You and your fellow business owners have decided on an LLC as the appropriate business structure for your new business. At this point, you still have an important decision to make: the management structure of your LLC.
For most LLCs involving one or two owners, the decision is easy. When an LLC is small with just a few owners—which many small businesses are—a member-managed LLC is often the best management structure. However, in some cases, a manager-managed LLC may be the more appropriate choice.
With a manager-managed LLC there are two further choices to be made: the LLC can be managed by a group of managing members, or the owners may choose a third party to manage the LLC. The former is practical when some, but not all, of the members or owners are interested in managing the LLC while the latter is generally chosen when none of the members or owners have any desire to participate in the management of the LLC.
Member-managed LLCs vs. Manager-managed LLCs
In a member-managed LLC, all members play an active role in the day-to-day management of the company, and all members are authorized to act as agents of the company and can bind the company contractually. In many states, member management is the default management structure for LLCs; if you want a manager-managed LLC instead you must set this out in your LLC’s formation documents or operating agreement.
In a manager-managed LLC, members no longer play an active role in the day-to-day running of the company, nor are they agents who can bind the company contractually. Instead, management is delegated to either a group of members, who are known as managing members, or to a third party non-member. Unless your state places restrictions on who can manage an LLC, third party managers can also be another entity rather than an individual.
Reasons for Choosing a Manager-management Structure for Your LLC
While many small businesses opt for member-managed LLCs, in certain situations a manager-managed LLC may be the more appropriate choice. Reasons for choosing a manager-managed LLC include the following situations:
- Members who wish to be passive investors or who lack management skill and experience. If some (or all) members don’t want to play an active role in running the business, or are uncertain of their management abilities, it makes sense to choose the manager-management structure and either delegate management to a group of managing members or to a third party manager.
- Too many owners. When there are a lot of members, sharing the management of the company among all the members can become very unwieldy, hampering the ability of the company to run efficiently. In this situation, a manager-managed LLC may be the more appropriate choice of management structure.
The Definition of an LLC Managing Member
So what is an LLC managing memberLLC managers are also an agent of the business, which means he or she has the authority to enter into contracts on behalf of the LLC.
The Rights and Obligations of LLC Managing Members
The rights and obligations of LLC managing members should be fully documented in your LLC’s operating agreement. In a managing member LLC, managing members can have a number of rights and duties that are not shared by non-managing members, including the following:
- Decision-making powers related to the day-to-day management of the company. Examples of these powers include decisions related to the company’s daily operations and human resource decisions such as hiring, firing or promoting employees.
- Authority to enter into contracts. As an agent of the LLC, a managing member has the authority to bind the company contractually. This authority can come into play in a large number of situations, from contracting with a supplier to the purchase or sale of land on behalf of the LLC.
The extent of these rights and obligations should be set out in the operating agreement. For example, when hiring decisions or supplier decisions are being made, an operating agreement should set out whether managing members have the sole authority to make such decisions, or whether group or some other form of other approval is required.
Personal Liability of an LLC Managing Member
The LLC is a limited liability company and this limited liability protection covers both managing members and non-managing members. However, this liability protection doesn’t extend to any wrongdoing on the part of any member that affects the business. Because managing members will be more involved in the day-to-day business of the company than non-managing members, there may be more risk of personal liability, which may arise from any intentional wrongdoing or negligence on their part during their management of company operations.
Tax Implications for LLC Managing Members
LLCs are treated much like partnerships when it comes to taxes. This means that the LLC itself doesn’t pay taxes. Instead, profits of the LLC are divided up and distributed among members. This share of profit, known as the distributive share, is calculated according to the terms of the operating agreement. Often, the distributive share will be based on each member’s percentage of interest in the LLC.
While the rules surrounding self-employment taxes are complicated, currently managing members should expect to pay the self-employment tax of 15.3 percent on his or her distributive share from the LLC. Non-managing members, who don’t participate in the management of the company, are not subject to this tax. When drafting your LLC’s operating agreement, it’s a good idea to consult with a tax advisor to see what the full tax implications are for both managing members and non-managing members.
Your Operating Agreement
Once you’ve decided on a manager-managed LLC, it’s important to document your choice in either your LLC’s formation documents or in the operating agreement. The operating agreement is a particularly important document which should set out specifics related to the management of the company, including specifics related to decision-making powers.