Formation & Operation of an LLC in California – continued.
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Capitalization and Debt Financing

As in general partnerships and limited partnerships, California law permits the members of an LLC broad discretion to determine among themselves how cash, other property, or services will be contributed to the limited liability company by each member at the time of formation or at any time thereafter.

A limited liability company is permitted in California to borrow money from its members or from third parties. The financial condition of a member is not normally taken into account by a lender, except to the extent that the lender is relying upon the member’s initial or future capital contribution commitment as a source of repayment of the debt. Members will sometimes be asked by a lender to the limited liability company to sign promissory notes payable to the limited liability company in the amounts of their future contributions.

The promissory notes are then assigned as collateral to the lender to secure the loan to the LLC.

An LLC may also raise additional capital by creating and issuing additional interests in the LLC to new members. Unless the operating agreement provides otherwise, the consent of all members is required to issue new interests in the limited liability company. Because the issuance of additional interests to new members almost always will dilute the profit shares of the existing members, operating agreements that give the LLC the authority to issue additional interest usually impose conditions, such as requiring a minimum capital contribution for any new member or that any additional interests be offered first to the existing members.

Management Rights & Control

California permits a limited liability company to divide management rights and responsibilities among the members or to grant management rights and responsibilities to “managers” which the membership has designated or elected.

Unlike a limited partner in a limited partnership, a member does not become personally liable for limited liability company debts if the member participates in the control of the limited liability company’s business. In the absence of an operating agreement to the contrary, California law permits members to vote on certain specific management matters, such as the approval of a plan of merger or consolidation or the issuance of a new interest in the LLC.

If the members delegate management responsibilities to managers, the members will not be involved in the day-to-day management of the company’s business. If a member becomes concerned that the managers may not have taken the necessary steps to enforce a claim of the limited liability company against a third party, each member has a special right to bring a legal action (called a “derivative action”) to obtain a judgment in the name of the limited liability company against the third party.

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