The limited liability company, or LLC, structure shields the personal assets of each member of the business. Even so, members should have an exit strategy in case a member needs to sell his ownership interest. The member also should know how much his interest is worth -- a valuation he can make in several different ways.
Fair Market Value
The LLC’s operating agreement -- the contract among the members that describes their relationships to one another and the business -- should define a valuation procedure. Operating agreements often determine the value of a member’s interest based on fair market value, which considers several factors, such as the amount each member contributed to the total capital, how much control each member has and the average value of a business of the same size operating in the same industry for the same amount of time. The operating agreement can also describe an alternate valuation procedure.
Business Value and Percentage Ownership
Once the business has some track record regarding its overall performance, then -- whether the value of the business has increased due to success or decreased due to failure -- valuing ownership may be a simple function of calculating the total value of the business and multiplying the value by the relative ownership percentages of each member. Assume an LLC is valued at $500,000, and one member has a 20 percent ownership interest. Using a simple valuation formula based on total value over ownership percentage, this particular member’s share is worth 20 percent of the $500,000, or $100,000.
Business Valuation and Control
The LLC’s operating agreement may determine valuation based on the amount of control an LLC member has. Assume that the value of the business is $500,000 and one member has contributed 20 percent of the total capital. Now consider that this member’s total control in the LLC -- his ability to make decisions for the LLC -- accounts for only 10 percent. If the LLC determines value based on a member’s ability to make decisions, this member’s total share is only worth $50,000.
Ownership interest is often valued based on the amount each member contributes to the LLC. This is slightly problematic for new LLCs: The company doesn't have a historical record, and the valuation of a member’s initial interest in the LLC is speculative, possibly worthless. Businesses begin with the best of intentions, but even with the help of angel venture capitalists and donations, the initial interest in new LLCs is highly subjective, and new members will have difficulty convincing others to buy their shares until the company shows some signs of success.
Based in Traverse City, Mich., George Lawrence has been writing professionally since 2009. His work primarily appears on various websites. An avid outdoorsman, Lawrence holds Bachelor of Arts degrees in both criminal justice and English from Michigan State University, as well as a Juris Doctor from the Thomas M. Cooley Law School, where he graduated with honors.