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Rotating cogs of an LLC

Should a manager or a member run an LLC? Which one protects you more?

by Jonathan Dougherty | Contributor
March 14, 2023

Is a manager-managed limited liability company the best way to run your LLC? Or are you better off with a member-managed LLC? What is the difference between the two, and which gives better protection if one of the members dies or becomes disabled?

To make the right decision, it’s important to understand the pros and cons of the manager-managed LLC versus the member-managed LLC and focus on which one gives you more protection in avoiding business failure and interruption from the incapacity or death of a member.

LLCs are popular

Building blocks of a LLC

LLCs are the most popular business entity in the United States today and have been for many years. There are more than 21 million LLCs in the U.S. compared to only about 1.7 million traditional C-corporations.

And according to Forbes, 73% of new formations in Delaware are LLCs, with only 18% choosing to be corporations. Forbes, by the way, is also an LLC, Forbes Media LLC.

Many larger companies are LLCs with billions of dollars in revenue and thousands of employees, like Google LLC, Hertz Vehicles LLC, Koch Industries, Pepsi-Cola, Nike and Sony.

And some companies start as LLCs and later switch to more formal and complicated structures. For example, Facebook was initially formed as a Florida LLC in 2004.

But the majority of LLCs are smaller companies with only a few members.

No matter what size, the LLC members must choose how to run their company. They can hire a manager to run the company's operations, or the members can run the day-to-day operations.

This is a critical decision for the owners because of the different protections and advantages offered by the two choices.

LLC Advantages for Small Businesses

An LLC is a state-created entity designed to help small businesses. LLCs can give pass-through taxation benefits like a partnership and liability protection like a corporation.

Also, LLCs are the most popular entity for running a small business partly because they have few formal requirements. Every state has different laws about corporations, LLCs and partnerships. But in general, while corporations must file minutes, resolutions, hold shareholder meetings and more, LLCs are not required to do so.

You can choose to have your LLC follow all the formal actions of a corporation, but there are no state requirements to do so. While you must pay an annual fee to the state, you don't even need to have annual meetings.

This flexibility of management styles makes the LLC ideal for small and family-run businesses.

Limited personal liability

Corporations have shareholders and issue shares of stock. Similarly, LLCs have members and membership interests. And like a corporation, an LLC is a separate legal entity from its owners.

The LLC is a separate entity responsible for its debts and obligations. Although the owners might lose the money they invested in the LLC, their personal assets are generally not at risk.

An LLC can choose its tax status

Surprisingly, many business owners wrongly believe that an S corporation and an LLC are the same.

While an LLC is a state-created business entity, an S corporation is simply an IRS tax classification. And the IRS does not recognize the LLC as a separate tax status or classification.

But if it qualifies, the LLC can be taxed as an S corporation, allowing profits and losses to pass through to the owners according to their percentage interest in the company. This avoids the double taxation associated with C corporations.

LLC management

In addition to limited liability and pass-through tax status, LLCs are popular with small businesses because of the little paperwork required and the flexible management style.

The main choice for the owners of an LLC is whether they want to have a manager-managed LLC or a member-managed LLC.

LLCs can have many owners or just one owner, which is called a single-member LLC. If you own a single-member LLC, you still need to decide if it will be member managed or manager managed and whether you will serve as manager or appoint someone else.

But when there are multiple owners or investors, the members must choose whether they want to collectively manage the LLC or elect and hire a manager to do so.

Whoever manages the LLC has control over the day-to-day operations and the authority to make business decisions, like:

  • Hiring and firing employees
  • Opening and managing bank accounts
  • Entering into binding contracts on behalf of the LLC
  • Borrowing money in the name of the LLC
  • Buying and selling equipment, real estate and other business assets.

These are broad powers and why some small business owners are reluctant to use a manager. When you form your LLC and file your Articles of Organization, you will state whether the LLC will be managed by the members or a manager. But the Operating Agreement is typically where the manager's authority and powers are listed in detail.

For example, when the manager opens a bank account, the bank will want a copy of the Articles of Organization that verifies the existence and current status of the LLC with the state. But, the bank will also require a copy of the Operating Agreement, signed by the members, giving the manager the authority to open a bank account and act on the LLCs behalf.

Member-managed LLCs

Most small businesses choose the member-managed LLC to run their business. And suppose you do not select a management type in your Articles of Organization when you form your LLC. In that case, most states will default to the member-managed status.

