How to Add a Member Using an LLC Admission Agreement

Adding Members

Before you can add members to your LLC, you have to make sure your operating agreement allows it. If you do not have an operating agreement, you should create one before adding new members. Generally, because adding new members is a major decision that affects the company's ownership percentages for all of the current members, you will need to get a majority vote on adding members. Your operating agreement should outline whether you are able to add new members, and if so, what percentage of the vote must pass. Depending on how you set up the operating agreement, you may need a simple majority or a supermajority of the vote to admit additional members.

Additionally, the LLC operating agreement should tell you how much interest in the company the new members will receive. Whether all members share equally in the interest in the company or new members have a smaller piece of the pie, infighting could be avoided when the operating agreement provides for distribution. An LLC may be set up as a manager-managed LLC, where the managers have more votes and more interest in the company than other members or have absolute discretion, or it could be set up as a member-managed LLC, where all members have an equal interest in the company. However, even a member-managed company may have members who have more interest in the company because of the amount of capital they provided for startup.

If your operating agreement does not allow for new members, but the majority or a supermajority of votes to amend the operating agreement to add members is successful, then you will have to vote on the amendment, amend the operating agreement, and then vote on each of the members you want to add.

Capital Contributions

A new member may buy into the company with cash payments or may provide other types of capital as an investment in the company. Capital may include equipment, real estate, or even services. If the member is buying in with services, be sure to document which services are part of the deal and how much each type of service is, or document an hourly wage or salary and a way to keep track of the hours the new member or members put in.

If the new member wishes his or her capital to be used for a specific purpose, then that is stated in the admission agreement. Some members might wish to remain silent, where they do not vote on company matters but only provide capital and receive distributions. This is also stated in the admission agreement.

Sale and Purchase of Interest

To add new members, the current members must sell and transfer some of their interest in the company and its assets to the new member or members. The percentage of interest being transferred or sold is part of the admission agreement. Along with this, the admission agreement must also state what the new member or members agree to pay into the company, whether that payment is in cash or in the form of assets, including real estate. Once the transactions are completed, the new member or members have all of the rights associated with their percentage of interest, including voting rights.

All of the monetary values and percentages of interest should be included in the admission agreement so that if there are any disagreements later, all those members are able to refer back to the agreement and/or the operating agreement.

Additionally, the members must set out the recapitalization of the company in the admission agreement. The Internal Revenue Service (IRS) must be notified of the recapitalization so that it is able to tax the appropriate amount per member.

Admission Agreement Bound by the Operating Agreement

If you do not have an operating agreement, then prior to creating an admission agreement and admitting new members you should create an operating agreement. The operating agreement dictates the actions of the members, how much each member owns in the business, what the voting shares are, and other administrative actions. One of those administrative actions is whether new members are allowed in the company.

Voting percentages are important as they are tied to distributions. Once you create an operating agreement, then you are able to create the admission agreement to allow new members into the company.

Since the company is already formed, anything you put into the operating agreement will need to be voted on by the members. When you form a company yourself or with a partner—before you add other members—you may create the operating agreement to your own specifications. Once you have members, they must vote on any amendments, including creating a new operating agreement, and you may not get something in there that you believe should be in there. For example, you may want to be the sole person who can authorize a loan, but the other members may want there to be a supermajority vote to approve a loan application.

If the operating agreement is created at the time you create the business, you have only yourself and other founding members to discuss and agree on items that are in the operating agreement.

Keep in mind that the admission agreement is bound by the operating agreement so that when you create a new admission agreement, the operating agreement must be attached to it. Current members must be given the chance to review the amended operating agreement, if it was amended, and the admission agreement before it is forwarded to the new members to review and sign.

Prior to signing the admission agreement, each member must read and understand the operating agreement. The members must also be given enough time to seek the advice of their own attorneys. Once a new member understands the operating agreement, he or she may then sign the admission agreement.

Notifying the Secretary of State and IRS

Once you have voted in a new member and have completed the requisite documents for the LLC, you must also notify the state of the new member. Rules are different for each state, but in most cases you will have to file an amended annual report. Fees to amend the annual report are also different depending on the state. In addition, you must notify the IRS that you added new members to your LLC.

Taxes and Other Financial Advice

Because all members' tax obligations will change upon acceptance of new members, each member should seek tax and other financial advice, preferably before voting in new members. The number of distributions will change, which means that the amount of taxes paid on those distributions will change.

Tax brackets may change for each member; current members may find themselves in a lower tax bracket while new members might increase their income so that they are in a higher tax bracket. Depending on the number of distributions and how the limited liability company is set up, the pass-through income must be reported on each member's personal taxes.

In most cases, the distributive share is the same as the percentage interest each member owns. For example, if the operating agreement pays out to two managing members at 50 percent each, each managing member will pay taxes on 50 percent of the business profit. However, if the operating agreement allows for a special allocation so that one member may have 50 percent of the vote, but receives 60 percent of the profits, separate IRS rules apply and the members must be careful to follow those rules.

The IRS assumes that each member receives their entire distributive share each year. Thus, even if some of that money is left in the business to expand the business or purchase inventory, the members must pay taxes on that money respective of their distribution percentages.

Additionally, multi-member LLCs must file Form 1065 with the IRS. The form is informational and it ensures that each member is reporting his or her income properly. Each member, including new members, also gets a Schedule K-1 that shows each member's share of the profits and losses.

Risk

Every investment, including an investment in an LLC, comes with risks. Each new member must understand that there is always the possibility of losing some or all of his or her investment. Furthermore, if the admission agreement so states, the new member understands and agrees that the company is an illiquid investment and that his or her shares cannot be pledged, sold, or traded other than how such activity is dictated in the admission agreement.

Information Access

Adding new members is a huge decision. Most company documents are kept confidential. However, new members must have access to financial statements and documents and the records and books for the company. The new member and his or her representatives have the right to look at this information prior to signing an admission agreement. Additionally, the new member may ask questions about the company and its finances, and those questions must be answered to the satisfaction of the member. You may ask a potential new member to sign a confidentiality agreement prior to looking at the company's financial information.

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