LLC Membership Redemption vs Cross Purchase

When an LLC member decides to sell their membership interest, there are generally two methods by which the transaction can occur — redemption of membership interest and cross-purchase. Each method has various pros and cons, depending upon your objectives. The following explains the differences between these two methods.

Redemption of Membership Interest

The first method that can be used to sell a membership interest in an LLC is redemption of membership interest. With a redemption, the LLC itself buys back the membership interest from the selling member. The remaining members of the LLC retain their ownership stakes in the company. The redeemed membership interest is then canceled or retired, reducing the total number of membership interests in the LLC.

Typically, the buying members use company funds to purchase the redeemed interest. The tax treatment of the transaction may vary depending on whether the LLC is classified as a partnership, corporation, or disregarded entity for tax purposes.

The two major advantages of using the redemption of membership interest include:

• Simplicity — The transaction involves only the selling member and the LLC.
• Control — The remaining members maintain control over the LLC's operations and decision-making.

One of the only disadvantages of a redemption concerns tax treatment — the tax implications must be carefully considered before using this method. Importantly, the tax treatment may be less favorable in comparison with a cross-purchase, especially if the LLC is taxed as a corporation.

Cross-Purchase

The second method that can be used to sell a membership interest in an LLC is a cross-purchase. With this method, one or more existing members of the LLC purchase the selling member's interest directly from them. The purchasing members increase their ownership stakes in the LLC, while the selling member exits the company. The LLC itself is not directly involved in the transaction, aside from facilitating any necessary paperwork or approvals.

Generally, the buying members use personal funds to purchase the selling member's interest. The tax treatment of the transaction may vary, depending on the structure of the LLC and the tax basis of the membership interests.

The advantages of selling a membership interest in an LLC using the cross-purchase method can include the following:

• Potential tax benefits — Depending on the tax basis of the membership interests, a cross-purchase may allow the purchasing members to benefit from a step-up in basis, especially if the LLC is taxed as a partnership.
• Flexibility — The transaction can be structured based on the preferences and financial capabilities of the buying members.

One of the disadvantages of using the cross-purchase method is the complexity with which these transactions are carried out. Since the transaction involves multiple parties, it may require coordination among the buying and selling members. The other drawback of this method involves control. For example, the buying members may increase their ownership stake in the LLC, potentially altering the balance of control among the members.

Should You Use the Redemption or Cross-Purchase Method?

Ultimately, the choice between redemption and cross-purchase depends on various factors, including the preferences of the members, the tax implications, and the specific circumstances of the transaction. It's essential to consult with legal and tax advisors to evaluate the options and determine the most suitable approach for your situation.

Contact an Experienced Michigan Business Law Attorney

The process of selling an LLC membership interest can be complex — and it’s crucial to have a knowledgeable business attorney by your side who can provide the guidance you need. With offices in East Lansing, Mt. Pleasant, Grand Rapids, and Detroit, The Gallagher Law Firm offers professional services and skillful advice to business owners and LLC members for all their legal needs. To learn more about how we can assist you with your business matters, contact us online or call (517) 853-1500.