Nov 18

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The Need for Member Control Agreements for LLCs

Often, new business owners question whether they need a member control agreement. They commonly don’t know of the possible pitfalls of operating without one. In this article we will address why a member control agreement for an LLC is a necessary component for the business. A member control agreement should address four primary issues.

Determine Ownership
Operational Control
Succession Planning
Protecting Limited Liability of Single Member LLCs

While they can, and usually do address more, these four will be covered below, as they are necessary components to most LLCs.

Determining Ownership

The LLC’s Member Control Agreement details how much ownership in the company each member has. Many companies choose to have ownership be proportional to the capital investment of the members. For example if Member A invests $1,000 and Member B invests $2,000, then B will have twice as many shares as A.

However, one need not necessarily allocate ownership in proportion to capital contributions. What’s known as a “passive investor” might contribute the majority of the capital initially, while a member that actively manages the company will own shares in excess of his capital contributions. It is for this reason that LLCs, unlike corporations, also do not require that a member’s voting rights be equal to that of their ownership stake. Any combination can be chosen by the members.

Operational Control

Not only does the Member Control Agreement control the ownership of shares in the LLC, it also spells out how voting operates. You could choose to have one share equal one vote. Or, the Member Control Agreement could give each member an equal say regardless of the number of shares held.

The agreement will also spell out what constitutes a majority for making major decisions affecting your company. You will want to spell this out because often major decisions need to be made.

Succession Planning

No one wants to think about this when starting their company, but what happens if a member dies or retires? The Member Control Agreement can provide, for example, that the remaining members are allowed the first opportunity to buy the leaving member’s shares. LLCs can protect assets by removing the voting power of shares taken involuntarily from a member. This is an advanced topic and you should consult an attorney on how to use LLCs for asset protection.

In addition to members leaving the LLC, the member control should spell out how new members are added. Often LLCs will choose that it take a unanimous vote rather than a simple majority to add a member.

Protecting Limited Liability of Single Member LLCs

Some people believe that if you’re a single member LLC, there is no need for a Member Control Agreement. After all, the Member Control Agreement is essentially a contract among members as to how they’ll run the company. However, a Member Control Agreement is useful because it can help preserve your company’s limited liability status. If you operate your single member LLC without a Member Control Agreement, then your business begins to look very similar to a sole proprietorship.

The danger there is that if that happens, a judge could pierce your corporate veil (protection) under the “alter ego” theory, saying that your LLC and you as an individual are actually one and the same. With a formal Member Control Agreement, you make it clear that you as an individual and the LLC are two separate entities.

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