In a member-managed LLC, the members have the authority and responsibility to collectively make management decisions and run the business. Typically, every member would have a say in the management proportional to their ownership percentage of the LLC. For example, a member with a 30% ownership would have three times as many votes as a member with 10%.

Without a designated manager, each member generally has the authority to sign contracts and obligate the other members to financial transactions, like borrowing money or selling assets. This will depend on the terms of the Operating Agreement.

This management choice is usually made by LLCs with just a few members, all of whom want to be actively involved in the business' daily operations. The members can delegate different duties to each other, like marketing and operations. Still, this choice is for “hands-on” members. This is not a good choice for passive investors or LLCs with many members.

Manager-managed LLC

It is often not practical to have all the members manage the LLC. Some of the members might be investors that are looking for a passive investment in the company. Or there might be too many members to make working collectively practical. Some of the members may not have the time, skill or industry knowledge necessary to successfully run the company together.

In these and other scenarios, the financial health should have the members elect and hire a manager to handle the day-to-day decisions and operate the company. Members can retain authority over essential functions, like adding new members or selling or dissolving the company. The powers delegated to the manager, and those maintained by the members, are delineated in the LLCs Operating Agreement.

Typically, the manager makes day-to-day business and operational decisions designed to run a profitable LLC. The manager can answer questions from employees, vendors and customers and make decisions quickly.

When the LLC has investors, manager management of the LLC is the norm. While some investors may be active in the business, many are passive. They look upon their membership interest in the company as an investment. It is often in the best interest of member investors to hire a qualified manager to run the business.

And in a small-family LLC, the parents might want a manager for the business because the children are unable, or not yet experienced enough, to run the business successfully.

And when there are more than four or five members, running the business collectively is logistically challenging. Even with Zoom meetings, getting the time to have all members constantly meet to decide operational issues takes time and effort. LLCs with many members often opt to have a professional manager.

Pros and cons of both styles of LLC management

The difference between your LLC being managed by the members or a manager is more than just about the formality and flexibility of running the company. There are critical differences between the two methods.

The choice impacts all aspects of the business. It is also crucial in determining what protections are available should the owners become disabled incapacitated or die. When considering the LLC as part of your family's estate planning, it is best to consult an experienced estate planning attorney about which makes the most sense for you and your family.

Advantages of a manager-managed LLC

Efficiency and speed: Managers make timely decisions faster and more efficiently.

Clear division of labor: The manager runs the business, oversees the staff and operations and makes daily decisions. Members, including passive investment members, are not responsible for these operational decisions and act more like a corporate board of directors.

Centralized management: Managers can make decisions more efficiently and quickly than a group of members. This avoids the “too many cooks in the kitchen” scenario.

Flexibility: Members can select and hire professional managers with a depth of expertise in the LLC’s industry and the knowledge of how to run a business efficiently. This allows members to succeed in industries where they may not personally have detailed, specialized knowledge and experience.

Protection for passive members: Members who do not want to be involved in day-to-day operations can rely on managers to make crucial decisions on their behalf.

Easier to raise capital: Potential investors are typically more willing to invest in a manager-managed LLC because they have more confidence in professional management. Passive investors want the peace of mind of having an experienced manager. And even active investors like having a professional manager to work with when growing the business.

Disadvantages of a manager-managed LLC

Additional costs: Many small LLC members work for little or no money or salary starting out. Hiring a professional manager to run the business can be more expensive than having members manage the LLC. Managers are typically paid a salary. This added expense may be more than the LLC can afford initially.

Knowledge: Many LLC members are intimately familiar with their industry, particularly in a niche industry. The manager may have experience running the business but need a depth of industry knowledge.

Lack of control: Members may have less control over the business’ day-to-day operations, which could lead to disagreements or conflict if they disagree with the decisions made by the managers. The Operating Agreement needs to be carefully drafted to detail the manager's authority. And the LLC needs to keep records of the manager’s actions to ensure their authority is not exceeded.

Less democratic: Members have less input into the business management, which could be a concern for some of them.

Potential for conflicts of interest: Because managers may have different incentives than members, there may be a potential for conflicts of interest that could negatively impact the business.

Complexity: Having a manager-managed LLC can add complexity to the structure of the business. Suppose the business operations and administration are not well planned. In that case, this could make managing and operating more difficult.

Difficulty in raising capital: While most investors favor a manager-managed LLC, some investors in niche industries may be hesitant because they may perceive a lack of member involvement and the manager’s potential for conflicts of interest.

