Ultimate LLC Compliance Guide. Michael Spadaccini
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shares, or member’s interest. There are other, less used terms, such as percentage interest, percentage share, or LLC share—all proper terminology. In this sense, the ownership terminology of LLCs is more akin to the terminology of partnerships, where the ownership is expressed in terms of percentage interest or percentage share, rather than in a defined number of shares of stock. In the business world, you might hear the phrase “LLC stock.” That phrase is not necessarily incorrect; it simply is not used often. It is better to discuss LLC ownership in terms of percentage or share. Throughout this book, we’ll use several terms for LLC shares.
Now, you won’t issue any membership shares until after your articles of organization are filed. You cannot have owners until you have a legal entity that they can own. You may wish to designate more than one class of ownership shares; this designation must be made in the articles of organization. Such a designation can be made with the filing of your articles or it can be made by an amendment any time after the original filing, with a bit of paperwork. You should have a good road map of your ownership structure early in the organization process, because you must set forth that structure in the articles of organization.
Classes and Types of Membership
All LLCs must have at least one class of ownership with voting rights. Without at least one class of voting ownership shares, an LLC’s owners could not vote and therefore the LLC would be powerless to take any legal action. The overwhelming majority of LLCs, especially small LLCs, have only one class of ownership with voting rights. Typically, you won’t need to overtly claim a voting class of ownership in your articles of organization; the state statute will imply that your LLCs owners enjoy voting rights.
Your LLC may have one or more additional classes of membership interest, if you designate additional classes. Secondary classes of voting interest appear in infinite varieties. But secondary classes are rare and I have never advised their use in my law practice unless it served a very good purpose.
To go forward, we’ll need to borrow some terminology from corporate law. Types of corporate stock can be broadly categorized into three groups: common, preferred, and hybrid. Similarly, an LLC could create multiple classes of ownership. Nevada, for example, allows LLCs to create multiple classes of membership shares.
Common stock is simply plain voting stock, the simplest form of stock. This is equivalent to an LLC’s ordinary membership units.
From here, things get very complicated. Typically, but not always, preferred stock is stock that entitles its holder to a monetary priority or preference over another class of shares. Often, preferred stock entitles the holder to priority in receipt of dividends and, if the corporation liquidates, asset distributions. In other words, preferred stockholders get paid first and common stockholders get what remains. Preferred stock often carries no voting rights. Sometimes preferred stock contains provisions establishing that it can be converted to common stock.
Often, investors who bring capital into the company will insist on getting preferred stock for their investment, so that they get paid first if the company is liquidated. Another common reason for investors insisting on preferred stock is that it entitles them to mandatory dividends.
While a dividend or liquidation preference is the most common feature of preferred stock, preferred stock can have other features. Though it’s far less common, preferred stock can be supervoting. Supervoting preferred stock is a class of stock that entitles the holder to a greater voting percentage per share than a company’s other class or classes of stock. Many states allow the authorization and issuance of supervoting stock and supervoting classes of LLC ownership. Such stock can have 10 votes per share, 100 votes per share, 1,000 votes per share—there is no legal limit on the number of votes per share. Supervoting stock is a powerful device if one wishes to maintain voting control of a corporation or an LLC.
Hybrid stock refers to debt instruments that are convertible into ownership—they are not true equity instruments. For example, a promissory note—a document evidencing a loan—that is convertible into shares of an LLC’s ownership is hybrid stock.
▼ Expert Tip
Don’t issue multiple classes of stock unless you have a clear need. Consider this decision carefully. Multiple classes of stock create a good deal of complexity and increase operating costs; they are more appropriate for larger entities. In my practice, clients often ask me to create and issue multiple classes of shares when it really isn’t necessary. Nearly as often, clients complain later that they should have taken my advice and authorized only one class of stock.
The rights and privileges of all an LLC’s classes of ownership must be set forth in the articles of organization with a certain degree of particularity. Sample clauses establishing multiple classes of shares that you can include in your articles of organization appear in the articles of organization forms in this book.
FUNDAMENTAL CHANGES
All limited liability company acts provide technical and mechanical rules for fundamental changes—changes that impact on the LLC in a significant way. For example, merger or consolidation, dissolution or liquidation, reorganization, sale of most of an LLC’s assets, and amending the articles of organization are considered fundamental changes.
Some fundamental changes are beyond the scope of this book. Mergers, dissolutions, and the sale of a business are complicated transactions with diverse legal implications. Tax, securities, and antitrust are only a few of the legal issues that may be involved. Because your focus is on running your business, consider using the services of a competent business attorney in these areas.
A brief discussion of the more common fundamental changes follows.
Merger or Consolidation
A merger is the combination of one or more corporations, LLCs, or other business entities into a single business entity. Mergers are complex and flexible events. Mergers can involve two or more companies, even dozens of companies. Mergers can also consolidate entities of different types: an LLC can merge with a corporation or with a partnership. When two LLCs enter into a merger, one entity (the disappearing LLC) is absorbed into the other (the surviving LLC). The disappearing LLC ceases to exist for all purposes, with only the surviving LLC continuing. In general, the surviving LLC takes over all rights, liabilities, debts, and obligations of the disappearing LLC.
A consolidation is quite similar, involving an agreement of two or more corporations of LLCs to unite as a single entity. Often, a consolidation involves the formation of a third entity into which the assets and liabilities of the constituent entities are transferred.
For most limited liability company acts, the concepts of merger and consolidation are treated in the same fashion. If you’re considering either, consult with your business attorney.
The mechanics of a merger work as follows. To effect a merger of two entities, the board of directors or managers of both entities cause a plan of merger to be prepared. If a corporation, the board votes to approve the plan and recommends that the plan be submitted to the shareholders for approval. If an LLC, either the members vote or the managers vote and then present their vote to the members for a separate vote. Specifics regarding member and manager meetings and voting are found in later chapters.
A plan of merger includes:
• The names of the entities participating in the merger
• A clear statement of which entity will survive and which entity will disappear
• The date when the merger will take effect; if this is not stated, then the merger is effective upon filing with the secretary of state
• A calculation outlining how much ownership in the surviving entity the owners of the disappearing entity will receive
• Any other information that the entities wish