Drafting LLC Company Agreements: What is a Capital Contribution?
July 24, 2013 | By Vela Wood
I recently had a meeting with a client who wanted to make sure his initial investment in an Limited Liability Company was well documented by the LLC. One way to document the initial investment is in the LLC’s Company Agreement. This starting investment is also known as an initial Capital Contribution.
Capital Contribution can best be explained by first defining capital in the business context. Capital is defined as the cash or assets in an LLC (or any type of entity for that matter). Capital can include cash, accounts receivable, equipment, and even physical property.
Naturally, putting the words together, a capital contribution is a member’s contribution of assets, usually cash, into the LLC. Generally, the Company Agreement will have an exhibit or schedule attached that breaks down the ownership structure of the LLC. This exhibit or schedule will also list the capital contribution of each member of the LLC. The capital contribution for each member can fluctuate, and needs to be properly recorded in each member’s capital account balance.
You may be asking yourself, “Okay, that’s great, but what is the purpose of documenting the capital contribution?” Lucky for you, I have provided some reasons why documenting your capital contribution is important.
The Texas Business Organizations Code (TBOC) states that a member’s liability is limited to the amount of his/her capital contribution. Thus, if you contribute $5,000 to the LLC and the LLC gets sued, your risk of loss is limited and can’t exceed the $5,000 you put in.
If your LLC needs to obtain a loan from a bank, the bank will ask you (and they do!) how much and what has been invested into the LLC. A bank will refuse to give the LLC a loan if there is no collateral for the bank to fall back on.
Potential investors usually ask how much and what has been contributed to the LLC. Without any documentation, investors find it difficult to determine whether to invest or not.
The initial capital contribution provides a tax basis in the LLC for each member.
Hopefully this helps you to better understand a Company Agreement. Stay tuned for our next installment, coming no sooner than when Kevin asks me for it.
Are you thinking: Why do I even need an LLC?
Posted in Company Agreement Series
Vela | Wood is a boutique corporate law firm that focuses on small businesses, entrepreneurs, and startups.