Advantages of a member-managed LLC

In contrast to a manager-managed LLC, where professional managers are hired to run the business, a member-managed LLC is run by all of the members of the LLC. While this structure may only be suitable for some businesses, it offers several advantages over a manager-managed LLC.

More democratic: All members have a say in business decisions in a member-managed LLC. This can be especially important for small or family-owned businesses, where all members may have a personal stake in the business’ success. This structure feels like a more democratic form of organization.

More control: The members have direct control over the business. In small startup LLCs, members want to be involved in day-to-day operations. They have a direct say in business decisions. This more hands-on approach ensures members that the business is being run in a way that aligns with their values and goals.

Better aligned interests: LLC members have a vested interest in the business’ success and are more likely to make decisions that benefit the company in the long term.

Lower costs: With no managers to pay, member-managed LLCs may be less expensive to operate. This is important for small businesses or startups, where every dollar counts. By avoiding the expense of professional managers, members can allocate more resources to other aspects of the company, such as marketing or product development.

Better communications: LLC members usually have a closer relationship with the business and are more likely to communicate regularly with each other than with a manager. This is very common where members are also family members or close friends.

Disadvantages of a member-managed LLC

Potential for disagreements: Members may have different opinions and priorities regarding running the business. This could lead to disputes about operational decisions and harm the efficiency and profitability of the company.

Lack of expertise: Members may be experts in their field but neophytes in running a business. This is often true in startup tech companies, where programmers and designers are virtuosos in their field but have little to no business experience.

Time commitment: Running a business, especially the operations of a start-up LLC, can be more than a full-time job. Managing the company might take valuable time away from other areas like critical decision-making, marketing, and product development.

Risk of liability: Members actively involved in the management of the LLC could be exposed to personal liability under some circumstances.

Difficulty in raising capital: Except for niche industries, most investors favor investing in manager-managed LLCs.

What about the death, disability or incapacity of a member?

Choosing between a member-managed or manager-managed LLC is a critical decision. And the correct answer relies on factors like the need to raise future capital, the type of products or services you offer, the complexity of your operations, how many members you have, whether it is a family business and more.

But often overlooked is the most critical factor in financial and estate planning -- what happens to the business if one of the owners becomes disabled, incapacitated or dies? And what happens to the owner's interest in the company and their family?

Although every business is unique, a manager-managed business offers many advantages in the case of death or disability.

Suppose there are only a few members, each with a key function in the company, and one dies or becomes disabled. In that case, this can be a catastrophe for the company. The company's operation is affected, which will impact sales, production, revenue and more. The death of a member is often the critical factor in the company's downfall.

And the ability to raise further capital, or even a bridge loan, becomes impossible. The death of a key member is one of the main concerns of initial LLC investors.

But with a manager-managed LLC, the business continuity operations are not dependent upon any one member. And the manager is often the company's public face to the business world, so customer and vendor confidence stays intact.

By integrating the LLC into the members' financial and family estate planning, they can use a manager-managed LLC structure to ensure the business continues and the business interest, or its cash value, can be passed to the heirs of the deceased.

A manager-managed structure can ensure the business continues running when you are no longer there. And your estate planning attorney can ensure that buy-sell agreements, living trusts, and other tools are in place. Hence, the business continues, and your family gets the value of your share of the company should death or disability occur.

Why your LLC should be included in your estate planning

Choosing whether to have a manager-managed LLC or a member-managed LLC is critical in deciding how you want your company to be operated.

LLCs have fewer formalities than corporations, and there is no requirement to have a manager. But having a manager-managed LLC will impact how your company is run, its ability to raise capital, and more.

Having a manager can help ensure your company will continue should you suffer death or disability. With strategic estate planning, your company is poised to continue. Your family can get the full value of your interest in the company when needed.

Fortunately, there are powerful business and estate planning tools and strategies to help you ensure this happens. But planning the best strategy for you and drafting the best documents requires legal, financial, and tax planning expertise.

How do I create an estate plan?

There are numerous options and scenarios to consider when developing an estate plan that protects your legacy and achieves your objectives, and important decisions should be made with the advice of qualified lawyers and financial experts. Membership with Legacy Assurance Plan provides members with valuable resources and guidance to develop comprehensive estate plans that take life's contingencies into consideration and leave a positive impact for generations to come. Legacy Assurance Plan members also receive peace of mind that a team of trusted, experienced professionals will assist them in developing legal, financial and tax strategies that will meet their needs today and for years to come through periodic reviews.

This article is published by Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at legacyassuranceplan.com.

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Email - info@legacyassuranceplan.com
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