When launching a Limited Liability Company (LLC), one of the most critical considerations is the ownership structure. Unlike a corporation, which issues shares of stock to represent ownership, an LLC utilizes membership units to represent an owner’s stake in the business. Understanding the nuances of LLC membership units is essential for both establishing the LLC and managing its operations effectively. This article provides an in-depth explanation of what LLC membership units are, how they work, and why they are crucial for business owners.
In the context of an LLC, a “membership unit” is akin to a share of stock in a corporation. It represents a portion of ownership in the LLC and may carry with it certain rights, including but not limited to:
Ownership in an LLC is divided among the members based on their initial contribution, which could be capital, assets, or even services. Membership units enable a standardized, quantifiable measure of this ownership. They also provide flexibility in how profits and losses are allocated, how much say each member has in decision-making, and how the company is managed.
When the LLC is formed, the founding members agree upon the total number of membership units that the company will issue. These units are then distributed among the members, usually in proportion to their capital contribution. The specifics of unit issuance, rights, and valuation are generally outlined in the LLC’s operating agreement—a foundational document that all LLCs should have.
Depending on the complexity and needs of the business, an LLC may issue different types of membership units, each with unique rights and privileges:
These are the most straightforward type of units, generally granting the member voting rights and a proportionate share of the profits and losses.
Members holding preferred units often receive priority distributions, which means they get paid out before common unit holders. However, they may have limited or no voting rights.
These units are typically issued to members actively involved in running the business. They may grant enhanced voting rights concerning the management of the LLC but might not necessarily come with a higher claim on profits.
The value of a membership unit is determined by a combination of the LLC’s total worth and the specific rights and benefits attached to the unit. Over time, the value can change due to fluctuations in the company’s assets and liabilities, the operating environment, or market demand for the units.
The process for transferring or selling membership units is generally outlined in the LLC operating agreement. Some LLCs impose restrictions to ensure that ownership stays within a specific group or that existing members have the first right of refusal.
Understanding LLC membership units is crucial for any business owner contemplating the formation of an LLC or looking to attract investment. Properly issuing, managing, and valuing these units can have a substantial impact on the LLC’s success and the satisfaction of its members. Always consult legal and financial experts to navigate the complexities of LLC membership units effectively.
Well, in a corporation, which is a legal business entity, a company, the symbol of ownership is called shares or stocks, and those are owned by the owners – which we call shareholders. In an LLC, the ownership of the company is by the members, and their symbol of ownership is called either units or interests.
So, for example, instead of saying a shareholder owns stock in a corporation, if you are talking about an LLC, you would say, “A member owns units in a limited liability company,” or “A member, the owner, owns an interest in the limited liability company.”
You might ask, why are they called interests versus units? Well, limited liability companies allow a lot of flexibility for the owners to figure out how that LLC looks. It is called the power of contract. There is a lot of flexibility to contract with the other owners about the shape and rules of your LLC. Sometimes, business owners say, “We are going to model this more after a partnership,” and a partnership’s ownership interest is called a partnership interest. So just like owners of a corporation have shares, owners of a partnership have a partnership interest. Thus, an LLC can adopt that concept and call it their ownership interest or a member interest. However, an LLC might want more of a corporate model or corporate terminology. So when owners of an LLC are drafting their operating agreement, which is essentially the bylaws for the LLC, the owners of the LLC can call the ownership interest a unit or a membership unit. This is much more similar to the concept of stock or shares in a corporation.
Prior to LLCs, we had corporations and partnerships – those were the two primary entity types that could have multiple owners. But then when an LLC was created, it was essentially a blend of partnership law and corporate law, creating a new framework for business owners. As a result, there is still a lot of flexibility in how business owners set that up. This highlights why some of these online services that provide templates for LLC startups can often be more harmful to business owners than helpful. I can’t tell you the number of times that business owners have used Rocket Lawyer, LegalZoom, and Harbor Compliance – I am going to name them. These are template services out there, and while they can offer some really good material and help some people, I have seen substantial legal problems, litigation, and disputes among business owners who unknowingly agreed to these massive templates without understanding what the terms meant.
I would rather see you use ChatGPT to work out the terms of an agreement that are relevant to you and that you understand, and then agree to those terms, rather than signing some template that you don’t comprehend, which was provided by some online service and contains language stating what you will do and your understanding of how things will be handled, even when you don’t understand it. Moreover, if there were a perfect template, everybody would use the same one. However, these services each provide a different template. The Bar Association offers templates, and often, you have other associations that offer templates as well. If you want to find all the templates for a certain type of contract online, just hop onto Google, and type the name of the contract you are looking for, like “independent contractor agreement,” “website design agreement,” or “stock transfer agreement.” Then, after the search term, add “file type: PDF” to specify “Google, show me only PDFs.” By doing this, you will come across various templates, each with different terms, conditions, and provisions. Instead of just adopting all the provisions in the first template you find, I would recommend that if you can’t hire an attorney to handle it properly – either because it’s a smaller transaction or your budget doesn’t allow it – at the very least, take the time to use artificial intelligence to create a contract that reflects what you truly want. This way, you won’t blindly accept a bunch of terms from the first template that seems relevant to your situation.
If you would like more information about any of these topics today, if you are interested in a business owner and getting educated on common mistakes business owners make and how to avoid them yourself, you can go to aaronhall.com/free and sign up to get a number of videos and other resources to help equip you to prevent problems in your business.
This is for entrepreneurs, startups, business owners, and CEOs. Generally, I am thinking about companies with under 500 employees, even as few as one or two, because for you as a business owner or a future business owner, you can either prevent these problems or pay the much more expensive cost of having the problem and having to clean it up afterward. The purpose of this YouTube channel is to help you avoid problems, grow your company, provide great value to your customers and clients, create a great environment for the people that you work with, and experience the success that comes from having a good company built on best practices.
I am Aaron Hall, an attorney for business owners and entrepreneurs. If you have questions about any of this, feel free to put them in the comment section below. Look forward to seeing you next time.
Important: This material was prepared by law firm staff for educational purposes only. Use this to spot issues to discuss with your lawyer, not as a replacement for a lawyer. You should not rely on this info. It may not be appropriate for your circumstances. It may be out-of-date or otherwise inaccurate.
Aaron Hall
Business Attorney
Minneapolis, Minnesota
[email protected]
