When you setting up your Limited Liability Company and writing your operating agreement, one of the most important decisions you can make is if the LLC will be Member-Managed vs Manager-Managed.
What is a Limited Liability Company (LLC)?
Invented in the early 1980s, LLCs were an attempt to combine the benefits of a sole proprietorship/partnership with the protections of Corporations. This structure is actually setting up a legal entity that can own assets and incur liabilities just like a living person. This legal distinction allows the owner(s) to own the assets and incur debt in the name of the LLC making the LLC liable for the debt and judgments, not the owners.
It also allows the owner(s) to file a simple personal tax return like a solo or partnership that are pass-through tax structures for their ownership percentage, but also provide the corporate veil protections of liabilities of the company to personal assets of the owner(s).
Management Types for LLC
The owners of LLCs are called members. When there is only one owner, it is referred to as a single-member LLC; and when there are two or more owners, it is referred to as a multi-member LLC. A normal single-member LLC is taxed similar to a sole proprietorship and a normal multi-member LLC is taxed similar to a partnership.
Because the LLC is its own legal entity, but not an actual breathing person, managers are required to run the day-to-day operations. The company has two options: Member-Managed vs Manager-Managed. Member managed is when one or more members manage the company. Manager managed is when the members hire one or more non-member managers.
Member-Managed vs Manager-Managed
Member-managed LLCs
With single-member LLC, choosing this management style means the lone member will make all decisions for the business.
With multi-member LLCs, the members will decide at the beginning if one, some, or all members will manage. Each member will have votes according to their share in the business for all major decisions as outlined in the operating agreement, but only the ones who wear the “two hats” of owner and manager will make the day-to-day decisions.
Manager-managed LLCs
In this management style, the members chose managers outside of the members to run the day-to-day operations of the company. At setting up the LLC, the members will create a written operating agreement that spells out what decisions will be reserved for the members and what decisions are delegated to the managers hired.
Reasons to Choose Manager-Managed
There are four primary reasons to choose to hire managers:
1. Passive Members
Sometimes members begin LLCs because they see a need for the business and wanted to invest their money into fulfilling that need, but do not have the time or desire to actively manage the day-to-day operations of the LLC. When this is true for all the members, managers can be hired to take care of most of the decisions. This frees up the members to only be needed for massive decisions that were reserved in the operating agreement.
2. Lack of Expertise
Sometimes the LLC is started in an industry that none of the members have the expertise in the operations of the LLC. Managers who do have that expertise need to be hired because of their special training and/or experience in the industry. Think of a group of wealthy business leaders who open a medical company focusing on a certain disease needing to hire doctors or experienced hospital administrators to run it.
3. Non-Human Members
LLCs can be owned by other businesses that are corporations or other LLCs. Often businesses will own smaller businesses that might handle parts of their overall product. The owners of the business likely would hire managers to run the LLC their business owns. Sometimes this occurs when one business buys out another and the owners of the purchased LLC stay on as managers.
LLC’s can also be owned by Trusts and Estates as well. Often single-member LLCs might have been managed by the sole member, but death or disease cause the business to go into an estate of the deceased or an established trust of the deceased or suffering. In these cases, a manager might be brought in to handle the business for a period of time or indefinitely.
4. Size of the LLC
Often when LLCs get to be very large, the LLC might need to take on managers with varied responsibilities like a corporation would hire CEO, CFO, COO, etc. to take care of different aspects of the business. Single members might not want to take on more members but need to give up some aspects of running the LLC.
The same could hold true in multi-member LLCs where the needs outnumber the members’ ability to take care of. In both of these cases, managers may be hired to take on some of these needs being out of members’ abilities or time.
Pay for LLC Managers
Non-member managers are employees of the company and would draw a salary and the LLC would be responsible for payroll tax withholdings and their portion of FICA and Workers Compensation obligations.
Member managers have options. A lot of the time when some manage and some don’t, those that do are their “buy-in” to their interest in the LLC and they simply draw their earnings from their share of profits of the business. But the member-managers can also wear two hats, member and employee, and receive two types of pay:
- Member will share in the profits of the LLC in the amount of their ownership percentage, and
- A salary can be received as a manager. In this case, the member-manager is considered an employee, with a reasonable salary required by IRS and all the usual payroll tax withholdings out of salary and the LLC having to pay their share into FICA and Worker’s Compensation.
This needs to be explicitly explained which way will be chosen in the LLC’s operating agreement and any employment agreement if the salary is paid to member-managers.
Selecting Your LLC’s Management Style
It is best to decide between member-managed vs manager-managed management style before registering the business in your state. The operating agreement that you prepare needs to specify what you are choosing and try to decide how situations will be handled coming out of this decision.
Many states also require you to list if member-managed vs manager-managed on the application to register the LLC.
It is best to speak with financial professionals prior to setting up your LLC to be advised on state laws and regulations on LLC and the consequences of the different styles of member-managed vs manager-managed that will specifically affect your LLC.
LLCs also require Employer Identification Numbers (EIN) for financial and tax purposes. This will be essential when you pay salaries, even if just to a managing member.