Money Contributed to a Limited Liability Company- How is is Categorized?

A new business will always need some capital or access to capital to start a business. Even an ongoing business may need funds from time to time as it deals with cash flow deficiencies or expansion.

While a limited liability company has the right to borrow money, the most common method of getting initial capital is by having the initial members contribute capital to the LLC in exchange for their membership interests.

However, a member can also loan money to an LLC even if he or she is a member.

When a member contributes money to an LLC, it is very important that the transaction categorized as either a capital contribution or a loan and that the transaction be documented in sufficient written documents.

When money sent is a capital contribution, the amount is credited to the member’s capital account but it is not a loan that the LLC is required to pay back. No debtor-creditor relationship exists. If that member is later distributed profits back, it will be credited against the capital contribution amounts of the member.

When money sent is a loan, a debtor- creditor relationship is formed. The LLC owes the member the money back. The terms of the loan (amount, interest rate, repayment terms, default provisions) should be documented in a written loan agreement or promissory note between the member and the LLC.

If there are other members, the loan transaction should be approved by the LLC membership because it is called a “interested transaction” (one between the LLC and one of its own members). It is really important that the loan transaction be fair and equitable to the LLC to avoid any unfair transactions benefitting the lender member.

So, in summary, the LLC and the member can agree on how money sent from the member to the LLC is to be categorized. The categorization of a member capital contribution or a member loan results in a different transaction and different treatment of the transaction by both the LLC and the member. In order to avoid later disagreements, this categorization should be agreed upon and sufficiently set forth in writing signed by the LLC and the member . . . and if applicable, the proper governance vote should take place with all members to approve the transaction.