LLC Shareholder Agreement: Everything You Need to Know

An LLC shareholder agreement encompasses the specific expectations between the different shareholders of the business.3 min read

An LLC shareholder agreement encompasses the specific expectations between the different shareholders of the business. A limited liability company (LLC) is in some ways similar to a corporation but with less formal of requirements.

Advantages of an LLC

Many business owners choose to form an LLC because of the following advantages:

  • To protect the business owner with limited liability
  • To benefit from pass-through taxation, similar to a sole proprietorship or partnership structure

Although LLCs are common due to their tax and limited liability advantages, it can be difficult to find clarity when an issue arises that is not mentioned in the governing documents. Different LLC members often have different interests. If a disagreement occurs, it can be difficult to determine the best solution.

Generally speaking, an LLC does not have shareholders. Instead, partners or contributors are referred to as members. An operating agreement sets the specific terms of the LLC membership.

LLC Membership Agreement

One of the first and most important steps in creating an LLC is to create a membership agreement. An LLC membership agreement should include the following points:

  • Management expectations and positions
  • How profits and losses will be handled
  • The specific membership rights
  • The required process to terminate the LLC
  • The acceptance and termination process of members

It is important to keep in mind that the LLC membership agreement is a legal document. This means that it is legally enforceable and all members should carefully review it before signing. Although some states do not require that an LLC membership agreement is created before starting a business, it is always a good idea to create one regardless.

An LLC membership agreement protects personal liabilities while also clearly listing the expected operating terms of the business. A membership agreement can prevent misunderstandings from occurring between business partners. Shareholder agreements are especially useful for small businesses in which the members are active in the day to day operations of the business.

LLC Shareholder Agreement

Shareholder agreements are often used in a corporation setting rather than in LLCs. However, LLC companies can also benefit from shareholder agreements. If you are going to use a shareholder agreement in an LLC setting, it is important to understand the process and to ensure that it makes sense for your business.

There are a few specific provisions that are often found in shareholder agreements that could benefit an LLC membership:

  • Buy/sell provision: Buy/sell provisions are used to place a monetary amount on a member's interests for tax purposes after their death.
  • Texas shotgun provision: This process involves one member choosing a buying point in which they would purchase another parties interest.
  • Drag along/Tag along provision: Any members with more than 50 percent membership can set the price of the sale of the interest in the company.
  • Rights of first refusal provision: The other members of the LLC must refuse the sale of interests before a member can sell to an outside party.

It is best to evaluate each provision in the shareholder agreement before applying it to an LLC business setting. Some provisions will be useful to a company whereas others will not make sense.

LLC Operating Agreement

An LLC operating agreement is a mix between a shareholder agreement and an LLC membership. It often includes the specific bylaws and agreements of the business. One of the biggest advantages of an LLC operating agreement is that it fills in the often unambiguous parts of an LLC membership agreement. There are default provisions which take place when questions arise and a solution is not available. For this reason, many states require that all LLCs have an operating agreement in place. A few examples of fill-in provisions include:

  • A mandatory member vote on how to handle profits and losses
  • A majority vote is required for admitting new members
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  • A majority vote is needed for amending any LLC agreement articles
  • LLC members must hold, minimally, annual meetings
  • Profits are divided among members based on their individual contributions

Keep in mind that all provisions will not work for every business. It is necessary to determine what type of agreement works best for yours.

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