Adding Investors – Part 2

Adding Investors and others to your Entity – Part 2
by Bukre Ayan

The Ninth in a Series of Articles for Entrepreneurs

Our previous article discussed the decision-making process and the importance of entity compliance before having a co-owner and/or attracting new investors. After you find the right co-owner or an investment opportunity becomes more certain for your corporation or limited liability company (LLC), what comes next?

Governing Documents – Operating agreements of LLCs and bylaws of corporations are legal documents that govern the operation of those entities. Those legal documents should describe the procedures you need to follow before or after adding someone to your entity like voting requirements and issuing a share/membership certificate. If your operating agreement or bylaws doesn’t provide about the procedures, then the NY statutory laws apply. Additionally, if you have a professional service company (like law firms, architecture firms, or physical therapy clinics), all investors and co-owners must be licensed and authorized to practice in the profession for which the entity was formed.

Tax Consequences – You have two options: selling from your ownership (i.e., shares for corporations, membership units for LLCs), or selling from authorized unissued shares of corporations or unissued membership units of LLCs. Selling from your ownership may seem tempting as it directly brings you the sale proceeds. However, as a selling member or shareholder, you will need to pay income tax out of this deal when you sell some of your membership units/shares. Conversely, if the company has unissued shares/membership units and you issue these to the new investor or co-owner, the sale proceeds go into the company. So, there won’t be any taxable income. (For more information, please consult with an accountant.)

Contract – Once you understand the specifics of adding a new co-owner or investor to your business, you should negotiate the terms of the investment, including, the payment method, issuance of ownership, percentage of ownership, and voting powers of the investors or co-owners. One thing you should keep in mind is that it’s never advised to have two co-owners each having 50% ownership in the company. It usually results in deadlocks when there is a disagreement, and bigger disagreements end with closing the businesses. So, if the entity will be owned by two persons, it’s better to have an owner holding majority of interest that is enough to pass key decisions. Also, if the co-owners will involve in the operation of the business, separate employment agreements may be signed to describe the rights and responsibilities of the co-owners including the skills they contribute, the hours they work, and their salaries.

Being a Minority Owner – If you become a minority owner after the transfer, you should remember this little-known fact that can be a large factor in your decision: NY legislation provides more protection to minority shareholders of corporations than to minority members of LLCs. Even though you should consult with an attorney before making a final decision, you should be more cautious if you are selling as an LLC member.

(Our next article in the January edition will be on Some Tax Tips for Your Entity. To see the previous articles, please visit our website at https://www.reedbusinesslaw.com)

Please be advised that this article is not intended to provide you with any legal advice, and prior results do not guarantee a similar outcome.

Photo of women-sitting-on-the-chair by RODNAE Productions and photo of woman-drinking-coffee by Sora Shimazaki.

Bukre Ayan is an international associate with the firm of Reed CNY Business Law, admitted to practice law in New York and Turkey, specializing in business, immigration, and real estate law. Spanish translations of this series are provided by Ms. Sylvia Espinosa, our firm’s legal intern from Mexico. Reed CNY Business Law represents individuals and businesses throughout Central New York and around the world. Contact us at bayan@reedbusinesslaw.com or sespinosa@ReedBusinessLaw.com.