Comparisons of LLCs and S Corporations

TERMINOLOGY COMPARISONS

Category
LLC
S Corporation
1. Entity reference limited liability company corporation
2. Permitted name references limited company, L.C., limited liability company, LLC corporation, incorporated, corp., Inc.
3. Enabling document Articles of Organization Articles of Incorporation
4. Internal governing document operating agreement bylaws
5. Governing group managers or members directors and officers
6. Owners members shareholders or stockholders
7. Unit of ownership interest* share

*This term is similar to the term used for ownership in partnerships and limited partnerships.

The following table lists NON-TAX comparisons of LLCs to S corporations.  (For a table that compares TAX attributes, see ***.)

Items included in the Table were selected in part for their susceptibility to “YES” or “NO” answers. However, as with any technical subject, a simple “YES” or “NO” answer is often an oversimplification. No attempt is made to list all of the exceptions or references in the Table.

Since there is wide variety in LLC statutes, it is virtually impossible in a short comparative table to list all differences. Instead, an attempt has been made to give the general rule or most prevailing rule on the issue.

It is possible for a particular state LLC statute to have an answer different than that listed. Accordingly, it is recommended that the user refer to language of the LLC statute of his or her state to identify variations from the answers given in the Table.

Comparison of NON-Tax Attributes

 
Attribute
S Corp
LLC
1. Limited liability for all owners. YES YES learn more
2. Dissolves on owner’s death. NO NO learn more
3. Perpetual duration allowed. YES YES  
4. Professional services permitted. YES YES learn more
5. Allows differing rights for distributions. NO YES learn more
6. Allows differing rights for voting. YES YES learn more
7. Allows differing rights for management. NO YES learn more
8. Single owner permitted. YES YES  
9. Multi-state operations possible. YES YES learn more
10. Owner may withdraw and be paid out on demand. NO NO learn more
11. Transfers of ownership restricted. YES YES learn more
12. Outside managers permitted. YES YES  
13. Management structure flexible. NO YES learn more
14. Anonymity for owners. YES YES learn more
15. Creditors of an owner can dissolve entity. NO NO learn more
16. Clear delineation of authority required to bind entity. YES NO learn more
17. Suitable for non-profit activities. NO YES learn more
18. Strict name designation and document formalities required. YES YES learn more
19. Ownership interests may be certificated. YES YES learn more
20. Entity created by filing Charter with state. YES YES learn more
21. Annual meetings and formal meetings required. YES NO learn more
22. Registered agent required. YES YES  
23. Annual reports to state required. YES YES learn more
24. Specific record-keeping required. YES MO learn more

1. Does this entity provide limited liability for all owners of the entity from the debts and obligations of the entity?

S Corp: Yes. Generally, the personal assets of a shareholder in an S Corporation cannot be reached to satisfy the debts and obligations of the S Corporation. Thus, only the shareholder’s investment in the S Corporation is subject to such liabilities. But, there are some limited exceptions.

If an S Corporation shareholder subscribed to purchase shares in the corporation, but did not fully pay for them, the shareholder would still be liable to the corporation to make good on that subscription and, to that extent, the shareholder’s personal assets could be reached by the creditors of the corporation. Similarly, if an S Corporation shareholder received distributions of money or property from the S Corporation which were improperly or unlawfully made, then that shareholder could be required to put the money or property back into the corporation.

Further, if a shareholder guarantees an obligation of an S Corporation then, to that degree, the shareholder would be personally liable for the obligations evidenced by that guarantee.

Should a shareholder in an S Corporation participate in fraudulent conduct with regard to transactions by the S Corporation, that shareholder may become personally liable because of participation in the fraud.

LLC: Yes. Generally, the personal assets of an LLC member cannot be reached by legal process to satisfy an LLC debt or obligation. Thus, only the member’s investment in the LLC is subject to such obligations. But, there are certain exceptions similar to exceptions for S Corporation shareholders. Personal liability of the LLC member may remain with respect to individual involvement in the generation or release of hazardous materials, unpaid contributions to the LLC, mistaken distributions from the LLC or an LLC loan or debt guaranteed by the LLC member.

