Member-Managed LLC vs. Manager-Managed LLC
The limited liability company (LLC) is a relatively new type of business legal entity in the U.S. The LLC functions for management purposes in a similar way as a corporation, but in some ways the management is different. This article explains the two ways an LLC can be managed - by one or more members or by a manager.
The Management of an LLC
(These two types of LLC's are taxed differently, which is why they are differentiated here.)
In the same was as any other type of business, an LLC must have one or more individuals who manage the company, acting like the board of directors does in a corporation. An LLC may be managed by all of the members or the LLC may decide to hire a professional manager. No state law requires an LLC to be member-managed. But which type of manager is better?
Member-managed vs. Manager-Managed LLC's
Member-managed LLCs work like this: All members participate in the decision-making process of the LLC. Each member is an agent of the LLC and each member has a vote in business decisions. Each member has the authority to make decisions on behalf of the company, but contracts and loan agreements must be approved by a majority of the members.
Manager-managed LLCs relinquish the authority of the members to the manager or managers, who become agents of the company.
A manager may be a member but does not have to be. A manager may be another LLC or a corporation unless your state sets restrictions on the types of entities that may be managers of an LLC.
Most LLCs are member-managed by default in most states. That is, no manager is selected and member management is assumed.
In most states, manager management must be designated in the Operating Agreement.
Reasons For and Against Manager-Management
LLCs often choose a manager in two cases:
- Passive Members: In some LLCs, members can be passive. These individuals may be investors and designated as members, but they do not participate in the day-to-day decision making of the company. Because they aren't participating in decision-making, passive members have less liability. In this case, it makes sense to have a manager or several managers (remember a manager can also be a member) to run the business. If there are both passive and active members, an active member should be the manager.
- Size of the LLC: In very large LLCs, it also makes sense to select one or more managers to run the company, since it would be prohibitive to try to get all the members together to make decisions. The members can then focus on their expertise and the work they want to do. A professional manager is also a good choice for a large LLC because the management is much more complex, and the day-to-day decisions can be a full-time job. It's important to remember that if your LLC selects a manager, the manager has the authority to make decisions for the LLC and this person has fiduciary responsibilities. If you don't want someone else deciding, then the members can and should retain that right.
LLC Managers Are Owners and Not Employees
First, it's important to note that LLC members are owners, not employees. But if an LLC member also performs management duties, that individual can receive compensation as an employee. His or her employment income is separate from the member's status as an owner.
This distinction should be spelled out in the LLC's operating agreement or an employment agreement. If your LLC hires a professional manager, that person is an employee. In either case, the person doing the management tasks should be paid a reasonable salary and payroll taxes must be withheld.
When to Select Your LLC's Management
The time to determine who will manage your LLC is before you begin operations. The operating agreement should specify who will manage and how decisions will be made.
Don't leave this important question for later or you may find yourself in legal difficulties.