Possible to have multiple equity holders in a single person LLC w/ an Op. Agreement

[kirbyj]

What is the name of your state (only U.S. law)? MA

I am involved in a startup company where multiple people are equity stake holders in the company.

The current corporation type is a single person LLC. The equity stake is defined within the operating agreement which exists between the primary owner and the minority equity stake holders. My gut tells me that the company should be switched to something like a multi-person LLC or an S Corporation. Is an operating agreement in this situation a legally enforceable document which can hold up in a court of law? In the company's current state as a single person LLC, are the minority holders at risk?

 

[LdiJ]

in a closely held organization an LLC can sell stock to raise capital. There are more restrictions on what can be done with the stock compared to stock issued by other types of corporations.

Does the owner wish to give up part of his ownership?


You should research closely held organization (or corporations). It should help explain the current situation and help you realize if the business structure should be changed.

LLC's do not have stock. They have memberships. They can certainly sell memberships, but if that is done, then it would no longer be a single member LLC.

So, the minute the other people became equity stakeholder's, then it became a multiple member LLC.

 

[justalayman]

LLC's do not have stock. They have memberships. They can certainly sell memberships, but if that is done, then it would no longer be a single member LLC.

So, the minute the other people became equity stakeholder's, then it became a multiple member LLC.

rxcuse the use of the improper term. An LLC can distribute shares. Shares do result in becoming members. It was late for me and had some weird thoughts running around so the entire post resulted in a nonsensical statement.

And yes, it must be a mm LLC in the situation described simply because there are multiple members. Given what the op stated though there is an issue because it if it is registered as a sm LLC and it is now technically an mm LLC the membership agreement surely will not take that into account.

So now what does the original owner have? Is it a member managed LLC? A manager managed LLC? What rights are afforded the investor members?

The art is crafting the membership agreement such that the investing members do not have control of the operation of the LLC (if that is what the business creator prefers). A problem though is that apparently the membership agreement does not address the many issues, the investors may be able to express more control in the creation of the new membership agreement than original owner intended or prefers.

At this moment the investors, unless there is no concern about losing them as investors, may be able to cause the business to become something the original owner had no intent of doing.

 

[LdiJ]

rxcuse the use of the improper term. An LLC can distribute shares. Shares do result in becoming members. It was late for me and had some weird thoughts running around so the entire post resulted in a nonsensical statement.

And yes, it must be a mm LLC in the situation described simply because there are multiple members. Given what the op stated though there is an issue because it if it is registered as a sm LLC and it is now technically an mm LLC the membership agreement surely will not take that into account.

So now what does the original owner have? Is it a member managed LLC? A manager managed LLC? What rights are afforded the investor members?

The art is crafting the membership agreement such that the investing members do not have control of the operation of the LLC (if that is what the business creator prefers). A problem though is that apparently the membership agreement does not address the many issues, the investors may be able to express more control in the creation of the new membership agreement than original owner intended or prefers.

At this moment the investors, unless there is no concern about losing them as investors, may be able to cause the business to become something the original owner had no intent of doing.

I am not aware of any states that require an LLC to register as either a single member LLC or a multiple member LLC. They simply are what they are based on the number of members. However, someone cannot have an equity stake in an LLC without being a member of the LLC. I agree that they could be investors, without being members, but that would not give them an equity stake.

 

[justalayman]

I am not aware of any states that require an LLC to register as either a single member LLC or a multiple member LLC. They simply are what they are based on the number of members. However, someone cannot have an equity stake in an LLC without being a member of the LLC. I agree that they could be investors, without being members, but that would not give them an equity stake.

It's not that it would be registered as a mm or sm LLC per se but in ma if there is a manager it must be included in the registration filing and if there is no manager originally and one is appointed the name of the manager must be added to the registration filing. So, since a sm LLC is not going to have a manager and a mm LLC will possibly (probably should be probably) have a manager, that will need to be changed. So who determines the managing member? Well, there is where the problem is since it is likely a membership agreement will have to be crafted at this time.

Along with that if there is a membership agreement (and why would there be with a sm LLC) either this business is about to get really weird or there will need to be a new membership agreement. Since the business is opening the LLC is about to open itself up to these new members and they are coming with cash in hand, they likely wield a large hammer in regards to the new membership agreement. Unless the current owner of the LLC is able to do without the investments, s/he is susceptible to giving up more than he desires.

While the agreement can establish varying levels of shareholders, given it will be crafted now whether original owner will be able to do that or not is in question.

 

[LdiJ]

It's not that it would be registered as a mm or sm LLC per se but in ma if there is a manager it must be included in the registration filing and if there is no manager originally and one is appointed the name of the manager must be added to the registration filing. So, since a sm LLC is not going to have a manager and a mm LLC will possibly (probably should be probably) have a manager, that will need to be changed. So who determines the managing member? Well, there is where the problem is since it is likely a membership agreement will have to be crafted at this time.

Along with that if there is a membership agreement (and why would there be with a sm LLC) either this business is about to get really weird or there will need to be a new membership agreement. Since the business is opening the LLC is about to open itself up to these new members and they are coming with cash in hand, they likely wield a large hammer in regards to the new membership agreement. Unless the current owner of the LLC is able to do without the investments, s/he is susceptible to giving up more than he desires.

While the agreement can establish varying levels of shareholders, given it will be crafted now whether original owner will be able to do that or not is in question.

An LLC is not like a limited partnership. An LLC is like an S-Corp in that they cannot have different classes/levels of members. The percentage of their equity stake however, can vary.

 

[justalayman]

An LLC is not like a limited partnership. An LLC is like an S-Corp in that they cannot have different classes/levels of members. The percentage of their equity stake however, can vary.

