How do you reserve 20% of an LLC (start-up) to future investors when drafting the operating agreement?

Asked almost 2 years ago - Van Nuys, CA

I want to form an LLC. I have one partner. He and I will own 80% of the company and we want 20% to be reserved for potential equity investors. The business is a website that distributes movies and we will build an advertising model around it. We would like to give a small percentage to our content providers (ie the owners of the films we distribute on the site) but no more that 20% of total equity as a way to entice them to enter into an agreement to sign with us. Now, should we simply dilute our ownership every time we sign a new content provider who will have class B common stock with no voting rights?

Attorney answers (4)

  1. Matthew P. Blair

    Contributor Level 11

    3

    Lawyers agree

    Answered . What are the reasons you decided on choosing an LLC as your entity? LLC's can hold stock but do not issue stock and the "owners" are members, not "stockholders." However, when executing an operating agreement, LLC members may agree to assign certain rights and benefits to some LLC members but not to others. LLC paperwork is typically more complex than other entities. I suggest contacting a local business attorney to discuss the best entity selection for your start-up and your long term goals.

    I hope you find this helpful.

    Matthew Blair
    www.beverlyhillsbusinesslawyers.com

  2. Scott J. Wittlin

    Contributor Level 11

    4

    Lawyers agree

    Answered . LLC owners have to own 100% of the membership interest. You can later distribute membership interests to new members (keeping within your framework of 20%). Doing so simply dilutes your profits interest. You can create a second membership class that is non-voting. That class would distribute a portion of the profits interest (up to 20%). You can from inception create two classes with you and your partners owning 100% of Class A and 100% of Class B non-voting. Class A gets 80% of the profits and Class B 20% of the profits. As you add class B members you dilute your 20% profits interest in Class B.

    I suggest you get a lawyer to help you draft this into the operating agreement.

    The above statements are provided as general information and not intended as legal advice. Each matter has its own... more
  3. Dana Howard Shultz

    Contributor Level 20

    2

    Lawyers agree

    Answered . I agree with my colleagues and will add the following:

    Multi-class LLCs are tricky (please see the post at the link below). The likelihood that you can form this LLC properly on your own is exceedingly low. You should seek the assistance of an experienced business lawyer.

    This information does not constitute legal advice and does not establish an attorney-client relationship.
  4. Jeffrey Ferris Clark

    Contributor Level 6

    Answered . Agree with colleagues. "Reserving" units of membership interest in an LLC for future issuance does not affect the 100% ownership of the company by its current members. It's simply an agreement by the current members to have the company issue such new units later (diluting percentage interests only when actually issued). The specific nature of such future issuances (size, class, etc.) can be either decided now (and be built into the Operating Agreement) or left open to future agreement by the members or by a grant of authority to the Manager(s). Remember that new equity owners become "members" of the LLC and need to be parties to your operating agreement (although non-member interests in company profits can be structured if you prefer).

Related Topics

Small business LLCs

An LLC (limited liability company) is a business entity that has elements of both a corporation and a partnership (or sole proprietorship).

Business contracts

A contract is an agreement voluntarily entered into by two or more parties that is intended to create legal obligations between them.

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