This is the third in a series about the efforts of Jim, Mary, Brett, and Paul to open a gelato shop.
They’ve made the decision (after consulting with their accountant) to structure their business as an LLC. Then they came to me to set things up.
They each had the preconceived notion that establishing the LLC would be a relatively straightforward process. File the articles of organization with the Secretary of State and execute a proforma operating agreement.
I had to disillusion them from this anticipated simplicity of the process. As I explained, even though this was going to be more involved than originally thought, this was an excellent opportunity for them to 1) see how well they functioned as a group, and 2) make plans and decisions now for issues that often arise during the life of a business.
We had already discussed two hot topics: how much cash each person was to contribute, and how much time each person was to devote to the gelato shop.
The next point I had them consider was the transferability of their individual ownership of the company. I explained what I meant.
Several different things can happen during the life of an LLC. One or more of the owners could die. A married member (that’s the name for an owner of an LLC, as opposed to shareholder for a corporation) could get a divorce. A member could get newly married. Someone could suffer a serious and debilitating injury or disease. A member could hit hard times and have to declare bankruptcy. An outside third party could offer to buy a member’s ownership in the LLC. There are numerous other possibilities beyond these.
But what all these events could trigger is a potential change of ownership, or, in other words, a transfer of ownership. And, if the members don’t do advance planning, they will be faced with making decisions in a heavy, pressure-laden situation where the interests of one member could be dramatically different from the other members.
As an example, say Mary gets a divorce. Because she’s a California resident, her spouse in essence owns 50% of her membership interest by virtue of community property laws. Upon the divorce, unless plans are made to the contrary, the spouse could step into the gelato shop as much an owner as Mary.
Or say Jim dies. Jim has three kids from two different marriages. They really don’t like each other. Now that Jim is dead, do his three kids become co-owners? Or, because of the enmity among the siblings, they fight each other in probate court over who should and who should not inherit Jim’s interest in the LLC. This results in the other members potentially not being able to make important decisions about the business because everything is tied up in court.
Or someone approaches Paul to buy his membership interest. Without making agreements now on how to handle such circumstances, Paul could sell his ownership in the company without even notifying the other members.
Or let’s say Brett needs a loan. The lender demands some security for the debt, which could include Brett’s portion of the business. When Brett defaults on the loan, does the lender become a new owner?
I have seen all these scenarios happen. And, if the owners have not planned ahead, any one of these scenarios could result in the collapse of the business.
But I told the four of them to relax, as they could make decisions now that could reduce or even eliminate the possibility that one of these situations could cause a major disturbance in the business.
For instance, they could agree that if one of them dies, the surviving members will pay the deceased heirs a fair market price for that individual’s membership interest. They could even take out life insurance on each other to help defray the costs.
Or all spouses could be required to sign a spousal consent that determines what happens to the community property interest each spouse has. There could be an agreement that the member gets to buy out the soon-to-be ex-spouse at a fair price.
All the members could agree that they would have to disclose to all other members if there was ever an offer to buy their ownership in the LLC.
So, I will press the four of them to discuss all of these points and to make decisions about how to handle much of whatever arises.
Carl Kanowsky of Kanowsky & Associates is an attorney in the Santa Clarita Valley. He may be reached by email at [email protected]. His column represents his own views, and not necessarily those of The Signal. Nothing contained herein shall be or is intended to be construed as providing legal advice.