Caution: Neither an S Corporation nor an LLC, of itself, will always shield its owners from liability for costs for clean-up of hazardous or toxic waste on property owned or operated by the entity if such owners were involved in the management or operations of the entity’s business. In other words, environmental damage liabilities can penetrate either a corporation or an LLC to impose direct liability on individuals personally involved with generation, placement or spilling of toxic or hazardous waste.

The above rules on limitation of owner liability–both for S Corporation shareholders and for LLC members–can be illustrated with some examples:

Example 1A:

Car Accident

Suppose you are a member in an LLC which operates a delivery service. One of the LLC employees causes a car accident while making a delivery and severely injures another person. That other person sues the LLC to recover the damages caused by the accident and obtains a judgment against the LLC for $200,000. Suppose the LLC’s maximum liability insurance coverage is only $50,000 and that the LLC itself only has assets of $30,000. Thus, there is only $80,000 available to pay the judgment. Q: Can the judgment creditor attach your home or your other personal assets to make up the difference–$120,000? NO! The debts of an LLC cannot be collected from an LLC member unless the LLC member has somehow obligated himself for those debts. The same rule would apply to an S Corporation shareholder.

Example 1B:

Unpaid Subscriptions to an S Corporation

Suppose that you were a shareholder in an S Corporation and had previously agreed to invest $10,000 in the S Corporation but had not yet done so. Q: Can a judgment creditor of the S Corporation reach your personal assets to that extent? YES–the $10,000 you owe to the S Corporation is an asset of the Corporation. If the $10,000 had been paid to the Corporation, it would be available to apply on the judgment.

Example 1C:

Mistaken Distributions from LLC

Suppose that you were a member of an LLC. Suppose also that the LLC had made a distribution to you of $5,000 under the assumption that you were entitled to that much. Then it was discovered that the $5,000 distribution to you was a mistake and that you were not really entitled to any of it, but you had not paid it back. Q: Could a judgment creditor of the LLC reach your personal assets to that extent, i.e., $5,000? YES–since that is an amount you owe back to the LLC, it is an asset of the LLC. If that amount were paid back, it would be available to apply on the judgment.

Example 1D:

Guaranty of Corporate Loan

Suppose you are a shareholder of an S Corporation which borrows $50,000 from a bank and that you are required to guarantee the loan. Later, the corporation falls on hard times and, when the loan needs to be repaid to the bank, the corporation only has assets of $15,000. Q: Can the bank collect the difference–$35,000–from your personal assets? YES–because you guaranteed the loan repayment to the bank. Neither LLC members nor S Corporation shareholders are protected from contractual liabilities, such as bank loans, which they have personally guaranteed.

Example 1E:

Professional Malpractice Liability

Suppose you are a physician in private practice with two other doctors and you together form an LLC to own and conduct the professional medical practice. The LLC has no malpractice liability insurance. Some time later, you are negligent in treating one of your patients which causes $300,000 in damages to that patient. The patient sues you and the LLC but the LLC only has assets of $120,000 at that time. Q: Can the patient recover the difference–$180,000–from your personal assets? YES. The laws of most states provide that an LLC cannot protect a member from claims arising due to the member’s own professional malpractice. The same rule applies to professional corporations.

Example 1F:

Suppose the same facts as Example 1E except that one of the other doctors, and not you, committed the malpractice. Q: Can the patient recover against you because you were a member of the LLC with that other doctor? NO. In most states, claims arising from the professional negligence of an LLC member besides yourself cannot come against your personal assets–unless, of course, you were somehow also involved personally in the negligent act.

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2. Does the entity dissolve on an owner’s death?

S Corp: No. This is one of the advantages of a corporation. The death or disability of a shareholder in an S Corporation has no effect upon the continued legal existence of the corporation itself. The corporation keeps on going. And, when an S Corporation shareholder dies, the shares owned can be transferred through the estate of the deceased shareholder to the heirs. Of course, this assumes that there is no “buy-sell” agreement in effect which requires the sale of the shares back to the corporation upon the death of the shareholder.

