How Do I Categorize Investors In An LLC

[mags24]

I am taking on investors in my New Jersey LLC, but I don't want to categorize them as members - does anyone know if this is possible?

[phanio]

What does it really matter what they are called - you can call them anything you want - try partners. The key is will expenses and income pass through and is their liability limited in the eyes of the IRS and courts. But, call them anything you want.

[SeattleCPA]

Owners in an LLC are members. That's what they're called. Note that you can have a manager-managed LLC, in which case you have manager members (who run the business) and non-manager member (who are passive).

[theieu]

well you can categorize them as business partners, since LLC is a form of business partnership and not a corporation or company.

[ArcSine]

If their investment takes the form of loans, even if it's subordinated debt, the investors are not LLC 'members' for any legal or tax sense. You have a lot of flexibility in designing the loan agreements to give them the kind of payouts that you and they have in mind.

But that flexibility isn't without limit. If you design the 'loan' agreements such that your investors' relationship with your LLC is, from an economic reality perspective, more like 'equity' than 'debt', there's a chance it would be characterized as equity by the IRS and/or the courts. In other words, if it walks, talks, and moves like equity, then it doesn't matter that the documents say "Promissory Note" at the top.

But 'member' isn't the same as 'manager'. You can certainly have 'silent' investors who own LLC membership equity that entitles them to some slice of the profits pie, but confers no rights to have a say in the operations of the biz. LLC membership 'equity' comes in a lot of flavors--you've got a lot of flexibility in its design. Be sure to get the guidance of an attorney with expertise in this area. Best of luck!

[torka]

Originally Posted by ArcSine

Be sure to get the guidance of an attorney with expertise in this area.

This is so important it deserves to be said twice. In bold type, even.

This is not a "DIY" situation. With the legal and tax implications involved, you need the advice and guidance of an expert.

--Torka

[SeattleCPA]

I think you can often take a DIY approach when setting up an LLC if you don't have outside investors or you don't have a lot of money.

Frankly--and here I speak as a CPA with, er, 25+ years of experience--you think you'd great get legal advice if, as a small business, you spend $2K or $5K or $10K for getting an entity setup.

Sadly, that's often not the case. The last really large S corp I assisted with, used (at my recommendation) a large law firm to quarterback the process. I was very disappointed. The firm assigned a very young, probably extremely smart, but totally inexperienced attorney. I had to tell her, for example, that shareholder spouses needed to sign the S election agreement for the LLC.

By the way, not that along ago, one of my clients converted their partnership to a corporation using a large "high technology" Seattle boutique law firm. The fee was around $10K. In the end, the lawyers didn't even create the paperwork to document the transfer of partnership assets to the corporation. Again, a newbie assigned to the project the partners thought was too easy...

[ArcSine]

Probably getting a bit off-course from the thread-starter's question, but the whole DIY-or-no is an interesting topic in its own right.

Steve makes a great point that the DIY approach is quite do-able, when the situation fits his qualifier "...if you don't have outside investors...". A lot of biz owners have the mistaken impression that an attorney's involvement is mandatory for every LLC or Corp set-up.

It's when outside capital comes to the party that the legal and tax complexities ramp up exponentially. Federal and state securities laws, minority investor rights under state law, confusing tax code issues....ad nauseum...

My advice to seek experienced counsel was more situation-specific, since Mags24 said that outside money was involved.

Cheers, all!

[torka]

Exactly! That was why I repeated the point.

When you start bringing in outside investors, everything gets more complicated. IMO, having competent expert advice is crucial to avoid potential issues down the road.

--Torka

[urvi09]

Originally Posted by theieu

well you can categorize them as business partners, since LLC is a form of business partnership and not a corporation or company.

Ya i agree that business partners is the perfect category for them.