Classes of Ownership Interests

April 13, 2006

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There are many common elements in an articles of organization, which is a key element in establishing the business entity.

The Corporation. In the corporation, the articles must indicate the classes of shares that exist, and the number of shares within each class that are authorized. In addition, the articles must state whether the stock has a par value.

Par value is an arbitrary amount per share representing the minimum the corporation can receive in return when it issues the stock. The amount paid in for par value stock represents what is termed the corporation's minimum or legal capital. A corporation cannot legally make a distribution to the owners based on their ownership interests (i.e., a dividend, or redemption of shares) that impairs this minimum or legal capital. Distributions can be made to the owners in ways not subject to this restriction; the most common example is a salary paid to the owners for services rendered on behalf of the entity.

Corporations are not required to issue par value common stock. In this case, the entire amount paid in for the shares represents the minimum or legal capital, unless the corporation sets aside a portion of the proceeds within a certain period (e.g., 60 days).

Remember, you must be able to prove that the corporation was adequately capitalized, as undercapitalization can form the basis for piercing of the veil of limited liability. For this reason, in most cases, no amount is set aside from legal capital when no par common stock is issued.

Note that par value has no relationship to fair market value. Fair market value represents the true value of the shares, which is based on the value of all of the entity's assets, less its liabilities. Par value, as described above, is an arbitrary amount per share selected by the owners. Its only significance relates to the concept of minimum or legal capital.

The LLC. Generally, there is no requirement that the limited liability company (LLC) describe different types of ownership interests in its articles of organization. Instead, consistent with the theme of simplicity that governs LLCs, this is accomplished in the LLC's operating agreement.

The concept of par value does not exist in the LLC, although there are similar restrictions on distributions to owners of an LLC based on their ownership interests. These restrictions also can be avoided through the payment of salary to the owners.

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Generally, the LLC is a simpler business form, as compared to the corporation. Thus, many arrangements, including the designation of nonvoting interests, in the LLC can be controlled by way of the operating agreement, rather than the articles of organization.

This especially simplifies the operation of the LLC because the operating agreement is not filed with the state. Thus, a modification of the operating agreement also does not have to be filed with the state.

So if you wish to restructure your business by using nonvoting ownership interests, which are desirable for estate planning purposes, the LLC form allows you to make this change more simply and easily.

By contrast, an amendment to the articles of organization (for an LLC or a corporation) must be filed with the state, along with a required fee.

Finally, while not required, it may be desirable to designate classes of ownership interests in the articles of organization for an LLC, as a form of constructive notice. Because the articles are filed with the state and constitute a public document, their contents will be presumed to be public knowledge.

This same practice also can be followed with other matters not required by LLC statutes to be designated in the articles of organization. Of course, any advantage here must be weighed against the fact that changes to the articles of organization (but not the operating agreement) will require a filing with, and payment of a fee to, the state.