If the S Corporation is a “professional corporation”, then the law may require the corporation to buy out the deceased shareholder’s shares in the corporation and, if those shares are not bought out timely, the estate of the deceased shareholder could cause the dissolution of the corporation in order to get paid. Disqualification of a professional to practice the profession may also cause this automatic buy-back provision to come into effect. Again, one must look carefully to applicable state law to determine if this could occur.

LLC: No.

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3. Is the entity allowed to have perpetual duration?

S Corp: Yes.

LLC: Yes.

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4. Can this entity conduct a professional practice or provide professional services?

S Corp: Yes. If the S Corporation is organized as a “professional corporation” or “professional association” under state law, it may own and operate a professional practice. Most states have specialized statutes which allow professionals to incorporate their professional practices. However, this allowance under state law has nothing to do with whether or not the corporation is treated as an S Corporation for tax purposes. A professional corporation can be either an S Corporation or a C Corporation depending on the decision of the shareholders.

LLC: Yes. In most states, an LLC may operate a professional practice. However, there are a few states which prohibit the use of an LLC for owning and operating a professional practice. Thus, one must look carefully to applicable state law to determine if the LLC can engage in this type of activity.

Under the laws of most states, only one type of profession can be practiced by each separate professional corporation or LLC. In other words, you can’t mix professions in the same entity.

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5. Is it possible for this entity to have differing rights for distributions to its owners?

S Corp: No. Distributions to shareholders of a corporation are sometimes called “dividends”. Dividends must be made proportionate to the share ownership in the corporation. No flexibility is allowed in changing this distribution pattern without jeopardizing the status of the corporation as an S Corporation for tax purposes.

LLC: Yes. Flexibility in structuring distributions to members is a distinct advantage of LLCs. If the LLC members agree, LLC distributions can be made to members in different amounts and at different times. In addition, certain members or classes of members may be entitled to receive priority distributions, ahead of distributions to other members.

Caution: Competent professional advice is needed before making disproportionate or priority distributions.

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6. Does this entity allow for differing voting rights of its owners?

S Corp: Yes. Ownership interests in an S Corporation can be classified into voting and non-voting shares. However, even in such situations, there are certain major decisions on which all shares of the corporation must have voting rights, such as mergers, sale of all corporate assets, or the mortgage or pledge of all corporate assets.

LLC: Yes. Except for certain major decisions on which all LLC members have the right to vote, voting rights in an LLC may be granted to specified classes of LLC interests or to only certain LLC members.

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7. Does this entity allow for different rights of its owners to participate in management?

S Corp: No. The structure for management of a corporation is fairly rigid. Shareholders, as such, are not entitled to participate in management. Shareholders elect directors and the directors appoint officers. Shareholders may, but need not, be directors or officers of a corporation. In fact, where there are numerous shareholders, it is customary for most of the shareholders to not be directors or officers. Directors set policy for the corporation and the officers carry out and manage the affairs of the corporation. Thus, only those elected as directors or officers can participate in management.

LLC: Yes. Depending on the desires of the LLC members, all, some or none of the members could participate in management.

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8. Can this entity have a single owner?

S Corp: Yes.

LLC: Yes.

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9. Is it possible for this entity to operate in multiple states?

S Corp: Yes. A corporation may operate in multiple states if the corporation is “qualified” to do business in each of such states. “Qualifying to do business” in a state normally entails filing an application.

LLC: Yes. The procedure for an LLC to “qualify to do business” in a state outside its state of formation is similar to that for corporations.

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10. May an owner withdraw and be paid out on demand?

S Corp: No. However, if the S Corporation is a professional corporation, the rules could be quite different. For example, the professional corporation laws of some states require the buy-back of shares of a deceased or disqualified professional shareholder. Usually, these provisions apply where there is no other provision for buy-back in the governing documents. Nevertheless, a mere “withdrawal” of the shareholder from a professional corporation would not normally trigger any buy-back rights. Rather, death or disqualification are usually the only triggering events.

