What is an LLC?
A limited liability company (LLC) is a business structure in the United States whereby the owners are not personally liable for the company's debts or liabilities. Limited liability companies are hybrid entities that combine the characteristics of a corporation with those of a partnership or sole proprietorship.
Why may I have difficulty financing my LLC?
Funding for your new LLC can be challenging because you may not have the financial history for potential lenders to decide to provide a loan. Instead, you may need to find different ways to fund your company to obtain the necessary capital to either launch or grow your business. Your best funding option will depend on your current personal and business financial situation. There are many funding options available in New Jersey that you can explore if for whatever reason you are denied more traditional methods of financing.
What are capital contributions?
A capital contribution is financing a company, in this case, an LLC, by the business members or owners. Generally, each member provides an initial capital contribution when initiating an LLC. There is no requirement for how much this capital contribution should be, but the compilation of all capital contributions should cover at least the operating expenses for starting up.
The operating agreement is not legally required in New Jersey but is strongly recommended. It may outline a schedule of capital contributions that members will commit to throughout the LLC's lifetime. If your LLC operating agreement includes a plan like this, you must meet your commitment for additional capital contributions by the times listed in the contract.
What are the different forms of LLC capital contributions?
Your capital contribution can be in various forms, including cash, property, or services. Cash capital contributions are generally straightforward. It can be as easy as drafting a check to provide to the LLC if it is from your funds.
Property contributions require more steps. You will need a market valuation to determine your property's value. A market valuation is a price an asset will fetch in the marketplace or the amount the investment community places on the property. Capital contributions in the form of property also can include some potential tax consequences. It would be best if you spoke to your tax advisor beforehand to understand what tax obligations you or the LLC may have from this form of capital contribution.
Services are the final form of the capital contribution we will discuss. Like property, you will also need to obtain a market value for the services you contribute to the LLC. There will also be tax consequences because you will treat the value of your services similarly to the actual income you earned. This means you will pay personal income taxes for these services. This is why services are not often a popular form of capital contribution.
Do I need to track my capital contributions? Why or why not?
Each LLC member will have an account that is not a real bank account. Instead, this account is meant for purposes of record keeping. It is crucial to account for the number of each member's contributions to the LLC and distributions of the LLC.
Maintaining a capital account for each member is essential because this determines each individual's percent ownership. If the LLC dissolves, the amount of LLC assets the members receive after all debts are paid is often similar to their percentage ownership.
Your company's bookkeeper will also use this information to ensure you follow your commitments outlined in the operating agreement for additional capital contributions throughout the LLC's lifetime.
The LLC's profits and losses can also be distributed amongst members based on the percentages provided by these capital accounts. This is not always the case, and the operating agreement can instead offer the shares of the distributions of profits and losses.
Are capital contributions required to start an LLC?
Capital contributions are NOT required for LLCs. It is common for LLCs to start with no capital investment. This is because the LLC is a service company that develops an intangible product. Some examples of businesses that may not need capital contributions to include software, insurance, maintenance and repair, and consulting companies.
What is the difference between a loan and a capital contribution?
So your LLC needs additional funds to run, and you would prefer not to provide a capital contribution, and your operating agreement doesn't require you to provide one at this point. Another way you can fund your LLC is through a loan instead. A loan differs from a capital contribution as it does not affect your capital account balance. It will need to be repaid to the lenders. Member loans are made like any other loan.
When you make the loan to your LLC, the company should provide a promissory note that includes information about the loan. The note should have the loan amount, the specified interest rate, repayment terms, and say what happens in the event of default.
The loan is not typically taxable to members of the LLC as it is not treated as a distribution to the members.
Make sure you are careful when selecting who to obtain loans from. Many for-profit lenders can provide you with short-term loans but at the cost of very high-interest rates. These loans can be considered predatory and prevent you from meeting your business obligations. Review the terms and conditions of any loan you take out carefully.
What are some loan types?
The New Jersey Government website lists many places you can visit for a loan. These include alternative lenders, banks, and lending organizations.
These are a category of lenders that are non-profit or from community organizations. Alternative lenders often have a mission to support certain social goals or low-income communities. Because of this, they often have less restrictions than banks when providing loans. Some examples of community lenders may include credit unions and some community development finance institutions. The loans are generally smaller and have fixed interest rates, making it easier to repay the loan. Alternative lenders may also provide you training or technical assistance on top of any loans. New Jersey has a line where you can ask any additional questions about alternative lenders in the area at 1-800-Jersey-7.
This is a common and traditional way for you to obtain your loans. It can be very difficult to get approved as mentioned previously. There may be requirements that include having another source of income, great credit, or other collateral.
If you don’t qualify for traditional bank loans, consider different lending institutions including the economic development authority or the U.S. small business administration lending partners. New Jersey has a site dedicated to exploring these options.
What are some other ways to provide LLC funding?
Equity investment is where an investor contributes capital to your business in exchange for a stock in your company. This type of funding does not need to be repaid. The downside is that accepting these investments may mean giving up part of your hold on the LLC's earnings. The advantage is that you could potentially bring in well-qualified partners who are motivated to help your business grow and succeed. An example of equity investment is angel investors. These investors are high net-worth individuals that provide financial banking for companies, often in exchange for ownership equity in the company. They are usually found amongst the entrepreneur's family and friends.
Another funding source is termed "rollover for business startups" or ROBS. This is money you borrow from your retirement account that you invest into your business. You do not need to pay taxes or early withdrawal fees. This is not considered a loan, but if your business fails, you can lose the funds you've invested. ROBS is risky and you may lose your retirement accounts, but it could be a source of capital without expensive debt payments. ROBS has a setup fee you need to provide, and there may be a continuing fee to ensure the transaction is monitored well. This transaction is complex and unique, so you must work with a firm experienced in ROBS transactions to ensure you understand what you are getting into.
Selling company stock is the final method we will discuss. Taking your company public is often a goal for businesses that grow quickly. Going public refers to allowing your business to sell ownership shares on the open market. Businesses may use this as a way to take money out of the company or as a way to raise funds to grow. Selling company stock is not only for large corporations and can be used for smaller businesses as well. The JOBS act, created in 2012, enables small companies to utilize crowdfunding to issue securities. This allows businesses to raise small amounts of money without publicizing the business.
Which option(s) should I take to fund my LLC?
Which option is best for you depends on many factors. It is important to speak to your financial advisor and perform proactive tax planning to decide what funding method is best for you. You can also search the New Jersey government site for additional information.