A question that often comes up with clients who conduct their business through a limited liability company is how to most efficiently add money to the business.
By default, many business owners assume that making a cash “contribution” to their LLC is the normal and most efficient way of doing it. Under Michigan law, each member or a particular group of members could make a contribution as needed. However, this “contribution” approach can cause fluctuations in each members’ capital accounts (i.e. the account that records contributions, distributions, shares of profit and loss, etc.). More significantly, these changes can create unintended consequences in the amount of ownership each LLC member has. This can affect how profits are divided and voting in some cases.
To avoid these issues, an alternative approach is making a loan to the LLC. The main benefit of the “loan” approach is that neither the members’ capital accounts or ownership interests change. They aren’t affected in any way by loan. Another benefit is that the loaning member will have a more secure position of being paid back (as a “lender”). This is because a lender is paid back “before” an owner in a LLC. And finally, making a loan adds an additional financial benefit to the LLC. Interest on the debt will likely be tax deductible to the company.
Now, a word of caution: proper documentation is necessary to define the terms of the loan (i.e. loan amount, interest rate, repayment terms, default provisions, etc.). So, these issues need to be put in writing to formalize the loan. If you’re interested in learning more about this approach or using it to provide additional funds to your LLC, feel free to contact me.