LLC: No.

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11. Are there restrictions on the transfer of ownership in the entity?

S Corp: Yes. Corporate law does not, of itself, impose restrictions on transfers of corporate shares. However, since shares in an S Corporation may be owned only by certain persons, shares cannot be transferred to non-qualified persons without the corporation’s losing its “S” status. To protect the S Corporation’s tax election, restrictions are often imposed to make sure that S Corporation shares cannot be transferred to a non-qualified person. Also, good management practice would suggest that restrictions on the transfer of shares be imposed to ensure that shares may not be transferred to a stranger or to a person whose interests are adverse to those of the corporation.

LLC: No. In most cases, the financial interests in an LLC can be freely transferrable. However, under most LLC statutes, management or voting rights in an LLC can be transferred only with the consent of all other LLC members.

Federal and state securities laws also impose restrictions on most transfers of ownership in both S Corporations and LLCs.

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12. Are outside managers of this entity permitted?

S Corp: Yes.

LLC: Yes.

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13. Is a flexible management structure permissible for this entity?

S Corp: No.

LLC: Yes.  An LLC has several choices for its management structure — to be managed by all of the members, to be managed by a few of the members (as managers) or to be managed by non-owner managers. The management structure must be designated in the LLC’s Operating Agreement. Some states require the names and addresses of those who manage to be disclosed in publicly-filed documents.

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14. Can the owners of the entity remain anonymous?

S Corp: Yes. Under the laws of most states, the identities of shareholders of a corporation do not have to be revealed in publicly-filed documents. Rather, in corporate reports filed with most states, only the identity of the directors and officers must be disclosed.

Federal income tax returns for S Corporations include a separate Schedule K-1 for each shareholder. That Schedule discloses the name, address and percentage ownership of each shareholder. The tax returns and Schedules K-1 cannot be released to the general public but are available to the other shareholders of the S Corporation.

Under the corporate laws of most states, a list of shareholders can be released to the public only if there is a “proper” corporate purpose for that disclosure. Very few purposes qualify as a “proper” purpose.

LLC: Yes. Under some state LLC statutes, LLCs may have to disclose the identity of the members in public documents. This normally requires the listing of the name and address of each member of the LLC. However, where the LLC is managed by managers and not members, only the identity of the managers (name and address) need be disclosed under most statutes.

As with S Corporations, the federal income tax returns for LLCs include a separate Schedule K-1 for each member of the LLC, which discloses the name, address and percentage ownership of each member. However, since income tax returns are protected from release to the general public, such information is only available to the LLC members.

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15. Can creditors of an owner cause the entity to dissolve and attach entity assets for payment of the debt?

S Corp: No. However, where a shareholder of an S Corporation owns a majority of the outstanding shares of the corporation, a creditor of the shareholder may be able to reach the assets of the corporation through an indirect route: the creditor could attach or foreclose on the shares, purchase the shares at foreclosure, and then vote the shares to dissolve the corporation. In this limited circumstance, the corporation’s assets could be forced from the corporation out to the shareholders, including the new shareholder/creditor.

LLC: No. Generally, a creditor of an LLC member cannot make the LLC’s assets available for payment of individual debts. An LLC member can, however, pledge her LLC interest as security for a debt.

If the member defaults on the debt, the creditor could foreclose on the LLC interest. Assuming the creditor purchased such interest at foreclosure, the creditor could become an LLC member if the LLC operating agreement did not provide otherwise. Upon any subsequent dissolution and winding-up of the LLC, the creditor would receive its share of the LLC’s assets.

Most LLC statutes limit a judgment creditor of a member to obtaining merely a “charging order” against the member’s interest. Under a charging order, the creditor would have the rights of an assignee of such LLC interest. This would entitle the creditor to receive whatever distributions are made by the LLC with respect to such LLC interest. But, being an assignee, the creditor could not thereby become a member of the LLC, nor does the creditor acquire any rights in any specific LLC assets.

