When you start a limited liability company (LLC), in most situations you will need to obtain an Employer Identification Number (EIN). In Indiana,the ...
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. To learn more about LLCs, read this Step By Step article.
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.
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.
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.
The Operating Agreement
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.
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.
Choosing your management structure is an important decision to make when forming your LLC, as you’re essentially determining who can make critical decisions for your business. You and other members will have to agree on your management structure decision, and vote on who to appoint as manager or managers.
It is of the utmost importance to define your management structure in your operating agreement, and clearly define the roles and rights of all parties. It’s recommended that you have an attorney help you draft your operating agreement to protect all parties and the business. Forming an LLC is a simple process laid out in this Step By Step article.