A limited liability company, or LLC structure, is a popular form of business structure that's used by many entrepreneurs and startup companies. As an entrepreneur or small business owner, you may be wondering about funding your LLC.
Funding for an LLC can come from a number of sources, with capital contributions from members being one of the main sources—and often the only source—of funding.
LLC capital contributions
A capital contribution is the term used to describe the investment an LLC member makes in the LLC. When starting up an LLC, each member generally will make an initial capital contribution; there are no requirements as to how much this initial capital contribution must be, but it should, at the very least, be enough to cover the startup's initial operating expenses.
The LLC operating agreement often will detail a schedule of additional capital contributions that the members commit to making throughout the life of the LLC. If your LLC's operating agreement includes such terms, you will need to meet your commitment by making these additional capital contributions in the amounts and at the times stated in the agreement.
Forms of LLC capital contributions
If your capital contribution will be in the form of cash, making the contribution is generally as easy as making out a check from your personal funds to the LLC. Capital contributions, however, also can be in the form of property or services.
If you plan to contribute property, you will need to obtain a market valuation to determine the value of the property you are contributing to the LLC. Capital contributions in the form of property may also attract a number of potential tax consequences, so it's generally a good idea to consult with a tax advisor beforehand.
You also can make a capital contribution in the form of services. As with property, you will need to obtain a market value for the value of your services. There also are tax consequences, as you will have to treat this value as if it were actual income you earned for your services, meaning you will have to pay personal income taxes on the value of these services. Because of this, services are not as popular a form of capital contribution.
Accounting for LLC capital contributions
In order to properly track the amount of a member's contributions to the company and distributions from the company, each member of the LLC will have a capital account. This isn't a real bank account, but rather a notational one for the purposes of recordkeeping.
The primary use of a capital account is to record the value of the member's percentage of ownership; if the LLC were to be dissolved, the amount in each member's capital account should reflect the amount that member would receive after all debts have been paid.
In addition to the amount or value of your initial capital contribution, your bookkeeper will also use the capital account to keep track of any additional capital contributions you make throughout the life of the LLC.
The balance of the capital accounts also will be adjusted periodically to reflect the LLC's profits and losses. Such profits and losses are often shared among the members according to their membership percentages, but this isn't a requirement, and different percentages for the distribution of profits and losses may be used, so long as these percentages are contained in the LLC's operating agreement.
Additionally, the capital account should be adjusted to account for any distributions that may be made from the LLC to the members.
Loan vs. capital contribution (LLC)
So, you've made your initial capital contribution, but the LLC requires more cash for its daily operations, or perhaps it needs additional funds to make an investment in some necessary equipment.
If you don't feel up to making another capital contribution—and the terms of your operating agreement don't require you to at this particular point in time—you may want to provide the LLC with a loan instead.
When making a loan to the LLC, it's important to clarify that the money you are providing to the LLC is a loan and not a capital contribution that will affect the balance of your capital account. The best way to do this is with proper documentation.
The LLC should provide you with a promissory note that sets out the full details of the loan, including the amount of the loan, the terms of the loan including the interest to be charged, and a repayment schedule or repayment date.
