One of the most overlooked aspects when starting an LLC is the decision of how your LLC will be managed. Many business owners are unaware that they actually have an option of how their LLC will be managed and as a result fail to account for this in their LLC operating agreement. Outlining an LLCs organizational and management structure from the start is something that can save a lot of headaches down the road if conflicts between members arise or one or more members leave. In this article we’ll go over the 2 management structures available to an LLC, the rights of LLC members, why some LLC choose a manager-managed structure and who can serve as an LLC manager.
In an LLC, the owners are referred to as “members”. Throughout this article you will see the term “member” used quite a bit, so when you see it remember that we are referring to the owners of the LLC.Table of Contents:
- Management Structure of an LLC
- Statutory Rights of LLC Members
- Why Choose a Manager-Managed LLC?
- Who Can Serve As a Manager in a Manager-Managed LLC?
- Importance of an LLC Operating Agreement
When you choose to set up an LLC, there are two basic management structure options that are available. You can select from a member-managed LLC or a manager-managed LLC, which each offers different benefits.
Member-managed LLCs are the default option for a limited liability company. When you choose this option, all of the members share responsibility for how the business is run day-to-day. This is a popular option that suits small businesses, which don’t usually need a separate management level and have limited resources. It’s a good option if you and other members of your LLC want to be directly involved in running your business, taking care of day-to-day operations such as selling your products, rather than leaving it up to managers.
Member-managed LLCs are the default option by law in most states, meaning your LLC will automatically be member-managed unless you state otherwise in your formation documents or operating agreement.
A manager-managed LLC is the other option available to you when setting up your business. This can be the better choice for some businesses, such as when members want to be passive investors, rather than directly involved with running the business. This structure might work out for you if your business is complex and having all members involved in management would be too complicated, or if some members do not have good management skills.
The manager-managed structure offers more flexibility and benefits that allow the LLC to be run more like a corporation. Management can be delegated to one person or a smaller group of people, which can help to ensure skilled management. Managers can be members of the LLC or they can be hired separately. Additionally, more anonymity is afforded in a member-managed LLC.
What is the difference between Member Managed and Manager Managed LLCs?
The key difference is that in a member managed LLC all of the members are involved in key decisions. In a manager managed LLC one or more individuals are designated as managers (can be members, employees or outside appointees) and are responsible for decision making.
There are two main categories of rights involved in owning an LLC: management rights and economic rights.
- Management rights include participating in the management of the LLC through voting, participating in member meetings, being able to obtain information and the LLC, fiduciary responsibilities, and agency rights.
- Economic rights relate to the economic benefit of LLC ownership, including a right to distributions of profits. These rights can be combined, although they don’t have to be.
Under member-managed and manager-managed LLCs, these statutory rights are slightly different. With a member-managed LLC, members can have both economic and management rights in their capacity as a member. With a manager-managed LLC, the management rights belong to the manager(s), who may also be a member or members or may not be, while the economic rights remain with the members.
If an LLC is more commonly member-managed, why should you consider choosing a manager-managed LLC instead? There are several good reasons for choosing this structure that can benefit your business and its members.
- Resolve Disputes Choosing a manager-managed LLC means that disputes can be resolved more easily. There is a designated manager or managers in charge, and they take on the role of managing disagreements and disputes that need to be addressed.
- Large Number of LLC Members When there is a large number of LLC members, a manager-managed LLC often makes the most sense. Trying to balance the interests and skills of many different members is difficult and may even prove to be impossible. There is a higher likelihood of conflict and disputes, and it makes it more difficult for the business to be properly organized.
- Passive Investor Members A manager-managed LLC is also ideal for passive investor members. When members of the LLC don’t want to be involved in the daily operations of the business, it makes more sense for designated managers to take on the management of the company instead.
- Member Anonymity Members are also afforded more anonymity with a manager-managed LLC. While, generally, all members need to be listed publicly in the operating agreements of a member-managed LLC, there is more anonymity available for manager-managed LLCs.
- More Protection Finally, a manager-managed LLC provides more protection than member-managed LLCs. LLCs provide liability protection, but a manager-managed LLC can create further protection. If a creditor of a member obtains an interest in a manager-managed LLC, they would only gain the economic rights of the member, while the management rights remained with the manager. This can be used to prevent a creditor from arguing that they have management rights in the company.
A manager-managed LLC allows for either a member of the LLC or a non-member employee to serve as a manager. Hiring a professional manager might be preferable for some companies if none of the members have the right management skills or are interested in being a manager. It’s important to take into account that the compensation will differ for managers depending on whether they are LLC members or non-member employees.
One member can be designated as a manager of the LLC. They will be both a member and a manager, meaning they will receive two different types of compensation. They will share in the profits of the company based on the percentage of the business that they own. They can also receive pay as a manager, which includes being paid as an employee, providing them with a reasonable salary, and carrying out tax withholding. It’s important for the different duties to be outlined in the LLC operating agreement or in an employee agreement.
A professional manager who is not a member of the LLC is hired as an employee. They do not share in the profits of the company but receive a salary and have their payroll taxes withheld. They should also have an employee agreement, which outlines their duties and responsibilities, as well as their pay and benefits.
Want a more in-depth guide to starting an LLC? Check out our ultimate step-by-step guide:
How to Start an LLC: A Step-by-Step Guide to Forming an LLC
An operating agreement isn’t required when you set up an LLC, but it’s good practice to have one. It provides a number of benefits, especially where management of the LLC is concerned.
Why Your LLC Needs an Operating Agreement
Every LLC should have an operating agreement, even if it’s not strictly required. Even a single-member LLC can benefit from having one as it provides a clear outline of how the LLC will be operated. Some states may require you to have an operating agreement, so be sure to check before you decide whether you really need one.
An operating agreement is particularly important when there are multiple members because it puts the rules of running the business into writing. This can help to prevent disagreements and conflict later. If you run a single-member LLC, it will help you to ensure you have done everything correctly and that your business and personal affairs are separated. The operating agreement prevents you from becoming personally liable for company debts by clearly defining the boundaries.
Including Roles and Responsibilities in Manager-Managed LLC Agreements
The operating agreement can serve an important role for manager-managed LLCs. If an operating agreement is required, roles and responsibilities are often stipulated as part of the documents for manager-managed LLCs. This ensures that all members and the manager, whether a member of a hired employee, know what is expected of them and where their responsibilities begin and end.
Creating a Custom Operating Agreement
Creating a custom operating agreement can be the best way to ensure you cover all of your bases where your LLC is concerned. When you create a custom operating agreement, you can create different classes of membership, which have different voting rights. You are also able to outline voting thresholds for important company events and decisions. Your custom operating agreement allows you to create a formalized board of managers that functions similarly to a board of directors in a corporation. Additionally, it gives you the option to clearly define items such as changing members or dealing with the death or resignation of a manager that predetermined procedures are in place. This prevents the need to work out how to react to these situations at the last minute, which can cause problems.
While a member-managed LLC might be the more common option, a manager-managed LLC can be the right choice for many businesses, for a variety of reasons. Before choosing which is right for your business, it’s important to consider the benefits of a manager-managed LLC and when it is most beneficial.