When starting a business, many entrepreneurs choose to go the route of a Limited Liability Company (LLC). This popular business entity has many advantages, such as limited liability and debt for its owners, which are called members. In starting an LLC, a necessary first step is to establish the business’s structure, especially ownership percentages and responsibilities of all the company’s members.
What Does it Mean to Own a Membership Interest In a LLC?
LLCs in Massachusetts are governed by the Massachusetts Limited Liability Company Act. In the statute, as is the case for many states around the country, owners of an LLC are referred to as “members.” There are no limitations on members of an LLC in Massachusetts, so they may be individuals, corporations, foreign entities or even other LLCs. Further, there is no maximum number of members that an LLC can have.
When creating the LLC’s Operating Agreement, the members must decide everyone’s membership interest. This takes the form of percentage ownership of the LLC, which in turn gives each member certain rights and responsibilities within the business. Though members may divide the LLC’s interest by the initial capital investment of each member, they are free to determine membership interest in any way they see fit. It is also good practice for the percentage interests to appear in a capitalization table (or “Cap table” as it is informally called) —a tool used to track ownership stakes, investments, and equity distribution among members. This ensures transparency and clarity for all members involved.
Why Do LLC Membership Interests Matter?
Membership interests are one of the most important parts of LLC’s Operating Agreement. They determine how the company will be run, how profits and losses are distributed, and which members have decision-making authority. In Massachusetts, membership interests may be transferred among current members or new members, but generally, all other members of the LLC must give their consent. All these rights and limitations are crucial to how the LLC operates, and thus, percentage stakes in the business must be decided at the LLC’s inception.
What Are Key Considerations When Deciding Membership Interests?
Members should consider multiple factors in determining how to divide membership interest in their LLC. These interests determine profit distributions and dictate each member’s responsibilities and day-to-day operation of the business.
One primary consideration in deciding each member’s interest is their respective capital contribution, or the money each invests in the LLC. Generally, the more a member invests upfront to the business, the more control they should have in making decisions and earning profits. Other reasons for increased decision-making power is time spent, resources, and skills provided to the company. Another consideration is how many members the LLC has when the Operating Agreement is created. If there are only two members, the situation may be as easy at splitting it in half, but as more members get involved, the more complicated the percentage distribution becomes.
As the list of members grows, LLCs may be separated into “classes.” Typically, in a class division, certain members have exclusive rights like voting rights that other classes do not have access to. One or more classes usually just retain financial rights, but many times do not have any managerial power as it is left to one specific class of the LLC. These, among other factors, are useful to think about and discuss when drafting an Operating Agreement.
Does My LLC Need a Formal Written Agreement?
In Massachusetts, an LLC is not required to have a written Operating Agreement. This is because many LLCs have just one or two members and do not require membership interest distribution. However, it is strongly recommended that LLCs have a written Operating Agreement if possible.
The formal agreement has more advantages than outlining each member’s rights and powers. It also serves as a written record of the LLC itself and can be used or referenced to in any lawsuit that may arise between members or issues with financial institutions. A well-written Operating Agreement provides clarity to an LLC and prevents any potential issues for the business.
What Are the Responsibilities of Ownership?
Having a membership interest in an LLC comes with several responsibilities. Members must comply with state tax and regulatory laws, including registration with the Massachusetts Secretary of Commonwealth. One member is also required to act on behalf of the LLC in any tax matters before the IRS. Most responsibilities, however, stem from the Operating Agreement, so it is important for members to understand each of their responsibilities and to fulfill them for the business.
What Happens When Ownership Percentages Need to Change?
Changes to membership interests in an LLC happen frequently, and members must follow the terms in their Operating Agreement to do so. In Massachusetts, transferring membership interest does not automatically give the new member any control over the LLC’s affairs. The new member only obtains rights such as voting power if all other members agree. Each option and situation that may arise in the transfer of interests should be outlined in the Operating Agreement to avoid any confusion or disruption to the business if and when the situation arises.
Conclusion
Writing an Operating Agreement is the safest and most efficient way to determine and define LLC’s ownership distribution. To ensure that the agreement is legally sound and includes all the provisions that members want, it is essential to consult with a qualified business attorney who can help you through the process.
Contributions to this blog by Michael Touma.
