Start Here: Limited Liability Companies (LLCs) and Employee Ownership
Limited liability companies (LLCs) are a relatively recent form of business organization, but one that has become increasingly popular because of their simplicity and flexibility. In contrast with corporations, which have shareholders, the owners of LLCs are called members, and the unit of ownership is not stock but “membership interests.” The maximum number of members is not limited, and in most states an LLC can have a single member. LLCs also have great flexibility in the distribution of profits, allocation of equity value, and assignment of management and governance rights.
Many LLCs want employees to have an ownership stake in the company, and they have a wide array of choices. LLCs do not have stock, so they cannot establish employee stock ownership plans (ESOPs), give out stock options, or provide restricted stock, or otherwise give employees actual shares or rights to shares, but they can provide similar ownership-linked benefits to their employees. See the page on equity incentives in LLCs to learn about profits interests, unit plans, and capital interests. For a more detailed look, see our publication Equity Compensation for Limited Liability Corporations (LLCs).
In corporations, many core business functions, such as the allocation of profits, governance power, and tax liability, are based on holding shares. In LLCs, those functions are instead defined by an operating agreement, which is analogous to a corporation’s bylaws. The operating agreement means that LLCs may allocate, for example, greater governance power to one member and a greater share of profit allocations to another, even if both members have equal membership interests. Operating agreements may also allow for nonmember employees to receive compensation linked to the performance of the company.
- All 50 states have legislation defining LLCs, and their requirements vary. Legal counsel familiar with the specific laws in the state or states in which the LLC will operate should be involved in establishing or modifying the structure of the LLC.
- Since governance in LLCs is extremely flexible, many worker cooperatives are structured as LLCs. These companies are cooperatives because their operating agreements follow the requirements for worker cooperatives.
- Tax treatment is one of the more complicated areas in LLCs. They have flexibility about whether to be taxed as a corporation or a partnership (or, for single-member LLCs, as a sole proprietorship).
- LLCs can choose to be taxed as an S corporation, and if they do they can sponsor an ESOP, according to a 2015 IRS private letter ruling. The interaction between LLCs and ESOPs and the requirements for converting an LLC’s tax status are not simple and require work by a lawyer familiar with both ESOPs and your state’s LLC rules.