If an LLC member filed bankruptcy, the LLC might be dissolved by such an event. Also, assuming the LLC member owned a sufficient majority interest in an LLC to cause dissolution of the LLC, then, assuming the LLC interest was sold, a creditor, as purchaser of the interest, might be allowed to then exercise the rights of the LLC member and cause dissolution and winding-up of the LLC. In this way, the creditor could indirectly do what it could not do directly–obtain access to LLC assets for payment of the personal debt of an LLC member.

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16. Do those representing the entity need a clear delineation of their authority in order to bind the entity legally?

S Corp: Yes. Anyone representing a corporation must have clear authority to do so in order to cause the corporation to be bound by her acts. Usually, the President of a corporation has power under the bylaws and applicable law to bind the corporation. The same would usually be true for other designated officers. Where a person is not an officer of a corporation, then that person’s authority must be clear in order for the corporation to be bound by his acts. Such authority is normally given by a resolution of the board of directors of the corporation.

LLC: Yes. Evidence of authority is needed for the managers of an LLC to act since it is not always clear just who has authority to act. For example, an LLC may be structured to be managed by its members. On the other hand, an LLC could be managed by a non-owner manager. In either case, the authority of any persons acting on behalf of the LLC must be clearly delineated to enable those dealing with the LLC to know whether or not those persons have authority to bind the LLC. This is one of the troublesome areas for LLCs in everyday transactions since an LLC may often be required to prove, by written resolutions or provisions in its operating agreement, that the person acting really does have authority to bind the LLC.

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17. Is this entity suitable for non-profit activities?

S Corp: No. An S Corporation, by its very nature, is organized for “business”–meaning for profit. Accordingly, non-profit activities are not suitable. Should a person want to conduct non-profit activities, a non-profit corporation or non-profit trust should be organized for that purpose.

LLC: Yes. Most LLC statutes allow LLCs to be formed for any lawful purpose, which could include non-profit activities.

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18. Are strict name designations or document formalities required for this entity?

S Corp: Yes. Under most state laws, a corporation must indicate in its name that it is a corporation. Such designation may include “Corporation”, “Corp.”, or “Inc.” in the name of the entity. Also, it is critical when a document is signed on behalf of the entity that the name of the corporation be indicated plus the capacity of the person signing on behalf of the corporation. Otherwise, the person signing may, by such omission, become subject to personal liability for obligations under that document.

When signing a document for a corporation, the “signature block” might look like this:

Woodstock Enterprises, Inc.,
an Illinois corporation

By:____________________
Alice Rooney, President

LLC: Yes. LLCs are required to include in their names one of the following: “limited liability company”, “limited company”, “LLC”, or “LC”. A few states allow “Ltd.” to be used also, but this is not recommended since “Ltd.” is commonly used to indicate limited partnerships and confusion would arise if it were also used in the name of an LLC. The exact LLC name should be indicated on letterhead, business cards and invoices and on documents by which the LLC is to be bound. Failure to indicate the full name of the LLC on a document may cause the person signing for the LLC to be personally liable under that document.

When signing a document for an LLC, the “signature block” might look like this:

Rio Grande Engineering, LLC, a
Texas limited liability company

By:____________________
Poss Ferot, Manager

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19. May ownership in this entity be represented by certificates?

S Corp: Yes. It is customary for ownership in a corporation to be represented by certificates. A share certificate normally shows the number of shares, the registered owner of the shares, the date the certificate was issued, and any applicable restrictions on transfer.

LLC: Yes. Certificates for LLC interests are permitted, but not required. If LLC interests are certificated, care is needed to ensure that the certificates do not give the impression that they are freely transferrable or that they could be transferred in violation of federal or state securities laws.

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20. How is the entity brought into existence?

S Corp: A corporation is brought into existence by preparing and filing Articles of Incorporation with the appropriate state agency. The contents of those Articles are specified by state corporate law. Once those Articles are filed, the corporate existence is deemed to begin.

