In Utah, limited liability companies, or LLCs, are one of the most common approaches to business ownership. LLCs are perhaps the most flexible business type, and Utah statutes allow for very different approaches to structuring them, depending on the needs of the business. One key area of import is how ownership in LLCs is approached.
Membership
Equity holders in LLCs are called members, much like holders of equity in a corporation are called stockholders or shareholders. A single-member LLC can often be fairly simple since one person has total control of how the LLC operates and all decisions that are taken. Once more than one person is involved, more issues should be considered and addressed to ensure that the entity operates as expected and to avoid concerns that often happen down the road.
Utah Code 48-3a-4, et al, deals with how members relate to one another and to the limited liability company. In the absence of an operating agreement, background Utah statute controls with respect to the operations of the entity and any questions or issues that may arise. We strongly recommend that an operating agreement be created to ensure that the rules and agreements are clear about how the entity will work. An operating agreement will typically trump background law about most matters, and courts generally see it as an enforceable agreement between the members. Also, most financial institutions will require an operating agreement between the members in order to create financial accounts.
Unitizing
Normally, membership in an LLC provides very specific rights. First and foremost, the equity owned typically gives each member a right to a percentage of the profits of the entity, as well as voting rights as to what is done with the entity. Equity ownership in an LLC can be split up in the operating agreement by simple percentages, but it is usually more helpful to create “units” of equity, which are roughly analogous to shares of stock. For example, a member who owns 10% of the equity might own 100 units out of a total of 1,000 units issued. Creating units makes it clearer and simpler as to how equity will work, and the units can typically be sold like shares of stock. The units bring with them the rights and obligations set forth in the operating agreement or other operating documents of the LLC, and so the holder of the units can exercise those rights.
Profits Interest Units
Because the law surrounding LLCs allows great flexibility, most of the rules and approaches discussed here can be changed or varied according to the needs of the members and the entity. For instance, different types of units can be created. One very common approach is to create “capital units” and also “profits interest units.” This is common when some of the members of the entity are contributing capital to the company and want the full spectrum of rights related to the units, but other members do not contribute capital and might not get all of the typical rights. The profits interest unit holders do not have a right to capital distributions, since they did not contribute any capital to the company.
Profits interest units can be used with a founder of the company who will not contribute capital, and are also often seen when an LLC wants to give its employees extra motivation to help the company succeed, like how stock options are often issued to employees of a young startup corporation. If, for example, an LLC is currently worth $1 million, it might issue profits interest units to a new officer that represent 10% of the total equity, but the profits interest units would only be of value if the company increases above the $1 million it is currently worth. If the company were to sell tomorrow for $1 million, those profits interest units wouldn’t be entitled to anything. But if the company value increases to $3 million and sells, then the profits interest units would be entitled to 10% of the value above the original amount, i.e., 10% of the new $2 million in value, or $200,000.
The primary requirement for profits interest units is that they don’t get any capital return, but they have broad flexibility in how they are structured after that. Profits interest units may or may not have voting rights, information rights, the right to participate in certain meetings, and other rights usually associated with equity. At the extreme, they may effectively just provide “economic rights” to the holder, so that the holder gets the agreed monetary benefit but no other benefits.
Enlist a Utah Business Attorney
Owners of equity in LLCs should ensure that they have the rights and opportunities they require for their specific needs and that the operating agreement and other entity documents are clear about how everything will work. Our deep Utah business law knowledge can help you with your business structuring needs or other operational requirements. Whether you are seeking to create a new Utah business or need to review or update an existing business, we are available to discuss your options and answer your questions at an initial free, thirty-minute consultation. Call us at (801) 477-6838 for a free consultation. You can also email Ben at benjamin.beasley@freemanlovell.com, fill out a contact form below, or set up an appointment to meet at our offices. We look forward to helping you.
