Investing in LLCs
§ 7.1Define What Is Being Purchased
When making an investment in an LLC, the investor should determine whether the acquisition consists of a percentage ownership interest or a particular number of units. A primary difference between LLCs and corporations is that the business owners are called members rather than shareholders, and the members typically own a percentage interest in the company instead of shares. To simplify the investment process, some LLCs define their members’ ownership interests by units that equal the percentage interest. For example, an LLC might contain one hundred units equal to 100 percent interest in the company and might want to sell thirty units to an investor (a 30 percent company interest) in exchange for a particular cash investment
The primary document needed to invest in an LLC will be either a unit purchase agreement (UPA) or a membership interest purchase agreement (MIPA), depending on how ownership interests are defined. This document should include the key terms of the deal:
•amount of consideration to be invested in the company (can be cash, other assets, or services);
•amount of units/interest given to the investor;
•vesting schedule, including any benchmarks;
•other requirements of either the issuer or the investor;
•restrictions on transferability of the units/interest;
•securities information;
•tax matters;
•events of default and recourse; and
•dispute resolution terms.
PRACTICE TIP: The UPA/MIPA should include specific clarification on whether the securities are exempt from registration, any legends to be included on ownership certificates, and any investor responsibilities for securities and tax matters.
Often, the LLC’s operating agreement or company agreement will need to be amended to reflect the investor’s status as a member and other negotiated terms as appropriate. Properly drafted buy-sell provisions are crucial to maintaining control of the company in case any members voluntarily or involuntarily transfer their interests to third parties. A proper buy-sell agreement should—
•define events of member default and company recourse;
•define how fair value of units/interest will be determined;
•define voluntary and involuntary transfer events and consequences;
•review and potentially modify company management roles and definitions; and
•review and potentially modify member voting matters.
For an example of a buy-sell agreement, see part 3 in form 23-1 in this manual.
PRACTICE TIP: The LLC should provide mechanisms for the units/interest to revert to the LLC in case of default by the investor. This can be done through including buyout clauses and assigning a low value to the units/interest in case an event of default occurs.
Since LLC investments meet the definition of securities in the Securities Act of 1933 and its state law equivalents, such investments must comply with federal and state securities laws. 15 U.S.C. § 77b(a). The transaction must either be registered with the Securities and Exchange Commission (SEC) and relevant state securities boards or qualify for an exemption to registration. Common exemptions for LLC investments can qualify under rule 504 or 506 of Regulation D (17 C.F.R. §§ 230.501–.508). Be sure to also check state blue-sky laws (state-level securities regulations) for the state(s) affected by the investment. Form D is a bare-bones description of the transaction that will still need to be filed with the SEC (and likely a similar form filed with the state securities board), even if the transaction is exempt from registration. Talk to a securities attorney about your particular transaction to be sure of compliance requirements.
PRACTICE TIP: To qualify for a rule 504 or 506 exemption from registration, the investing party cannot purchase the securities with intent to resell them within six months. Language verifying this requirement and the investor’s intent will need to be in the UPA/MIPA, and operating agreements typically restrict investors from transferring securities to third parties for longer periods.