Note: For a corporation to be taxed as an S Corporation, however, additional steps are required. Namely, the corporation must prepare and file Treasury Form 2553 with the IRS–see item *** and related discussion.

LLC: An LLC comes into existence when Articles of Organization (or Certificate of Organization) are prepared and filed with the appropriate state agency. The contents of those documents are specified by state LLC law.

Although filing Articles brings a corporation and an LLC into existence, other documents are needed for the entity to become “organized”. Chief among these documents are bylaws for a corporation and an operating agreement for an LLC. Competent legal counsel is essential in preparing these other documents.

Filing fees are required when forming either a corporation or an LLC. The amount of such fees varies by state.

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21. Are annual meetings of owners and formal minutes required?

S Corp: Yes. Most states require at least an annual meeting of shareholders of a corporation and that minutes of such meetings be kept. But, there are some corporate statutes which eliminate such formalities. Failure to keep minutes might be a dangerous practice since it may later be difficult to prove just what actions had been approved by the shareholders and the board of directors.

LLC: No. Neither annual meetings nor formal meetings are required for LLCs. However, important actions taken by the members of the LLC (or by the LLC’s manager, if it has one) should be reduced to writing as a prudent management practice. Meetings for LLC members may be held if they are convened under provisions in the LLC’s operating agreement.

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22. Must the entity designate and maintain a “registered agent”?

S Corp: Yes.

LLC: Yes.

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23. Are annual reports to the state required for this entity?

S Corp: Yes.

LLC: Yes.

As with all reports of this type, typically there is a filing fee that is required with the report.

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24. Does the law require this entity to keep any specific records?

S Corp: Yes. In most states, corporations are required to keep on file, and available for inspection by shareholders and their representatives, a copy of the following:

  • Minutes of all meetings of shareholders, written consents of shareholders, notices of shareholder meetings, waivers of notice of shareholder meetings, and other written actions of shareholders;
  • Minutes of all meetings of directors, written consents of directors, notices of director meetings, waivers of notice of director meetings, and other written actions of directors;
  • A copy of all communications to shareholders;
  • A list of the directors and officers of the corporation, showing the name and business address for each;
  • A copy of the annual reports of the corporation filed with the state agency;
  • A list of shareholders showing, for each class of shares, the name and address of, and the number of shares owned by, each shareholder, with the list arranged alphabetically by surname of shareholder within each class;
  • A copy of all financial statements for the corporation prepared for periods ending within the prior three (3) years;
  • A copy of the Articles of Incorporation currently in effect; and
  • A copy of the bylaws currently in effect.

In addition, corporations may be required to keep records to support information filed on tax returns for up to six years. Also, there could be special requirements for record retention based on the type of business in which the corporation is engaged.

LLC: Yes. Since most LLC statutes were fashioned from the Revised Uniform Limited Partnership Act (“RULPA”), provisions similar to RULPA were included in most LLC statutes. Consequently, most LLC statutes require the following records to be available for inspection by LLC members and their representatives:

  • A current list in alphabetical order of the full name and last known business street address of each member, showing each member’s percentage interest in capital, profits and losses of the LLC;
  • A copy of the stamped Articles of Organization and all certificates of amendment to the Articles, together with an executed copy of each power of attorney, if any, pursuant to which any certificate of amendment has been executed;
  • A copy of the LLC’s federal, state and local income tax returns and reports, if any, for the three most recent years;
  • A copy of the financial statements of the LLC, if any, for any period ending during the three most recent years;
  • A written statement setting forth:
    • the amount of cash and a description and statement of the agreed value of the other property or other items of value contributed by each member and which each member has agreed to contribute;
    • the times at which, or events on the happening of which, any additional contributions agreed to be made by each member are to be made;
    • any right of a member to receive distributions, including the right to a return of all or any of the member’s contributions;
    • any event upon the happening of which the LLC is to be dissolved and its affairs wound up; and
  • Such other documents as may be required by the LLC statute or by other laws.

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