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. It is a relatively new hybrid business structure available in most states, including New York. The owners of an LLC company are referred to as members. During the establishment of an LLC in New York, you are required to submit an operating agreement. This agreement delineates management responsibility, profit sharing, funding obligations, the continuation of the company, and dissolution as the members see fit. This allows members to be similar in understanding how the company will run and prevent conflict.
At the end of this article, we will discuss specific New York opportunities available.
Why may I have trouble funding my LLC?
Funding for your new LLC can be especially difficult 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 capital needed to either launch or grow your business. Your best funding option will depend on your current personal and business financial situation.
What are capital contributions?
A capital contribution is financing a company, in this case, an LLC, by the business members or owners themselves. Generally, each member provides an initial capital contribution when initiating an LLC. There is generally no requirement as to how much this capital contribution should be. Still, the compilation of all capital contributions should cover at least the operating expenses for starting up.
The operating agreement, a document required by New York state when establishing your LLC, will often outline a schedule of capital contributions that members will commit to throughout the LLC’s lifetime. If your LLC operating agreement includes a schedule like this, you must meet your commitment for additional capital contributions by the times listed in the agreement.
What are the different forms of LLC capital contributions?
Your capital contribution can be in various forms that include 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 personal funds.
Property contributions require more steps. You will need to obtain a market valuation to determine your property's value. A market valuation is the price an asset will fetch in the marketplace or the amount the investment community places on the property. Capital contributions in the form of the property also can include some potential tax consequences. You should speak 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?
It is important to account for the number of each member’s contributions to the LLC and distributions of the LLC. 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 important to maintain a capital account for each member 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 are following 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; the operating agreement can instead provide the percentages 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 is different 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.
What are some loan types?
Bank loans are one method to obtain a member loan. If you have a solid business plan, good credit history, and plan to keep the business in the local area, you could qualify for a local bank loan. They are more challenging to obtain for new businesses today than a decade ago but are still available. This can help fund larger business expenses. You will need to personally guarantee each bank loan. Make sure you know what you’re getting into before agreeing to take this loan. As with every loan, you must ensure you feel comfortable repaying it based on the agreed-upon terms.
SBA loans are another type of loan. They are difficult to qualify for and require that the business exists for at least two years. When applying for this loan type, the business needs to show growth and profitability for at least the last three months. You can get access to as much as $5 million, but it will take a while before you can get any of SBA loan at all.
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 often 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 that you may lose your retirement accounts, but it could be a source of capital without expensive debt payments. ROBS has a setup fee that you need to provide, and there may be continuing fee to make sure the transaction is monitored well. This transaction is complex and special, so you should 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 businesses to utilize crowdfunding to issue securities. This allows businesses to raise small amounts of money without necessarily having to take the business public.
What are some other funding opportunities available in New York?
COVID-19 was difficult for many businesses. New York established a Business Pandemic Recovery Initiative that provides approximately $800 million in state funding for small New York businesses. You can find programs that align with your business by clicking here. This program will offer up to $50,000 to your small business.
New York also has a variety of grant programs for specific business types, including tourism, arts, musical and theatrical productions, restaurants, and more. You can view available New York grants here.
Finally, New York is offering small business lease assistance for those who are at risk of eviction. You can learn more about this assistance program here. Through this program, you can also renegotiate your lease and avoid litigation costs.
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 method of funding is best for you.