LLC Structures: Member-Managed vs. Manager-Managed

Key Takeaways

• LLCs offer two management structures: member-managed and manager-managed, each suitable for different business needs and sizes.
• Member-managed LLCs grant all members equal authority in decision-making and are often best for smaller, owner-operated businesses.
• Manager-managed LLCs delegate control to selected managers and are ideal for companies with passive investors or complex operations.
• An operating agreement is essential to define roles, responsibilities, voting rights, and decision-making processes, regardless of structure.
• Single-member LLCs default to member-managed but can choose manager-managed if external help is needed.
• Clearly documenting the management structure in the articles of organization and operating agreement helps avoid legal complications.
• LLCs combine liability protection with operational flexibility and tax advantages, making them one of the most popular business entity choices.

Two types of LLC management structures exist: member-managed and manager-managed. This article will cover the key aspects of each management structure. 

A Limited Liability Company (LLC) is a legal entity which is managed by its members. A member is defined as an individual who has an ownership interest in the company. LLCs have a more streamlined organizational structure compared to corporations due to the lack of formal structures such as a board of directors. An LLC provides its members with more flexibility and control, it also limits personal liability.

There are two types of LLC management structures: member-managed LLC and manager-managed LLC.

Member-Managed LLC

A member-managed LLC may consist of single or multiple members. Each member has the authority to make decisions to bind the LLC. This structure provides each member with the responsibility to play an active role in the management and operation of the business.

• A member-managed LLC is often preferred by small businesses or family-owned companies. In this structure, each member plays an active role in the day-to-day operations and has the authority to make decisions for the LLC. This arrangement is akin to a partnership where owners have direct control over business activities.
• One of the key advantages of a member-managed LLC is simplicity. It doesn't require formal appointments or separate management, making it more straightforward to operate. However, it may become more complex as the number of members increases.
• Decision-Making in Member-Managed LLCs: In this setup, members vote on business decisions, usually in proportion to their ownership percentage unless otherwise specified in the operating agreement. Having a clear operating agreement helps streamline decision-making and avoid conflicts.

A member-managed LLC may be suitable if the following is true:

• The business is small.
• The business has limited resources.
• The business has a low number of members.
• Members have sufficient management experience and skill.
• All members want to be active participants in operational decisions.

To establish the organizational structure, an operating agreement may be created. An operating agreement is a binding contract between members. It can formalize conditions such as member voting rights, capital contributions, buy-out provisions and decision making. For example, it may state that a decision can only be made if there is consent from a percentage of all members. Alternatively, it may stipulate a management model where certain members are responsible for specific areas of the business. 

Advantages and Limitations of Member-Managed LLCs

Member-managed LLCs offer simplicity and transparency in governance, making them a common choice for startups and small businesses. All members are directly involved in decision-making, which fosters collaboration and minimizes overhead costs associated with a separate management layer.

Advantages:

• Easier to establish and maintain, especially for closely held businesses.
• Greater transparency and trust among members who are actively involved.
• Lower administrative costs since there's no need to pay external managers.
• Ideal for businesses where every member has a vested interest in daily operations.

Limitations:

• Potential for disputes if members disagree on operational decisions.
• Less scalable for growing businesses that require professional or specialized management.
• May be overwhelming for members without management experience or time availability.

Manager-Managed LLC 

A manager-managed LLC is where one or more individuals are selected as the LLC manager. The LLC manager has the authority to manage the company and may be a member or a non-member (externally contracted). 

• In contrast, a manager-managed LLC is structured more like a corporation. This management style is ideal for larger LLCs, where not all members want to be involved in daily operations. The members appoint one or more managers who may or may not be members themselves. These managers handle the daily management and decision-making responsibilities of the LLC.
• Roles of Managers: Managers can be individuals, entities, or companies hired to oversee operations. They are often responsible for setting the strategic direction, hiring staff, and managing business finances. This structure is helpful when some members are silent investors or when the LLC wants to tap into professional management expertise.
• Operating Agreement in Manager-Managed LLCs: The operating agreement outlines the managers' responsibilities, including their authority to make certain decisions, manage finances, and enter into contracts on behalf of the LLC. It's crucial for defining the scope and limitations of a manager’s power to ensure clarity and compliance.

Unlike in a member-managed LLC, members of a manager-managed LLC cannot make decisions to unilaterally bind the company. Members are also unable to interfere with the LLC manager's operational decisions. However, members can make structural decisions and changes to the company. For example, members can replace the manager or change the company to a member-managed structure. 

An operating agreement is important to formalize the roles and responsibilities of the manager and the members. The document can limit the authority delegated to the manager. 

A manager-managed LLC may be suitable if the following is true:

• The business is large and complex.
• Members lack sufficient management experience and skill.
• All or some members do not want to be active participants in operational decisions.

