The Internal Revenue Service (IRS) classifies limited liability companies (LLCs) as single-member LLCs or multiple-member LLCs. Although the IRS makes this distinction based upon the number of people who own the company, the state law under which the LLC is formed does not. All LLCs are subject to the provisions of controlling state law, including the provisions regarding equity capitalization and the way an LLC goes about raising money through the sale of an ownership interest in the company.
An LLC is formed under a state business statute, commonly called a Limited Liability Company Act (LLCA). Although every state passes its own laws, there are certain basic provisions that are required of an LLCA that make the company formed under it fit the legal definition of an LLC. One of these basic provisions is the way ownership interest in the company is held. The ordinary wording of the ownership interest provisions of an LLCA can be viewed in the national Uniform Limited Liability Company Act that serves as the model for many states' LLCAs.
Although an LLC receives some of the benefits of a corporation and can choose to be taxed by the IRS as a corporation, it is not a corporation under the law. Ownership in a corporation is reflected by a person holding shares of stock in the company. Ownership in an LLC, by comparison, is reflected by a percentage ownership interest in the company that is carried on the company's books. In short, an owner of an LLC does not hold stock in the company, and the company cannot sell shares of stock to raise money.
Selling shares of stock in exchange for an equity position in the company is the way a corporation capitalizes itself. Owners put up money, property and services to be used by the corporation for operational purposes. An LLC can also raise money in exchange for equity, however, it is not done by selling shares of stock. Instead, an LLC can sell a percentage interest in the company that allows the buyer to fully participate in the management of the company.
Some LLCs issue stock certificates to represent an owner's percentage interest because investors often like to have something in hand to represent their investment, rather than just a tally on paper. These stock certificates are merely cosmetic, however. They are not transferable securities and do not represent ownership in the company. Another important consideration to keep in mind about the way equity is exchanged for capital in an LLC versus a corporation is that ownership of stock in a corporation does not necessarily give the stockholder any ability to manage the corporation. Ownership interest in an LLC, even a small minority position, comes with the full right of equal participation in every decision and the ability to manage the affairs of the company. Ownership interest in an LLC is structured like a partnership, and under partnership law, all owners have equal rights. When you sell an interest in an LLC, you are bringing on a full partner.
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