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 Washington.
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.
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 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, a document not required by Washington state when establishing your LLC but strongly recommended, 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 plan like this, you must meet your commitment for additional capital contributions by the times listed in the contract.
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 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 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.
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 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, and the operating agreement can instead offer the shares of the distributions of profits and losses.
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 include software, insurance, maintenance and repair, and consulting companies.
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.
Bank loans are one method to obtain a member loan. They are more difficult to obtain for new businesses today than a decade ago but are still available. 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. This can help fund larger business expenses. You will need to guarantee each bank loan personally. 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 an SBA loan.
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 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 necessarily taking the business public.
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.