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Member Managed vs. Manager Managed LLCs

Member Managed vs. Manager Managed LLCs. Which to choose?

When forming an LLC, the question of member managed vs. manager managed often comes up. Recently my son went on his state website to start his own LLC. He down loaded the member managed llcdocument and began answering the questions and then gave me a call. “Which should I check, member managed or manager managed, and why,” he asked?

I have to give my son credit for his good sense. He did not just arbitrarily check one and hope he did the right thing. I was able to explain to him that there are legal reasons why this question is asked and understanding the reason is an important first step.

Legally there are four elements,  any one of which can be used to define an LLC. Note that I didn’t say there four elements of an LLC. To be legal, an LLC can only have two of the four elements. The four elements are liability shielding, centralized management, transferability of interests, and continuity of life. If you have more than two of these elements then you don’t have an LLC.

The most important element that every LLC should have is limited liability. Pay attention to how the LLC describes the limited liability element. It should say something like, the members and managers will not be liable for the debts and obligations of the LLC. Once the LLC has limited liability it can choose just one other element.

The element that pertains to the choice of member managed vs. manger managed is centralized management. In a corporation, the shareholders vote in officers and directors. Those people are usually not “owners” of the company. This means that the management is centralized in the officers and directors. In an LLC, who manages? If you choose to have centralized management then you have the managers be the managers.

Many advisors simply tell their clients that they should check the member managed box because it is the most popular option. It is true that member managed is the most popular option. The reason is that if your operating agreement says that the members will be the managers (officers and directors) then you do not have centralized management. This means that you can then elect to have transferability or continuity of life as your second LLC option.

There are times when you have no choice but to have a manager managed LLC. If you have a silent LLC partner who is putting in money, but wants no part of the LLC management, is one example. Then in the member managed vs. manager managed, you must pick manager managed and you will have centralized management as your second choice.

I have seen many operating agreements where their advisors obviously don’t understand the four elements of an LLC. They make LLC documents that have more than two of the elements. Let’s face it, if you don’t know the law, it would be nice to have all four of the elements available to the company. If you want all four elements, you need to form a corporation, because by definition of law if you have more than two of the elements, you are not an LLC.

If you don’t have a true LLC, when you get to court, the courts will treat your business venture as a partnership and you will lose the liability shielding. This means that you will be personally liable!! LLC Wizard has a complete discussion of all four of the elements used to define an LLC, so you can pick the ones you need to best define your company. Don’t take a chance with your liability protection. Get the knowledge you need to make a good company.

 

3 Comments
  1. I understand – but I don’t understand – at least not why there can be only two elements. Specifically, the, “[B]y definition of law….” statement. My state statutes don’t appear to say anything about this.

    Of course, not being an attorney doesn’t help my understanding.

    In any case, I have a recently formed Minnesota SMLLC that does not have an operating agreement – I’m doing research to rectify that. I see the manager-managed LLC as desirable because it allows me to designate a succeeding manager in case of death, disability, etc. If I make that choice, how does it restrict transferability of interests and continuity of life in the operating agreement? Does the choice of manager-managed restrict my ability to sell, add members, etc? Does it prevent me from requiring the LLC be dissolved on my death? Or do I have to leave those subjects to the discretion of the current manager (me, until I’m dead, disabled, incapacitated)?

    /s/jr

  2. Jerry,
    The matter of having only two elements comes from case law, or past cases that judges use to interpret the law. As for free transferability and continuity of life, you just have to have some type of restriction on those elements. You can still have the ability to transfer interest but just not freely. You can also keep a company going as long as there is a restriction that makes it so that it is not automatic.

  3. followup question from Jerry:
    Thanks for your reply. Since I asked the question, I’ve looked at your operating agreement template – that, at least, gave examples of how to handle transferability and continuity of life. But now I have another question: My state makes continuity perpetual by default. If I do nothing to change that, but select, say, a manager-managed LLC along with liability protection does my state’s default continuity provisions cause me to cross the line since I can override that provision?

    And my answer: Perpetual existence is not the same as continuity of life. You can have perpetual existence without continuity of life. Perpetual existence just means that the LLC will keep going till something happens to end the LLC (like a members death). Continuity of life means that the LLC will continue even after the death of one of the members.

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