When forming an LLC, you must decide whether it will be Member-Managed or Manager-Managed.
What is a Member-Managed LLC?
A Member-Managed LLC is where all of the Members (owners) have the ability to bind the LLC into contracts and agreements, as well as take part in the day-to-day operations and business decisions.
What is a Manager-Managed LLC?
A Manager-Managed LLC is where the LLC Members appoint one or more Managers, who are then the only one(s) that have the ability to bind the LLC into contracts and agreements and take part in the day-to-day operations and business decisions.
An LLC Manager can be an existing Member (ex: 2 of 4 Members are Managers, and the other 2 Members are passive owners) or an LLC can have an “outside Manager” (ex: all the Members hire someone who does not own any of the LLC, but is simply hired to run the business).
The above was the “quick answer” to the differences between a Member-Managed LLC and a Manager-Managed LLC. For those of you who are still getting familiar with LLCs, we’re going to dive into things in a bit more details…
In most states, your LLC’s type of management must be listed in your Articles of Organization (sometimes called Certificate of Organization or Certificate of Formation).
Additionally, which type of management you choose for your LLC will dictate which type of Operating Agreement your LLC uses (a Member-Managed Operating Agreement or Manager-Managed Operating Agreement).
Before going further, let’s cover some basic LLC vocabulary.
An LLC Member is an owner of the LLC. An LLC Member can own 5%, 100%, or any percentage for that matter. All states allow for Single-Member LLCs, where there is just 1 Member, or an LLC can have multiple members, called a Multi-Member LLC. There is no limit* to the number of Members an LLC can have.
In the context of LLCs, the term “Management” can mean many things (depending on how the Operating Agreement is drafted), but in general, it means the ability to bind the LLC into contracts and agreements, participate in the business decisions and take part in day-to-day activities.
Additionally, the person (or persons) managing the LLC also have the ability to:
• make all legal and financial decisions
• open and close bank accounts
• enter into any and all contracts and agreements
• buy/sell real estate, vehicles, investments, and other financial instruments
• dispose/divest of the LLC’s assets
• borrow money and obtain financing
• hire employees, staff, and independent contractors
Whoever is managing the LLC has a fiduciary duty (a legal obligation) to act in the best interest of the LLC.
Now that we understand what LLC Members are and what LLC management is, let’s discuss the 3 different types of LLC management:
1. Member-Managed LLC:
A Member-Managed LLC is when all of the LLC owners (again, called Members) have a right to bind the LLC into agreements and they regularly make business decisions and run the “day to day” activities.
The keyword in Member-Managed LLCs is all, meaning that all of the LLC Members have the ability to bind the LLC.
If some of the Members don’t want to partake in the day-to-day activities, they can appoint a Manager or Managers. These Manager(s) can be existing LLC Members, or they can be non-Members, which we discuss below.
2. Internal Manager-Managed LLC:
An Internal Manager-Manager LLC is when some of the Members do not want to run the business and make decisions, and instead want the other Members to take care of this.
Let’s take an example of a 4 member LLC for the purpose of real estate investing. If 2 Members (Steve and Susie) are responsible for the funding and don’t want to run the business, all the Members can agree to appoint the other 2 Members (Bob and Barbie) as the Managers. We call this an “Internal” Manager-Managed LLC, since the Managers, Bob and Barbie are also Members of the LLC.
3. External Manager-Managed LLC:
An External Manager-Managed LLC is very similar to an Internal Manager-Managed LLC, except this time, none of the Members are the Managers, and instead, all of the Members take a “back seat” and they hire an outside person or persons (who is not an owner of the LLC) to run the company.
And I guess there is also a 4th “unofficial” type of management, but we didn’t want to make things too confusing. It’s simply an LLC that has both internal and external Managers. For example, a 5 Member LLC where 3 Members are “passive Members”, but the other 2 are Managers, in addition to one other person they hired as Manager, who is a non-Member.
*Note: If an LLC is formed with no Operating Agreement, and where no decision is made as to how the LLC will be managed, then state law comes into play; which states that the LLC will be Member-Managed.
How are 1-Member LLCs (Single-Member LLCs) Managed?
Most LLCs that have 1 Member elect to be a Member-Managed LLC, but a Single-Member LLC can also be Manager-Managed.
This may make you scratch your head a bit. In short, the Member can choose to manage the LLC him/herself, or the Member can elect a Manager (also being him/herself) to manage the LLC.
The pros of this setup is that in some states, where you are required to publicly state (via your LLC’s Articles of Organization) who the Members or Manager are, listing yourself as “Manager” does not automatically let the public know that you own the LLC. If instead you were to list “Member”, this clearly states that you are the owner of the LLC.
Most LLCs are Member-Managed
The majority of our readers are forming LLCs with 1 to 3 Members, and most of them choose to have their LLCs be Member-Managed. This is the simplest and easier route to choose.
Binding Contracts in a Manager-Managed LLC
It’s important to note that in a Manager-Managed LLC, it’s only the Managers that can enter into and bind the LLC to a contract.
The Members (that are not Managers) cannot bind the LLC to contracts or agreements and they cannot take part in the day-to-day operations (typically, unless they get authorization in writing from the Managers).
An LLC Member can advise an LLC Manager, but an LLC Manager does not have to follow or agree to this advice.
Having said that, Members still have power, since if all Members agree, the Members can remove the existing Managers and appoint a new one. All Members must agree to such changes in writing.