If you've chosen to structure your business as an LLC, you've still got another important decision to make. You’ll need to decide on a management structure.
In a member-managed LLC, the owners have collective control over company decisions. A manager-managed LLC places management authority in the hands of a professional manager or one or more elected members.
This choice goes to the heart of your company’s day-to-day operations, so it’s a good idea to consult an attorney.
An LLC is a business entity structure that offers owners limited personal liability for business debts and obligations. It’s a popular type of business structure because it’s easier to create and involves less paperwork compared to a corporation.
An LLC might have one owner (called a single-member LLC) or multiple owners. If you’re the sole owner, then you’re in luck — you don’t need to decide between member management and manager management. You are by default in charge of all management decisions.
Things get more complicated when a company has investors or multiple owners. In that case, all the members can collectively manage the LLC, or the LLC can elect a manager.
Whoever is in charge of management will be able to make the following types of decisions on behalf of the company:
Enter into legally binding contracts and sign agreements.
Buy and sell real estate, equipment, vehicles and other business assets.
Open, close and manage business bank accounts.
Hire employees and other staff members.
Borrow money through a business loan.
As you can see, the people in charge of managing the LLC are pretty powerful. You want to make sure you place this power in the right hands. Typically, you would elect member-management or manager-management when you file your LLC’s articles of organization with the state. Management authority is delineated in more detail in the LLC operating agreement.
A member-managed LLC places management authority in the owners of the LLC (called “members:”). Each owner has a voice in decision-making. Depending on the specifics of the operating agreement, the owners might have equal say, or authority might be proportional to the level of ownership in the business. For instance, a partner who owns 40% of the LLC could have twice as much say as a partner who owns 20% of the LLC.
In a member-managed LLC, each owner is an agent of the LLC and has the power to bind co-owners by signing company contracts, borrowing money and making other decisions. But members must vote to approve such decisions.
This is the right choice for your business if you and your owners want to be actively involved in the company’s affairs. For instance, let’s say you jointly own an e-commerce business with one other person. You want to be involved with launching and running the website, and your co-owners want to handle marketing and pricing. Since you both are actively involved in operating the business, you should opt for a member-managed LLC.
Member-managed LLCs are more common than manager-managed LLCs. In fact, in most states, member-managed LLCs are the default management structure. If you don’t specify a management structure in your LLC operating agreement, you’re by default a member-managed LLC. A member-managed LLC generally also costs less to operate because it doesn’t have officers or a board of directors the way a corporation would.
In a manager-managed LLC, the owners elect a manager or managers to handle day-to-day business decisions. Members still retain authority over some things, such as dissolving the company. That said, the manager is the main legal agent of the LLC and can quickly make decisions on behalf of the business without waiting for all members to approve. There could be one manager or multiple, and the manager could be a member (but need not be). If the manager isn’t a member, they are called a professional manager. The managers act as a board of directors would for a corporation.
Manager management is appropriate when an LLC has investors. Most investors are passive investors or “silent partners.” This means they own a portion of the business but don’t have the time or expertise to make day-to-day decisions. In this case, members can vote for the most knowledgeable people to be the managers. For instance, in a family-owned business, parents can keep management authority in their hands while entrusting their children with some ownership of the business.
Let’s say you and your business partner in the e-commerce company attract money from two investors. Now you, your partner and the two investors are members of the company because you each have an ownership stake. But all the members can vote to make you and your partner the LLC managers. That way, you or your partner can quickly make business decisions without having to get consensus from others.
A manager-managed LLC is also helpful if you have a large company with many owners. If you have more than four or five owners, it can become very difficult to frequently get everyone together to vote on management decisions. It’s better to delegate management responsibility — which can amount to a full-time job — to a few of the members or to a professional manager.
Pros and cons
As you can see, there are some crucial differences between a member-managed LLC vs. manager-managed LLC. The choice will have a big impact on your day-to-day decision-making processes.
Pros of manager-managed LLC
Makes it easy for investors to passively invest in the business.
Makes it easier for large LLCs to operate quickly.
Allows managers with active control to make quick decisions without having to get the consensus of all owners.
Centralizes decision-making authority, preventing a “too many cooks” situation.
Cons of manager-managed LLC
All owners don’t get to participate in management decisions.
Need to carefully document the manager’s authority in the operating agreement.
A professional manager might not understand the business as well as the owners.
A professional manager needs to earn a salary, which can be hard on smaller businesses.
Pros of member-managed LLC
All members have a say over management decisions.
Less complicated structure, particularly for small companies.
Excellent choice for retailers and other brick-and-mortar businesses.
Cons of member-managed LLC
Management of the LLC can be a full-time job, taking owners’ time away from strategic decisions.
This structure makes it difficult to raise money from investors.
How to choose
Ultimately, the choice between a member-managed vs. manager-managed LLC depends on the specifics of your business. If you have family investors or other investors, a manager-managed LLC is the obvious choice to centralize decision-making authority in a few key people. The same goes for a company with many owners.
Connor Jackson, a business attorney at Jackson LLP Healthcare Lawyers, says:
"A manager-managed LLC may be preferable when there are members who want a more passive role or don’t have the ability or desire to participate in management. In a larger LLC with many members, manager-managed may be the better option because it can streamline business decisions. There isn’t a need for each member to agree or coordinate on every business decision."
But for a small business with just two or three co-owners, it’s easiest to divide management powers among the owners with a member-managed LLC. This structure gives owners more say over the future of the business, something that most entrepreneurs crave.
Member management is also a wise choice if your business requires very specialized expertise, says Steven Sinatra, who co-owns World Pawn Shop with his father.
"We went for member-managed, because we are in a business that it’s hard to replace yourself. There is so much to know to be a pawnbroker. It takes two to three years for our employees to get the hang of their job. With member management, you can run your business exactly how you want it to run. You can fix problems instantly."
Here are operating agreement templates from Rocket Lawyer for a member-managed LLC and manager-managed LLC.
Remember that LLC members are owners in the business. They receive distributions out of the company’s profits, but they are not employees. Professional managers, on the other hand, are considered employees and do receive a salary for their work. As with any other employee, you must withhold income and payroll taxes from a professional manager. If someone is both a member and a manager, then they can receive a salary for the portion of time they spend on management duties.
Fortunately, LLCs are a flexible business entity structure. With some tweaks to your operating agreement and buy-in from other members, you can change your management structure in the future. Just be sure to consult your attorney before making any choices that could affect your business’s future.
A version of this article was first published on Fundera, a subsidiary of NerdWallet.