How are LLC Membership Interests Valued?
Suppose a borrower claims to have a successful limited liability company, LLC. He claims that his membership interest in this LLC is valuable collateral that he wants to pledge to obtain another commercial loan.
How should the commercial lender approach valuation of the LLC’s membership interest in determining how much to lend against it? The answer is not as straightforward as many believe because lots of restrictions against the assignment of LLC membership interests exist not only in statute, but also in the LLC’s governing contracts.
“A distributional interest is different than a membership interest in an LLC. ”
What are key points about a membership interest in an LLC?
- A membership interest does not mean the member owns any property of the LLC.
- Often restrictions against the transfer of the membership interest can be found in the Operating Agreement for the LLC, or even in a state statute.
- The distributional interest is only the right to receive distributions of profit and not engage in the management of the LLC.
- Cap Rates are often used to value commercial real estate LLCs, but that does not mean it is so easy to value the membership interest collateral – the value is typically just the distributional interest.
- A member’s K-1 will provide what the value of the distributional interest is.
- Don’t just rely on the pie-in-the-sky projections of any LLC’s cash flows, confirm them before performing the calculations to arrive at a reasonable valuation for the percentage of the membership interest collateral the putative borrower wishes to pledge.
