How to choose an LLC management structure
If you’ve started on an entrepreneurial path and are planning to form a limited liability company (LLC), you’ll need to determine your LLC’s management structure. LLCs have much management flexibility, which is one of the reasons they’re a popular choice for new business owners, but you will have to choose between a member-managed or manager-managed structure.
Some states require that you specify your management structure and the names of addresses of managers on your LLC formation documents, so you need to make this decision early on.
In this guide, you’ll learn the difference between the two structures and how to choose the one that’s right for you.
LLC defined
An LLC is a business entity type that offers personal liability protection for its owners, who are formally called members of the LLC. Unlike a sole proprietorship or partnership, in which the business and its owner or owners are considered one and the same, an LLC is a separate entity from its members. That means that the LLC can enter into its own contracts and have its own assets and debts. The LLC members are thus not personally responsible for the obligations of the LLC.
An LLC also offers pass-through taxation, which means that the LLC does not pay taxes. Profits instead pass through the LLC to the members who pay taxes on the profits at their personal tax rates.
Forming an LLC is relatively simple, and you can find many guides to starting an LLC online, even state-specific guides since each state has its own LLC formation process.
Member-managed LLC
One of your management structure choices is a member-managed LLC. In a member-managed LLC all LLC members are actively involved in operating the business. The key word is “all”. All members have certain roles and responsibilities in the company, and those roles can be structured in any way the members choose. For example, one member can be the finance manager, while another is in charge of marketing. This is where the LLC management flexibility comes in – there are no rules about how you choose to manage the LLC.
Manager-managed LLC
In a manager-managed LLC, all LLC members are not necessarily involved in the operations of the business. Some members may be silent partners or investors in the business, while other members are the appointed managers. Another scenario could be that all or some members are managers, but a non-member manager or managers are also hired. A third scenario is one in which the LLC is fully managed by non-members, and no members are involved in the management of the business.
In a manager-managed structure, roles and responsibilities can still be assigned in any way you wish.
LLC manager responsibilities
The choice of managers for your LLC is important because those managers will have certain key responsibilities and powers, such as signing contracts for the LLC, obtaining financing, handling bank accounts, and more.
They’re also going to be involved in the strategy and day-to-day operations of the business, so you’ll want to ensure that your chosen managers are qualified to do so.
When is a member-managed structure best?
In a member-managed LLC, all members have control over the business and its strategy and voting rights on key decisions. This gives members the ability to protect their financial interests. All members, however, should be qualified to manage the LLC and perform key responsibilities. If one member is more qualified as a manager, but the other members want to be involved, you could give the qualified manager more voting power, or final decision-making power in key business matters.
A member-managed LLC is also best if you don’t want to have non-members involved in control over the business.
When is a manager-managed structure best?
A manager-managed LLC gives members the ability to be passive investors in the business. This is common when family or friends invest in the business, but do not want a management role. In a manager-managed LLC, you can also retain full control if you bring in an investor later. You can make the investor a member without giving them management responsibilities.
A manager-managed LLC is also appropriate if some or all of the members are just not good managers. It’s very possible and not uncommon for startup founders to be great visionaries, but not great at the art of management. You and other members should honestly assess your abilities and do what’s right for the company.
A manager-managed LLC may also be your best bet if your LLC has many members. If you have too many people with a hand in the business, it can cause chaos and has the potential for disputes to arise. It’s the “too many cooks in the kitchen” theory.
The operating agreement
Whatever management structure you choose, it needs to be clearly defined in an operating agreement, even though most states do not require one. The operating agreement should describe who the managers are, and what their roles, responsibilities, and powers will be.
In addition to management roles, the operating agreement is critical because it also specifies member ownership percentages, how profits are distributed, the voting rights of members, how ownership can be transferred, and what happens if a member becomes disabled, dies, or chooses to leave the LLC for any reason.
It contains other important provisions as well, including how member disputes are resolved.
It’s very important to have an attorney involved in drawing up your operating agreement, particularly if your LLC has several members. You’ll want to ensure that all bases are covered so that you are less likely to ever reach an impasse that has to be resolved in court.
In closing
One of the best features of an LLC is the management flexibility it offers. You only have to make one choice, and can otherwise manage the business in any way that you see fit. However, that choice is an important one, because whoever you choose to manage your LLC is going to have significant control over the business. If you and other members are having difficulty making a decision, its best to seek the advice of your attorney. They can evaluate your situation and guide you in the right direction.
Author: Martin Eckler is an attorney with over 20 years of experience in commercial law, and business strategy.
In his current role with Step By Step Business, a company focused on helping aspiring entrepreneurs, he has been entrusted with reviewing all content and documents.