Adding a member to your LLC is a big step in the growth of your business. Perhaps your looking to gain a partner in the business. Or you have an investor ready to invest cash to help it grow and expand. Or perhaps you have a dedicated employee who you liked to reward or recognized for their years of hard work.
Don’t take this process lightly. There are many legal and tax consequences to contend with if not done correctly. Please use the guide below to help you.
Review the Articles of Organization
To start, visit the Colorado Secretary of State’s website, and find out how your LLC is managed. If your LLC is member-managed, amend your articles changing them to manager-managed. If an LLC is managed by its members, the new individual will have a say in company decisions, whether big or small. For example, under a member-managed LLC, even someone with a 1% ownership could sell your entire business out from under you. This may sound ridiculous, but what if you went away on vacation, and discover your business is gone when you return. You find out later your new business partner is now living in Costa Rica. An LLC’s articles of organization always override the operating agreement. Make this change if you have to.
Review the Operating Agreement
Look through your operating agreement and find out what it says about adding new members. Typically, operating agreement include details regarding how new individuals are on-boarded and the process the existing member should follow. There should be a clause dealing with changes in membership. If it does, you’ll need to follow this procedure.
If you don’t have an operating agreement, no worries. Colorado law requires a unanimous vote by all members to add a new member. Being the only member, have a meeting and vote to add the new person.
Document or Memorialize Your Decision
You’ll want to memorialize in writing your decision to add the new member. Creating a body of evidence detailing when the additional person was came into your business, will help you in case there’s ever a lawsuit or audit.
Amend your Operating Agreement
If you haven’t had an operating agreement before, your definitely have to have one now. There will be many more moving parts with the additional person that have to be accounted for. Details to include are roles and responsibilities of members; the decision making process; allocation of profits and losses; changing the business’s structure; transferring interests; estate planning transfers; as well as taxation and dissolution. If you’ve been doing things DIY up until now, I advise you to hire an attorney to help you. Many off the shelf operating agreements are not Colorado specific, and most likely will not tailored to your business.
Draft an Assignment of Membership Agreement
This contract outlines the interest you are transferring to your new associate, and what the new member is investing in return for that interest. This agreement can be similar to a deed or bill of sale, or can be a very complex document depending on your business.
Notify the IRS
Changing the LLC from a single member to a multi-member LLC which will effectively change the LLC’s tax status from a disregarded entity to a general partnership. Your LLC’s accounting books and records will need to close on the date the new member joins the LLC. Also, the LLC will also need to file short year tax returns for the current tax year if the new member joins the LLC during the tax year.
If the LLC is taxed as an S Corporation the all members must sign and file Form 2553 with the IRS. Additionally, businesses taxed as S corporations must file a Schedule K-1 for any person who at any point during the previous tax year was a shareholder.
Have a Member Meeting
Lastly, have you new member accept the operating agreement by signing it.
This article is for educational purposes only, and does not constitute legal advice about your case or situation. There may be exceptions to the information outlined above. Please consult an attorney if you have specific questions about your business.