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Does Capital Contribution Increase if a Company's Valuation Has Increased

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  • Does Capital Contribution Increase if a Company's Valuation Has Increased

    I have two questions regarding an Oregon LLC with 7 shareholders with initial valuation of $1,000,000:
    First, I have 5% interest (5 shares) of an LLC and my initial capital contribution of $50,000. Originally, 2-years ago, the company started with initial valuation of $1,000,000. Just recently the company's board did another valuation and it is at $2,000,000. So the value of my 5% interest has doubled. Now to my question, does my initial capital contribution doubles too to $100,000 or it doesn't change?

    Second: One of the shareholders (call him Mike) provided the company technical services on an IP in return for 2% interest in the company. Later, the company found out they can't patent it due to existence of prior art. So the company stopped working on the project and started on another IP, which the shareholder Mike has no involvement in. Mike is willing to give up his 2% interest back to the company. So is there a way for Mike's 2% interest gets transferred back to the company without going through a sale transaction where the company buys them from Mike.

  • #2
    The initial capital contribution should not change, the increase to $100,000 is your gain (which is unrealized until such time as you decide to sell your share).

    You will definitely have to do a sale transaction of some sort to get the 2% back from Mike. Now if Mike is willing to give you back that 2% for some nominal amount like $1, that's up to him. Really, though, you and Mike should be doing that with the guidance of at least a CPA and probably an attorney as well. This is not a do it yourself project.

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    • #3
      The change in the valuation of the enterprise doesn't affect your initial capital contribution. The very word "initial" is the key. Beyond that, you need to look at the LLC's operating agreement to see what effect the increased valuation has. There are mechanisms for revaluing and restating a member's capital account (not the initial capital contribution, however).

      As for Mike, depending on the operating agreement of the LLC, he may be able to forfeit his interest and that may not be a "sale" for state law purposes. However, for income tax purposes, it doesn't matter what you call it. A disposition of an interest in a partnership (which is how most LLCs are treated) is a taxable event and there may be tax consequences. Mike should talk to his accountant and/or attorney.
      David K. Staub (www.illinoisbusinessattorney.com)
      Forum posts are not legal advice, are for informational and educational purposes only, and are not a substitute for proper consultation with legal counsel.

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