LLC: Member-Managed Or Manager-Managed?

Can Too Many LLC Cooks Spoil the Broth?

When you fill out the paperwork required to form a Limited Liability Corporation (LLC), you have two management options:

• Member-managed
• Manager-managed

Whether you will be the sole owner of the business or you form a partnership, this is a vital decision that you need to make before starting operations. Once you understand the difference between the two management structures, there are a number of significant considerations involved in choosing the right one.

Understanding the Two Management Structures

Before choosing a management structure, all partners need to understand how each one works. The following definitions provide a relatively high-level overview, but it’s probably a bit more complicated than it sounds.

Member-Managed Partnerships

These are the most common structure and the default choice in most states. In member-managed partnerships, each member is a legal agent of the LLC and has the authority to make many decisions for the company without requiring a partnership vote.For example, a partner who takes on responsibility for purchasing parts for manufacturing operations can generally issue purchase orders without a majority vote from the partnership. He or she might also make any number of business decisions, as well, even if they reside outside of a specific department.Note that even partners who are legal agents of the company cannot make all decisions without a partnership vote. Entering into contracts or applying for loans still require approval by a member majority. The partnership agreement (often referred to as an operating agreement) can specify other decision-making rules as well.Finally, keep in mind that member-managed partnerships can still hire outside managers. Anyone you hire works for a paycheck and benefits without sharing in the partnership.

Manager-Managed Partnerships

This is a funny name for a flexible management structure in which you go outside of the core group of partners to put some or all managers in place, each with more rights than a manager hired to run a department in the typical way. Regardless of where they come from, the managers become agents of the company, even if they own no shares of the business. In other words, you can create a mix of partnership members and outside parties who have the rights needed to act as agents of the company.Let’s say that none of the core partners have the skills needed to make vital fiscal decisions for the company. They might bring in a financial wizard to oversee and approve major spending activities or other financial concerns. This person would have the right to act as an agent of the company based on the allowances set forth in the company’s operating agreement. Again, these manager-managers can make any required daily decisions, but they cannot enter into contracts or apply for loans without a majority vote by the partners.Of course, this is not the same as hiring department managers when needed to help run daily operations. You can certainly hire employees to manage parts of the business and even give them decision-making latitude without giving them partnership rights.

The Characteristics of Your Business Must Drive Your Choice

I wish I could list a set of rules that would simplify the decision between choosing between a manager- or member-managed LLC, but it really depends on the people in your partnership and the overall characteristics of your business. Even though member-management structures are most common, manager-managed structures can potentially offer more flexibility.Here are the top two things to think about:

• What are the intentions and abilities of the partners? The partnership may consist solely of a few individuals who are dedicated to running the business without any outside assistance. If this describes you, then a member-managed structure might be most appropriate since you can still hire department managers as employees down the road.
• How many members are in your partnership? This is where too many cooks can definitely spoil the broth. If you have an extensive number of partners, you probably do not want to call a vote for every decision. A manager-managed structure can still allow partner-managers and non-partner managers the right to vote on some or all issues, but passive members don’t necessarily need a vote.

Manager-Managed Partnerships are Flexible, but Complicated

On the surface, choosing a management structure sounds fairly straightforward, but don’t be fooled. Forming an LLC partnership typically involves numerous complex considerations — particularly when forming manager-managed partnerships — such as the following:

• The amount of authority enjoyed by non-member managers
• Whose decisions take precedence in the event that partners disagree with non-member managers
• Whether or not non-member managers can earn shares in the business, and whether it makes more sense to bring them in as partners on day one, even the value of their expertise replaces cash in terms of their investment
• How liability issues affect non-member managers
• The management authority allocated to each equity investor, if any

Every partner in the business will be well-served by studying NOLO’s article, Manager-Managed LLCs: The Details. This article will help you gain a greater understanding of the issues, and it might convince you that you need an attorney to make sure that you do it right.

A Well-Written Operating Agreement is Virtually Essential

Depending on the state where you form your LLC, you may or may not be required by law to develop an operating agreement for the partnership. But, when more than one person owns a small business, you may quickly see the problem with too many cooks without a clear set of provisions in writing and signed by all partners.If you want to try to do it yourself, you might  consider using online legal services such as LegalZoom, MyCorporation or Nolo. Still, while these services might be perfect for forming a very straightforward partnership between two like-minded people, they cannot delve into myriad unique circumstances that can arise.The choices that you make now are likely to affect your business’ future growth or its very survival. At the very least, arrange for a free initial legal consultation to help you decide if investment in a knowledgeable attorney will be a worthwhile investment.