In a limited liability company, the members are responsible for the company's debts and liabilities only to the extent of their capital contributions. This is one of the critical benefits of forming an LLC. So what is capital contribution?
It is the amount of money that a member contributes to the business. It can be in the form of cash, property, or services. In most cases, the member's capital contribution is also their ownership percentage in the firm. Let's take a closer look at this concept.
Owners of the LLC
Members are the owners of an LLC. An LLC can be owned by one member. This is known as a single-member LLC.
An LLC can also have two or more members, in which case it's a multi-member LLC. The owners are called members or shareholders (stockholders).
No matter what they're called, each member has percentage ownership in the firm and is entitled to that percentage share of profits (and losses).
Unless members have agreed otherwise in the operating agreement, their share of profits is based on how much each member contributed to purchasing the company's interest.
There are no limits on how many members an LLC can have or where they are from. The only restriction is that they all must be over 18 years old.
LLC management structure
When it comes to an LLC's structure, there are two options: member-managed and manager-managed. In a member-managed LLC, all members are involved in its operations and can serve as its agents.
Members of a manager-managed LLC appoint a manager to oversee daily operations and act as the LLC's representative.
This role could be assigned to one or more LLC members or a third party. Third-party management can even be a corporation or another LLC, depending on state restrictions.
What Can Be Constituted as Capital Contributions?
A capital contribution is a financial investment made by an LLC member. Each member of an LLC will typically make the initial capital contribution to cover start-up costs when the business is founded. This donation can be made in any amount.
For example, if an LLC has two members and the first member invested $75,000 in the establishment, and the second member contributed only $25,000 for a total of $100,000 in capital contributions to start up the business—the first member owns 75% of the company's voting rights.
The second party would own 25% of the establishment.
A capital contribution can be made in cash and property or services. If they are made in property or services, their fair market value needs to be determined and agreed upon by the LLC's members.
This is necessary to avoid any disputes down the road about the value of such contributions. The details of the contributions should be written in the operating agreement.
Three Types of Capital Contributions
- Equity investment: An investor gives money to a business in exchange for ownership shares. The investor becomes a part-owner of the business and has a say in running it. In addition, they typically receive certain rights and privileges, such as voting rights or the right to receive dividends (a portion of the company's profits). Equity investments are typically made in return for a percentage of ownership in the business, called a stake.
- Debt investment: this is when an investor loans money to a company in exchange for interest payments and a promise to repay the principal amount of the loan in the future. The company becomes indebted to the investor and must pay back the loan with interest over time.
- Convertible debt: This is when an investor loans money to a company in exchange for interest payments and has an option to convert their investment into equity in the future. If they do not exercise this option, they will be repaid like a regular debt investment.
Manage the LLC Capital Contributions
Members need to contribute money to their LLC in the amounts stated in the LLC operating agreement and at the times agreed upon in the operating agreement.
The company may implement a member's contribution agreement following the law.
The LLC's Operating Agreement should specify the particular amounts due from members and the schedule of payment for sums initially projected to be needed for the company's business.
Your bookkeeper will use the capital account to document any additional capital contributions you make throughout the LLC's life, in addition to the amount or value of your initial contribution.
How and when an LLC member can withdraw money from their company is determined by how they pay taxes. An LLC can be taxed as a sole proprietorship, partnership, C corporation, or S corporation.
- Sole proprietorship: This is the default tax setting for an LLC. Instead of receiving a paycheck, LLC members will take dividends from their personal capital accounts. All distributions are treated as personal income and will be recorded on each member's individual tax return. At the time of filing, these earnings are liable to state, federal, and self-employment taxes.
- C corporations: LLC members may be employed as workers and paid what is deemed reasonable pay by your industry's standards if you elect your LLC to be taxed as a C corporation.
- S corporation: S corporations, like C corporations, allow LLC members to be paid as company workers, with a reasonable compensation subject to all employment and payroll taxes. Any additional dividends handed out to members, unlike a C corporation, are subject to pass-through taxation rather than corporate taxation.
Is There a Set Amount I Have to Contribute to the LLC?
There isn't a set amount for initial capital contributions. You can contribute any amount. Members usually contribute enough to cover start-up expenses.
But what if you don't want to — or are unable to — contribute to the formation of an LLC? You may face tax and legal issues because you are not taking a personal liability in beginning the business without this donation.
Your share of any partnership losses, for example, is only authorized if you have a financial stake in the company (via your capital investment). There will be no loss if there is no interest.
How Much Money Can I Take Out From the LLC?
You can take as much money as you want, as long as you don't break the terms of the operating agreement. If you're the only shareholder, you can take as much money as you like, but you must leave enough money in the business to keep it running.
How Do I Keep Track of the LLC Ownership?
When you invest money into the LLC, your contribution, as well as the contributions of other members, are recorded as an equity (ownership) account on the LLC's balance sheet.
The initial contributions and any additional donations made during the year are recorded in each member's capital account. It also keeps track of distributions (amounts taken out by each LLC owner) during the year and a year-end capital account balance.
LLC Capital Contribution: Conclusion
As you can see, a capital contribution is an essential factor to consider when forming an LLC. By making a capital contribution, each member can reduce their individual risk and ensure they have a stake in the company.
If you're thinking of starting an LLC, be sure to talk to a professional for legal or tax advice, so you understand the implications of making a capital contribution. Thanks for reading!