to acquire a 25% interest in your company. The investor’s spouse might have a community property interest of that 25% share. By signing the spousal consent, the company informed the investor’s spouse that he or she might have a community property interest of that acquired 25% share. He or she agrees to sell the community property interest in the event of a divorce at fair market value back to the investor, other members of LLC or LLC itself. He or she also agrees not to will, gift, or lien the community property interest at any time.

Now. If you have any additional question regarding how to add a new member to LLC and what documents you need, you are always welcome to contact our office. We will explain things to you and see how you can complete a process efficiently and effortlessly. Call our office today.