When setting up your business, one of the most significant decisions you will make is which type of entity to form. If you have settled on forming a limited liability company (LLC), you must also choose the type of management structure it will have.
LLCs can be member-managed or manager-managed. Being an LLC manager means having the legal authority to bind the company to contracts and agreements and participate in day-to-day management. While most LLCs are member-managed—the default form of management under many state LLC laws—this often may not be the best choice. Regardless of the structure you choose, the management details should be clearly spelled out in the company’s operating agreement.
LLC Management Authority
Before delving into the differences between member-managed and manager-managed LLCs, it is important to explain what LLC managers are authorized to do.
The manager of an LLC is an agent of the company. As an agent, the manager typically has the legal authority to take the following actions:
- Make legal and financial decisions
- Enter into contracts and agreements
- Open, close, and manage a bank account for the LLC
- Take out a business loan and obtain financing
- Buy and sell real estate, equipment, vehicles, financial instruments, and other assets
- Hire and fire employees
- Dispose and divest of LLC assets
The ability to bind the LLC by their actions gives managers significant power. Managers, however, have a fiduciary duty (i.e., a legal duty) to place the interests of the LLC and its members above their own interests.
Member-Managed LLCs
Member-management is the most common form of LLC management, possibly because so many LLCs are formed without the aid of legal counsel and the disadvantages of member-management are not widely known. Every owner of an LLC is also a member. A member can own a 100 percent interest in a single-member LLC, or any other percentage in a multimember LLC. There is no limit to the number of members that an LLC can have.
In a member-managed LLC, the members run the company. Members have the right to bind the LLC (and its co-owners), with business decisions typically based on a majority vote of the members (e.g., signing a contract, obtaining a business loan, and other legal arrangements). Voting rights may be proportional to the ownership level, but different arrangements may also be specified in the LLC operating agreement. The members could choose, for example, to alter equal voting and decision-making rights to streamline operations while maintaining a member-managed structure.
For a small business with limited resources whose members want to be actively involved in its management, a member-managed structure might make sense. Such business owners might like to work as part of a team, engage directly with their employees and customers, and make and sell products. Just keep in mind that active involvement in management can be a basis for liability, and limiting liability is usually the main reason for setting up the LLC in the first place. So attorneys seeking to maximize asset protection would not typically recommend member-management if it can be reasonably avoided. Again, member-management is the default rule under most states’ LLC laws. If you do not alter this arrangement in the operating agreement or articles of organization, the LLC will likely be considered member-managed.
Note that in some instances, the single-member-managed LLC may have even weaker liability protection because it is more difficult to maintain the separation between the owner and the business. In particular, single-member LLCs that are member-managed are more vulnerable to attempts to pierce the veil. However, if the LLC member and the manager are different people, the member is afforded an extra layer of protection.
Manager-Managed LLCs
As an LLC grows in complexity and sophistication, or if it has many members, it might be less practical to have the members equally share responsibility for running the company. This can be true if the company takes on “silent partner” owners who simply want to invest in the business, or if it has a large number of members that makes shared management untenable. In these situations, delegating management duties to a manager or group of managers could be more efficient, in addition to reducing potential liability exposure of members due to their active involvement in management.
Manager-managed LLCs can be run either by one or some of the LLC members, or by an external manager or managers. Or, it could be a combination of the two (some internal managers and some external managers). The manager does not have to be a natural person. It could be a business entity, such as a corporation, a trust, or even another LLC (though some states restrict which types of entities can be LLC managers).
Management requires a distinct skill set that not all members may possess. The business may run more efficiently and professionally with designated, competent managers. But choosing a manager-management structure is not to be taken lightly, because once instituted, members give up considerable authority. They will no longer have a say in day-to-day business decisions and may not bind the LLC as an agent.
Even when managers run the LLC, members typically retain some voting rights. They can still vote to amend the operating agreement, elect and remove managers, admit new members, call for a merger or dissolution, and make other similar important business decisions.
Changing Your Structure Could Require Amending Articles
In some states, the management structure of your LLC is set at the time the articles of organization are filed with the state. Articles of organization are the founding documents of a company that lay out its basic structure.
If the members want to change the management structure from member-managed to manager-managed after the articles have been filed, they will have to vote to authorize the change. The state may require a unanimous vote for this change to take effect. The operating agreement should be updated as well to reflect the new management structure.
Keep in mind that, beyond the basic dichotomy of member-managed and manager-managed LLCs, there is a lot of room for nuance within the operating agreement. Other LLC documents, such as certificates of membership, a schedule of assets, and a statement of authority, should be created as well. Thorough documentation of your LLC is important to ensure the asset protection that LLCs generally afford their owners.
Do not rely on generic online templates to set up your LLC. Make sure your documents reflect the specific needs of your business and fully protect you and your business partners. For professional help structuring and documenting your LLC, contact us and set up an appointment.
