The Delaware Limited Liability Company (LLC) is the preferred legal entity for entrepreneurs and small business owners. Compared to a corporation, an LLC offers much more flexibility and minimal red tape.
The company’s Operating Agreement sets forth an LLC’s ownership. This internal document governs the affairs of the company and is not filed in the public record. Members can make changes to an LLC’s ownership structure privately without requiring any state filings.
An LLC can issue membership certificates to provide further evidence of ownership beyond the Operating Agreement. Membership certificates can be useful in some instances, however, they are often not advised. There are several pitfalls members need to avoid when issuing membership certificates .
We go over what LLC membership certificates are and how to properly issue them.
What Is An LLC Membership Certificate?
LLC membership certificates look like stock certificates issued by a corporation, however, they do not function in the same way. The certificate lists the name of an LLC member and details their ownership interest in the company.
The law does not require LLCs to issue membership certificates. This is because these certificates do not represent an official record. The LLC Operating Agreement is still the official record of ownership even if the company issues membership certificates. The LLC Operating Agreement will control in the event of any conflict with information presented on a membership certificate. LLC owners often do not use membership certificates as a result.
Some instances may require an LLC to issue membership certificates. One example is when an LLC Operating Agreement has UCC Article 8 opt-out language that confers the membership certificate legal status making it evidence of ownership. The Delaware LLC Act and Uniform Commercial Code require possession by a secured lender of a member’s certificate to perfect security interest in collateral. This is often the case for types of hybrid debt, such as mezzanine financing.
Members cannot issue membership certificates in blank name to the bearer. Delaware requires owners of an LLC to know at all times who the members.
Benefits of LLC Membership Certificates
One benefit of LLC membership certificates is that they list ownership interest as individual units rather than percentages. The LLC Operating Agreement traditionally divides ownership on a percentage basis. For example, an LLC with two equal members would allocate 50% ownership to each member.
Percentage based ownership is fairly straightforward when dividing between two or three members. However, percentage ownership becomes increasingly difficult to manage as more members are added or removed. Membership units make members feel like they own something tangible when they receive a membership certificate.
LLC Membership Certificate Pitfalls
LLC membership certificates are not official records of ownership and do not function like corporate stock. A membership certificate can make an LLC member feel more like an owner. This can often mislead members to think they can transfer a certificate simply by endorsing the back.
The LLC Operating Agreement often makes endorsing membership more complicated by imparting specific restrictions. Members put these restrictions in place to prevent the hostile takeover of a company by an unwanted individual.
LLC Operating Agreements typically have “pick-your-partner” provisions. These provisions provide that the other LLC members must first approve an ownership transfer before voting rights are conferred to a new member. Many LLC Operating Agreements also include a “right of first refusal” as another barrier to ownership transfer. A right of first refusal grants the company first, and then the other members themselves, the right to buy the interest before it can be transferred.
Do LLCs Have Stock?
An LLC does not have stock. LLC ownership is more like a partnership where owners agree on how they will divide the ownership pie.
LLC owners have complete “freedom of contract” under their private Operating Agreement. This allows them to arrange company ownership any way they decide. This includes differing capital contributions plus unique arrangements for distributions to members. An LLC can even create different classes of ownership units. Classes can account for different voting rights and privileges that members may have in an organization.
If you can dream it, you can do it in the Operating Agreement, provided it is understood between all members.
How To Create LLC Membership Certificates
LLC membership certificates should identify the following:
- The name of the company,
- The state of formation,
- The total amount of units authorized under the LLC Operating Agreement,
- The name of the member,
- The allocated units or ownership percentage issued to the member,
- Any transfer restrictions that may be necessary to declare on the certificate,
- Signatures of an LLC’s officers or managers.
Membership certificates can include a legend. The legend indicates any restrictions imposed on the member’s right to transfer ownership. The legend can be located either on the face or the back of the certificate.
The certificate can also acknowledge any contractual obligations the interests are subject to upon being transferred or sold. An LLC member is expected to be aware that their ownership rights are based on the Operating Agreement, not just a certificate.
The LLC’s secretary or manager typically sign the membership certificate. Authorized membership certificates must be consistent with the Operating Agreement.
The law does not require LLCs to issue membership certificates. These certificates however are sometimes provided to members who are less involved in the day-to-day operations of the business. Although membership certificates are one way to further memorialize ownership interest through additional, physical documentation, the internal Operating Agreement remains the principal oracle that is dispositive of who are the owners.