Five Considerations When Selling Your Limited Liability Company Membership Interests
Limited liability companies, or LLCs, are comprised of owners identified as “Members” under the LLC’s organizational document, which in Wisconsin is called an Operating Agreement. A Member’s ownership interest is typically denominated in units and expressed as a percentage of overall units called “Membership Interests.” The number of units issued is typically tied to the Member’s capital contributions to the LLC. When a Member is considering a sale or transfer of the Member’s Membership Interests in the LLC, proper legal, financial, and strategic steps are crucial for a smooth, compliant, and successful purchase and sale of the Membership Interests for the buyers and sellers involved in the transaction. Here are five key factors a Member should consider when navigating the purchase and sale of their Membership Interests in the LLC:
1. Review the Operating Agreement and Buy‑Sell Provisions
Membership Interests in an LLC can be assigned, transferred, and sold in whole or in part under the terms outlined and agreed upon by the Members in the LLC’s Operating Agreement. Most Operating Agreements include Buy-Sell provisions requiring the written consent of a certain percentage of the members (perhaps a majority or a higher threshold) for a Member to transfer its interest, and often a right of first refusal, which requires existing Members to be offered the opportunity to purchase the Membership interest before it can be sold to a third party. Some Operating Agreements allow certain transfers to occur without triggering transfer restrictions, like transfers for trusts and estate planning, to family members, or affiliates or related entities. Notably, buyers or assignees of the Membership Interests may receive only economic rights, and not management or voting rights, unless formally admitted as Members of the LLC. Bottom line, review the Operating Agreement carefully before proceeding with a purchase and sale transaction in order to determine who has the right to purchase the Membership Interests and what steps need to be taken to admit new Members under the terms of the existing Operating Agreement.
2. Get an Accurate Business Valuation
Successfully negotiating a sale requires knowing the fair market value of the Membership Interests being sold. A valuation process may consider methods like 1) an income approach, which is based on the LLC’s ability to generate future income or cash flow, 2) an asset approach, which considers the value of the LLC’s assets, or 3) a market approach reviewing what other similar entities are worth in the market. Obtaining an appraisal or business valuation can assist with tax compliance and can provide buyers confidence and support in the asking price during negotiations. Operating Agreements will also typically include valuation methods outlined in the Buy-Sell provisions to address what happens upon an involuntary transfer such as bankruptcy, divorce, death, or court-order.
3. Understand Tax & IRS Implications
LLCs are typically taxed as a disregarded entity or partnership. For example, multi-member LLCs by default, are typically treated and taxed as a partnership, which means that income and losses are typically allocated to the Members regardless of whether there is a corresponding distribution in order to pay any income taxes so allocated. In the context of a sale transaction, it is important to understand the tax implications resulting from the Member’s period of ownership in the year of the sale. Moreover, ownership changes can trigger new IRS filings, or a change from multi‑member LLC to single‑member status may require a new EIN or different tax election. Consult a tax attorney to ensure the sale is properly structured and reported.
4. Update Organization Documents Post‑Transfer
The Wisconsin Department of Financial Institutions does not require an LLC to update certain filings with the DFI upon a change in ownership. However, the remaining Members of the LLC should update the Operating Agreement and organizational documents to reflect the new membership and formally admit the new Member(s), if applicable. Amending the Articles of Organization or Operating Agreement to reflect new ownership is essential to avoid confusion and liability exposure down the road. Additionally, the Registered Agent should be reviewed and updated to ensure that legal process is routed to the appropriate person within the LLC.
5. Engage Qualified Professionals Early
The process of selling the Membership Interests can be complex and mistakes can cost more than the expert fees. The seller should work closely with a business and tax attorney to draft purchase and sale documents such as a letter of intent outlining the terms of the sale, confidentiality agreements, indemnities, and transfer documents. Moreover, engaging with a business and tax attorney will help structure the deal tax‑efficiently and manage any required tax elections. If there is no Operating Agreement or the existing Operating Agreement lacks Buy‑Sell provisions, or there is no Buy-Sell agreement in place, drafting one now with valuation triggers and Buy-Sell terms can alleviate future disputes and provide guidance upon a triggering event.
Final Thoughts
Selling an LLC Membership Interest is not simply a transfer, assignment, or sale. It is a process requiring legal precision, financial clarity, and thoughtful planning. Ensuring proper valuation, updating organizational documents, and enlisting professional guidance from an attorney will protect both the buyer and seller of the LLC Membership Interests and enhance the value of the transaction for both the buyer and seller. Each transaction carries nuances unique to the LLC, Operating Agreement, tax status, industry, and buyer type. The right preparation can avoid pitfalls and achieve a successful and legally compliant exit.
