LLC membership interests

Most companies have one or more owners. Those owners—which can include investors, executives, and employees—typically hold some sort of security that represents their ownership stake. At a corporation, these securities that represent ownership interest take the form of company stock. At a limited liability company (LLC), they are often called membership interests or membership units. 

What is an LLC membership interest?

Membership interests are a type of security that represents ownership in an LLC. Also called membership units, you might think of LLC membership interests as an LLC’s equivalent of company stock. 

How do membership interests work?

The interests held by the owners of an LLC, also known as members, typically entitle those members to a voting interest in the company and some portion of company profits. An LLC can issue membership interests in any way it sees fit. The percentage of any individual’s ownership in an LLC will often—but not always—correspond with the size of their investment in the company.

LLCs can issue different classes of membership interests with varying profit and voting rights, in the same way that corporations can issue different classes of company stock. 

When to issue LLC interests

Nearly every LLC will issue membership interests to its founding members at the time of the company’s formation. In most cases, this is the primary time when an LLC will grant membership interests; in some cases, it’s the only time. The large majority of LLC membership interests are granted at or around the time of the company’s founding. 

LLCs may grant new membership interests to new investors in a funding round or as a form of equity compensation to employees, similar to corporations. Employee equity compensation can be based on the price of interests. Other occasions when an LLC might issue new membership shares include the addition of new members, a company reorganization, or an M&A transaction.  

How to issue membership interests

An LLC issues its initial membership interests to any founding members as part of the process of formation. There is often a subscription agreement, wherein the interests are purchased.

An LLC’s operating agreement is another foundational document that governs the rights, preferences, and privileges of the interests and may also include procedures and policies for issuing new membership interests in the future. Some LLCs choose to issue physical or digital membership certificates to their members at the time of issuance. In most states, this is optional and not required by law.

If an LLC wants to issue membership interests at some point after the time of formation, it will typically follow the processes laid out in the operating agreement. If the initial operating agreement restricts or does not address the granting of new membership interests, the LLC may amend the agreement. In many cases, existing LLC members will vote on whether to issue new membership interests.

Transferring membership interests

If an LLC member wants to transfer their membership interests, the first step is to consult the LLC operating agreement. As is the case with issuing new membership interests, the operating agreement may include guidelines or restrictions for transferring membership interests that the member must follow. 

In some cases, the operating agreement may require remaining members to vote on the potential transfer of any member’s interest.  Some operating agreements may give existing members a right of first refusal to acquire any membership interests that may be transferred. Other operating agreements may prevent the transfer of membership interests altogether.

Once the possibility of transferring membership interests is determined, the next steps are to draft and then execute the transfer agreement. A transfer agreement is a legal document that outlines the terms of the transaction, including the parties involved, the purchase price, the percentage of membership interests involved in the deal, and other potential variables. 

Upon signing and executing the transfer agreement, an LLC should amend its operating agreement and any other relevant documents to account for the change in ownership. Some state laws require LLCs to amend their articles of organization or other similar foundational documents to reflect any ownership changes. 

Differences between LLC membership interests and equity compensation

In most cases, LLCs do not issue membership interests to a significant number of their employees as a form of equity compensation. Membership interests at an LLC are typically reserved for a smaller group of owners who are active in managing or owning the business. This is different from company stock at a venture-backed corporation, which is often used as a form of equity compensation for employees. 

The main purpose of membership interests is to establish ownership, control, and profit-sharing among the high-level business owners. The main purpose of equity compensation is to attract, retain, and motivate a wider swath of workers at a business, including executives and rank-and-file employees.