Member Capital Contributions
An LLC has one or more members, who contribute to the LLC based on their ownership share. Ownership share and all matters pertaining to member capital accounts are detailed in the operating agreement. Member contributions may be made in cash or non-cash (property, for example). Property contributions must be listed and described and the members must agree on the fair market value of non-cash contributions.
Member Capital Accounts
Each member of an LLC has a capital account which is shown in the balance sheet as an equity account. The member's capital account records the initial contribution and any additional contributions made. The capital account records each member's share of the profits or losses of the LLC. For example, if a (50% ownership) member's initial contribution is $10,000, and the LLC has a profit of $5,000 in the first year, that member's capital account would include the member's share of the profit and be listed as $12,500 as of the end of the year.
The member's capital account also records disbursements from the capital account, if these are allowed by the operating agreement.
Member Contributions and Distributions
Initial capital contributions on formation of the LLC may be any amount. Members usually contribute enough to pay startup expenses and assets. Simplicity Law says,
In some cases, inadequate capitalization could be a factor in disregarding an LLC and finding the members personally liable for the debts or obligations of the LLC (piercing the veil). If your LLC has particularly significant risks or liabilities, it may be necessary to have a greater capital contribution.
Contribution percentages can be different from distribution percentages. For example, initial member percentages of ownership can be set by the operating agreement and the agreement can set different percentages of share of the profits/losses. The members can do anything they want as long as it isn't in conflict with state law, as long as there is agreement and the agreement is stated in the operating agreement.
Capital Accounts and the Operating Agreement
As noted above, member capital accounts are governed by the operating agreement, which prescribes:
- Percentage of ownership of each member
- Required initial contribution
- Required additional contributions, if any
- Actions if member fails to make an initial contribution or required contributions
- Penalties for failure to make required contributions.
Capital contributions vs. Member Loans
LLC members may also loan money to the LLC, separately from their capital contributions. The terms of a member loan to an LLC, like any other owner loan, should be documented carefully in a loan agreement, specifying amount, interest rate, repayment terms, and default provisions. A loan by a member does not change the member's capital contribution or distribution of profits and losses. Read more about the difference between investing in a business vs. loaning to a business.
Most states do not specify capital contribution amounts, but some states have requirements for LLC operating agreements that may affect capital contributions, so be sure to check with an attorney in your state before you form an LLC and create an operating agreement.
Disclaimer: This article includes general information; the author is not an attorney or CPA and no legal or tax advice is being provided. State laws and individual circumstances may vary; consult your attorney before you make any decisions or take any actions that could affect your business.