Member-Managed vs. Manager-Managed LLCs

When starting a business, there are many things to consider. If you’ve made the choice to form a limited liability company (LLC) you’ll need to determine whether your business will be member-managed or manager-managed. 

LLC owners are known as members. In a member-managed LLC, the members run the business. In a manager-managed LLC, non-members are hired to oversee and run the business. 

An LLC is a business entity that offers liability protection for owners, as well as pass-through taxation, much like a sole proprietorship.

What Do LLC Managers Do?

An LLC offers its owner or owners considerable flexibility in terms of management. You can choose your management and operational structure. As with other business entities, managers can play various roles. For example, you might have a Chief Executive Officer (CEO) and a Chief Financial Officer (CFO), as well as other managers who are delegated specific duties.

Managers, whether they are members or employees, have the ability to make critical decisions and perform important tasks for the company including:

• Entering into contracts
• Signing legal documents
• Managing bank accounts
• Hiring employees
• Getting financing for the company

Because of the important nature of management roles, choosing managers and the management structure of your LLC is a critical decision that should be made carefully.

Member-Managed LLCs

In a member-managed LLC, the members (owners) of the LLC participate in the daily activities of the business. Most LLCs are member-managed because the majority are small businesses that cannot afford to hire a management team. 

Many LLC owners prefer to have a member-managed structure because they want to be in control of decision-making and directly involved in the operations of the business. Unlike corporations, LLCs do not have boards of directors to oversee the management. This means that whoever manages the company is in control of all decisions. 

In most states, LLCs are considered member-managed by default unless they have specified that they are manager-managed in the formation documents or operating agreement. 

Pros of a Member-Managed LLC

Most LLCs are member-managed, and for good reason. 

1. All members have control

In a member-managed LLC, all members have a role in the business and decision-making power. None of the members are silent partners with little control. Many LLC owners prefer member-managed because they want to have a hand in the direction of the business. 

2. All members can conduct LLC business 

In a member-managed LLC, all members have the authority to sign contracts, handle financial matters, and perform other business on behalf of the LLC – unless certain limitations are specified in the operating agreement. Members are better able to share responsibilities as not all of them need to be present to finalize transactions.

3. All members have voting rights

When the LLC is member-managed, all members have a vote on important matters as specified in the operating agreement. This includes cases in which some members disagree on a matter, and a vote is required to settle the dispute. This gives all members the ability to protect their financial interests in the business because they have voting power.

Cons of a Member-Managed LLC

Of course, a member-managed LLC is not perfect. In some cases there are real drawbacks. 

1. Members cannot be passive investors

Some LLC owners would rather invest and remain uninvolved in business operations. They want the profits without getting involved in management and business decisions. In a member-managed LLC, all members must be involved in operations, so this is impossible. 

2. Members may not be qualified managers

Some entrepreneurs are full of ideas but not so good at turning them into a successful business. Your LLC might have a member with limited management skills, but within a member-management structure he would still have to be involved in operations. 

3. Too many cooks in the kitchen

If your LLC has many members, it may be impractical for all of them to play a real management role. A manager-managed LLC allows you to designate certain members, perhaps the most qualified, to manage operations while other members remain passive. Too many member managers gets complicated fast and often leads to disputes.

Manager-Managed LLCs

In a manager-managed LLC, non-members are hired as managers. Some members still may be managers alongside the non-member managers, or none of the members can be managers. In this structure, any members who are not managers are passive investors and have no role in the operations of the company. 

This structure works when some or all of the owners want that passive ownership, or if there are a large number of members – too many to all effectively manage the LLC. Another reason to choose a manager-managed structure is when members simply don’t have management skills. Having a great business idea and the capital to start a company does not necessarily mean that someone can run a company. Hiring professional managers, in that case, can give the company a better chance of success.

Pros of a Manager-Managed LLC

While most LLCs are member-managed, sometimes a manager-managed LLC can be advantageous.

1. Allows passive investors

In a manager-managed LLC, some members can choose to be passive investors, or silent partners. Conversely, in a member-managed LLC, all members must have a role in the operations of the business. A manager-managed LLC is appropriate when a member or members want to be passive or if you raise investor capital for your business. The investor becomes a member after investing, but you may not want them managing the business.

2. Allows professional managers

While in a manager-managed LLC, some members can still be managers, you may want to bring in a trained and experienced manager to run the business. A management professional can offer much value and may be able to develop strategies to grow the business faster simply because of their experience and qualifications. This might also be a good idea if your LLC has slipped off course and the business ship needs to be pointed in the right direction. 

3. Better for LLCs with many members

If your LLC has many members, it may be impractical for all of them to play a real management role. A manager-managed LLC allows you to designate certain members, perhaps the most qualified, to manage operations while other members remain passive. Too many member managers gets complicated fast and often leads to disputes.

Cons of a Manager-Managed LLC

Even so, a manager-managed LLC is not always the best choice.

1. Members lose some control

In a manager-managed LLC, some members will inevitably give up some control of the business. Often, LLC members choose to be involved in order to maintain decision-making authority and keep a hand on the rudder. 

2. Managing members are more accountable

While an LLC offers personal liability protection for all members, that protection has limits under the manager-managed structure. If a managing member makes a poor business decision, for instance, non-managing members could hold that managing member accountable and even take legal action. In a member-managed LLC, this could never happen as all members are responsible for managerial decisions.

Which Management Structure Should You Choose?

An LLC offers you the flexibility to choose your management structure. If some members want to be passive investors, then a manager-managed structure may be right for you. This may occur if you started the company and then raised money from investors to grow the company, but those investors don’t want to be involved in operations. 

If you and other members want complete control over the company and day-to-day decisions, then a member-managed LLC is likely a better fit. Just be honest with yourself about your management skills and be sure that you and other members are capable of effectively running a company. 

Of course, if you choose a manager-managed LLC you will have to pay your managers a salary, which may be hard on your bottom line. While professional managers can be beneficial because of their skills, they rarely work for free.

How to Document Chosen LLC Management Structure

The management structure should be clearly defined in the operating agreement. An operating agreement for a limited liability company (LLC) is an important legal document that details who owns the business and also provides essential information pertaining to member duties and manager duties. An LLC operating agreement establishes the financial relationship between members and the basics of the working relationships between those members and the managers who oversee daily operations. 

An operating agreement is not usually required but is highly recommended. The operating agreement should clearly define the following:

• The percentage of each member’s interests in the LLC
• How profits and losses will be allocated to each member
• Each member’s rights and responsibilities
• The management structure and management roles of members
• The voting rights of each member
• Rules for meetings and voting
• What happens when a member sells their interest, becomes disabled, or dies

An LLC operating agreement provides legal and financial recourse for a number of situations. If conflicts arise between LLC owners pertaining to any of the following issues, the operating agreement will provide clarity.

It is extremely important to clearly define in the operating agreement who the managers are and their responsibilities and rights. In a manager-managed LLC, you should also define what rights the members will retain. Doing so will protect everyone involved.