Can You Sell Your Shares of an LLC?

It is possible to sell your ownership in a Limited Liability Company (LLC), but the process is distinct from selling shares of a publicly-traded corporation. An LLC does not issue “shares” in the same way; instead, owners hold a “membership interest.” This interest represents a member’s stake in the company’s profits, losses, and distributions. The ability to sell this interest and the steps required are governed by rules defined by the company and state law, making it a private transaction.

The Governing Document The Operating Agreement

The first step in selling a membership interest is to review the LLC’s operating agreement. This internal document is the primary source of rules governing the company, including the procedures and restrictions for transferring ownership. Without consulting this document, a member risks breaching their contractual obligations to the other owners.

Operating agreements often contain specific clauses that limit a member’s ability to sell their interest. A common provision is a requirement for member approval, which might stipulate that a sale to an outside party needs a majority or even unanimous consent from the remaining members. This ensures that the original owners maintain control over who becomes a part of their business.

Another frequent restriction is the Right of First Refusal, or ROFR. This clause requires a selling member to first offer their interest to the other existing members before they can offer it to an external buyer. The offer to the other members must be on the same terms and price as those offered to the third party.

Many agreements also include buy-sell provisions. These are pre-established terms that dictate the process and valuation for a sale when certain triggering events occur, such as a member’s retirement, disability, or decision to leave the business. These provisions can predetermine the sale price, often through a formula based on book value or a multiple of earnings, streamlining the exit process.

If an LLC does not have an operating agreement, the transfer process is governed by the default rules of the state in which it was formed. These rules are often more restrictive and may require the consent of all members for any transfer.

The Sale Process

The initial step involves determining the value of the interest being sold. If the operating agreement is silent on this matter, the members may need to use standard business valuation techniques, such as an income-based or asset-based approach. This often requires hiring a professional appraiser to ensure a fair price.

With a valuation established, the selling member must fulfill any pre-sale obligations outlined in the operating agreement. This involves formally notifying the other members of the intent to sell and extending any offer required by a Right of First Refusal clause. Obtaining the required consent must be documented in writing to prevent future disputes.

The transaction is formalized through a Membership Interest Purchase Agreement (MIPA). This legally binding contract identifies the parties, the percentage of interest being transferred, the purchase price, and payment terms. It also contains representations and warranties, such as the seller’s undisputed ownership and the buyer’s financial capacity.

The final stage is the closing, where the buyer pays the purchase price and the seller signs over the membership interest. Following the closing, the LLC’s operating agreement must be formally amended. This amendment removes the selling member and adds the new member, detailing their name and ownership percentage.

Tax Implications of the Sale

The sale of an LLC membership interest has direct tax consequences for the selling member, which are calculated based on the gain or loss from the transaction. The calculation involves subtracting the seller’s “adjusted basis” in their LLC interest from the sale price. The sale price includes not only cash received but also any of the seller’s share of LLC liabilities that the buyer assumes.

A member’s adjusted basis is a running tally of their investment in the LLC for tax purposes. It starts with the initial contribution of cash or property to the company and increases with any additional contributions the member makes and their allocated share of the LLC’s income. Conversely, the basis decreases by the amount of any distributions received from the LLC and the member’s share of any allocated losses. For example, if a member initially invested $50,000, was allocated $20,000 in income, and took a $10,000 distribution, their adjusted basis would be $60,000.

The gain realized from the sale of an LLC interest is treated as a capital gain. However, a portion of this gain may be reclassified as ordinary income under a specific tax rule. This rule applies if the LLC holds what the Internal Revenue Code Section 751 refers to as “hot assets,” which are assets that would generate ordinary income if sold by the LLC directly, primarily unrealized receivables and inventory items.

The “hot asset” rule prevents members from converting what would be ordinary income into a lower-taxed capital gain through the sale of their interest. When an LLC holds these assets, the seller must determine the portion of the sale price attributable to their share of the hot assets. That portion of the gain is taxed at higher ordinary income rates, while the remainder of the gain is treated as a capital gain. This bifurcation requires a careful allocation of the sale price and can significantly affect the seller’s final tax liability.