When to Choose a Manager-Managed Structure

Opting for a manager-managed LLC is beneficial in scenarios where centralized authority and streamlined decision-making are needed. It’s particularly suitable for businesses that involve outside investors, require professional oversight, or anticipate rapid growth.

Ideal scenarios include:

• Passive investors who prefer not to be involved in operations.
• Businesses needing to hire external professionals to manage complex functions.
• Multimember LLCs with conflicting schedules or varying levels of business experience.
• Companies seeking to establish a formal hierarchy to mirror corporate governance.

Furthermore, this structure can enhance efficiency by allowing managers to act swiftly without requiring consensus from all members, provided that the operating agreement grants them such authority.

LLC Management Structures for Single-Member LLCs

• Single-member LLCs often default to a member-managed structure because there is only one member involved. In these cases, the owner has full control over decision-making and management of the company. However, a single-member LLC can choose to adopt a manager-managed structure by hiring a professional manager.
• Operating Agreements for Single-Member LLCs: Even though an operating agreement is not always required for single-member LLCs, it is a good practice to create one. It helps outline the management structure, especially if the owner decides to bring on a manager in the future or clarify the member’s role in the case of potential disputes.

Special Considerations for Single-Member LLCs

Although single-member LLCs (SMLLCs) generally operate under a member-managed model, there are additional factors to consider:

• Legal Clarity: Drafting an operating agreement helps maintain clear boundaries between the member and the business, protecting the limited liability status.
• Succession Planning: An operating agreement can outline what happens to the business in the event of the owner’s death or incapacity.
• Tax Classification: SMLLCs are classified as disregarded entities by default for federal tax purposes, meaning income is reported on the member’s personal return. However, the owner may elect corporate taxation if more favorable.

Even solo entrepreneurs benefit from documenting procedures and structure to support future expansion or business transitions.

Key Differences Between Member-Managed and Manager-Managed LLCs

• Decision-Making: In member-managed LLCs, all members share decision-making authority. In manager-managed LLCs, the appointed manager(s) handle decisions, reducing the administrative burden on the members.
• Flexibility: Member-managed LLCs are typically more flexible for small-scale operations. Manager-managed LLCs offer more structure and are beneficial when not all members want to be involved in daily operations.
• Complexity: A manager-managed LLC often requires more formal processes and documentation, including a detailed operating agreement that defines the roles and responsibilities of managers and members.
• Control: Members retain direct control in a member-managed LLC, whereas in a manager-managed LLC, members delegate control to appointed managers.

Comparison Chart of LLC Structures

Here is a visual breakdown comparing the two primary LLC structures:

Tax Implications for Different LLC Structures

While the LLC structure provides liability protection, it also offers flexibility in how it is taxed. The IRS does not recognize LLCs as separate tax entities. Instead, LLCs can elect to be taxed as:

• Sole proprietorship (for single-member LLCs by default)
• Partnership (for multimember LLCs by default)
• S Corporation or C Corporation (via election using IRS Form 2553 or Form 8832)

The management structure (member-managed vs. manager-managed) does not directly affect federal tax classification, but it may influence operational decisions and recordkeeping practices. Members and managers must stay informed of how the LLC’s tax status impacts their reporting obligations and income distributions.

Frequently Asked Questions

1. Can I switch from a member-managed to a manager-managed LLC? Yes, you can change your LLC’s management structure by amending the operating agreement and, in some states, the Articles of Organization.

2. Does the IRS care if my LLC is member-managed or manager-managed? Not directly. The IRS focuses on your LLC’s tax classification. However, your management structure can influence how business activities are reported and documented.

3. Can a manager of an LLC be held personally liable? Generally no, as long as the manager acts within the scope of their authority and doesn’t engage in fraud or illegal activities.

4. Do all states allow manager-managed LLCs? Yes, all states recognize both member-managed and manager-managed LLC structures, though specific filing requirements may differ.

5. Should I consult a lawyer to set up my LLC? Yes. A lawyer can help you draft a solid operating agreement and ensure your LLC complies with state-specific rules. You can find experienced attorneys on UpCounsel.

As the business is an LLC, this means that you would not be personally liable for debts of the business. However, as the sole owner, there is the risk that personal and business finances can become blurred. In the event of litigation where the plaintiff attempts to lift the corporate veil, a formalized operating agreement provides clear evidence of the separation between the LLC and your personal finances. This will safeguard your personal assets. 

For single-member LLCs, having an operating agreement can help establish credibility with banks, investors, and other entities. It serves as proof that the business operates as a separate legal entity, which can be crucial in maintaining limited liability protection.

If you need help choosing an LLC management structure, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.