Yes they can. The membership agreement is pretty much unrestricted so yes, there can be varying levels of membership.

Here is but one article on the issue:

https://www.legalzoom.com/knowledge/llc/topic/ownership-percentages

 

[LdiJ]

Yes they can. The membership agreement is pretty much unrestricted so yes, there can be varying levels of membership.

Here is but one article on the issue:

https://www.legalzoom.com/knowledge/llc/topic/ownership-percentages

I do not believe that portion of the article is going to hold for all states.

 

[justalayman]

I do not believe that portion of the article is going to hold for all states.

But your not sure, right?


Do you know if it holds for MA, given that is the germane state.

Do you know of any state it doesn't hold true?

 

[FlyingRon]

If we are going to talk ab out the poster's state of Massachusetts there indeed can be multiple classes and their shares and voting rights or other privileges are as laid out in the operating agreement. Members can be added at any time consistent with the operating agreement.

They are called MEMBERS and there's no such thing as "shares" or "shareholders" in a MA LLC.

The person may be confusing MANAGEMENT of the LLC (which can be a single person regardless of the number of members) with MEMBERS.

 

[justalayman]

If we are going to talk ab out the poster's state of Massachusetts there indeed can be multiple classes and their shares and voting rights or other privileges are as laid out in the operating agreement. Members can be added at any time consistent with the operating agreement.

They are called MEMBERS and there's no such thing as "shares" or "shareholders" in a MA LLC.

a member owns a share of the company.

this is from a site speaking of Georgia law but I see no reason it would not be the same in MA.

QUESTION:
How do you perfect a security interest in an LLC interest?

ANSWER:
A limited liability company interest consists of contract rights. Accordingly, the method for perfecting a security interest should be the same as that for general intangibles. Note, however, that it is possible for an LLC to issue certificates representing interests. In that case the secured party should take possession of the certificate along with an appropriate transfer instrument designed to have the same effect as a stock power. The practitioner should also consider requiring that its security interest be noted on the LLC's books and that the LLC agree not to effect transfers of the pledged interest.

It is not a registered share such as with publicly traded companies stock but none the less, a shareholders certificate can be issued. When dealing with multiple classes especially it is not improper to document the class of the interest as well as the percentage or units held by such a certificate.

and I see nothing improper about referring to it as a share holders certificate since that is exactly what it is. It documents the share held by the particular member.

 

[FlyingRon]

and I see nothing improper about referring to it as a share holders certificate since that is exactly what it is. It documents the share held by the particular member.

You may not, but it is improper none the less. We're not talking about Georgia. The terminology in the MCL LLC act is pretty clear. If you're going to work on legal documents you should use the correct and proper terms. There are no "shares" in LLCs. Corporations (or in Mass. terms: Business Corproations) have shareholders. LLCs have members. They are NOT the same thing even if they roughly have the same roles. Shares in corporations are fixed units authorized. LLC membership is somewhat less definite. You become a member but what that means with regard to voting and the entitlement to distributions is entirely defined by the operating agreement (this by the way is the one way that Massachusetts deviates from some other states, your membership rights are not determined necessarily by any contribution made to the LLC).

 

[justalayman]

Call it whatever you wish but members own a share of the company.


But call it an interest document if you prefer. It is an extra-statutory proof of interest in the LLC of a member. MA does little to require proof of said Interest and rights as there are no statutory requirements addressing the matter. Not much worse than the company books disappearing with a member having no proof of any interest in the LLC

Don't take that wrong. I understand your point and I understand where issuing is a share cert could be misunderstood. Regardless there is no law addressing the matter so the company can call it whatever is chooses to.





But if you're going to speak of proper terminology;

I believe the Massachusetts laws are referred to as MGL

Michigans laws are MCL. Might be a few others but MA is Massachusetts General Laws

Their law regarding the matter is title the Massachusetts Limited Liabiltiy Company Act, not the MCL LLC

 

[kirbyj]

Follow-on Question

Thanks everyone for your wonderful wisdom. I have some follow-on questions with further clarification on my original topic:

If there are two parties, party A and party B.
Company X exists as a single member LLC where Party A is the "single person" in the single member LLC.
Party A and Party B agree that upon any sale of the company, Party A shall get 60% and Party B shall get 40% which is defined in an operating agreement between the two parties.

Party A and Party B are actively involved in the operation of the business and provide comparable value to the organization.

If the end goal (i.e. exit strategy) is to sell the company, is the operating agreement between the two parties enough to protect Party B's interests and rights as an active contributing member of the company. Is Party B in any disadvantage? If so what? (i.e. tax liability, taxes, legal rights, capital gains when the company is sold)

If not, what are the best possible changes that should take place to represent and protect both parties?
* switch to multi-person LLC
* S Corp
* C Corp
* Other

NOTE: there may be more entities that will take on equity for Company X.

 

[justalayman]

Tell B to speak with an attorney. B needs to act properly to protect B's interest.

And if there is anybody else considering actuslly buying in to the LLC with an operating agreement like thst, well, tell them to run.


All the people involved here need some serious help setting it up properly. It's so far off track now with intent of taking it further off track one has to wonder what other problems may be present.

As example:


Company X exists as a single member LLC where Party A is the "single person" in the single member LLC.

enough to protect Party B's interests and rights as an active contributing member of the company


That situation is an impossibility.

The statement it is a single member LLC would mean there are no other members. If B is not a member then he cannot function as a member. He would be an employee which brings myriad concerns of labor law issues.

But if it is argued he is a member then it is not a single member LLC.