One very important decision you must make when you set up a new business is determining which type of entity you will form. There are many good reasons to set up an LLC, or limited liability company (here's a great blog post about whether to set up an LLC or an S-corp and here's another one about LLC ownership).
Once you have determined that an LLC is right for your business, you then must choose the type of management structure it will have.
There are two management structures for LLCs: member-managed and manager-managed. In many states, including New York, the default management structure under LLC laws is member-managed. If you live in a state where this is the default, your business will be considered member-managed unless you say otherwise in your articles of organization. You don't need to go with the default—however, you should assess your situation carefully and choose the structure that is best for your business, and then ensure that all management details are spelled out clearly in the company's operating agreement.
What are the differences between a member-managed and manager-managed LLC? Before we go deeper into the distinctions, let's first get clear about what an LLC manager is authorized to do.
Understanding LLC Management Authority
The manager of an LLC is an agent of the company and has the legal authority to bind the company to contracts and agreements and to participate in day-to-day management. Other actions an agent typically has the legal authority to perform include:
- Making legal and financial decisions
- Entering into contracts and agreements
- Opening, closing, and managing a bank account for the LLC
- Taking out a business loan and obtaining financing
- Buying and selling real estate, equipment, vehicles, financial instruments, and other assets
- Hiring and firing employees
- Disposing and divesting of LLC assets
LLC managers obviously have significant power. They also have a fiduciary duty (i.e., a legal duty) to place the interests of the LLC and its members above their own interests.
Member-Managed LLCs: The Default Management Structure in New York
Member-management is the most common form of LLC management. An LLC can have an unlimited number of members. In a single-member LLC, the member owns a 100 percent interest. In a multi-member LLC, every member owns a percentage. Every member of an LLC is an owner, and every owner is a member.
In a member-managed LLC, the members run the company and typically make business decisions based on a majority vote. Voting is the mechanism by which members can bind the LLC and its co-owners into actions such as signing a contract, obtaining a business loan, and engaging in other legal arrangements. While voting rights may be proportional to ownership level, the LLC operating agreement may specify different arrangements. In fact, the members could choose to maintain a member-managed structure yet streamline operations by altering equal voting and decision-making rights.
A member-managed structure often makes the most sense for a small business—especially one with limited resources and when the members want to be actively involved in company management. This structure is ideal when the owners enjoy collaborating as a team, engaging directly with their employees and customers, and working together to make and sell products. Again, be aware that member-management is the default rule under most states' LLC laws, and your LLC will likely be considered member-managed if you do not alter this arrangement in the articles of organization.
It's important to be aware that in some instances liability protection for the company may be weaker in a single-member-managed LLC because of the difficulty in maintaining the separation between owner and business. Single-member LLCs that are member-managed can be particularly vulnerable to attempts to pierce the veil. The member and the business are afforded an extra layer of protection, however, when the LLC member and the manager are different people.
Manager-Managed LLCs: Sometimes a Better Choice for More Complex Businesses
One of the challenges in a member-managed LLC is that as the organization grows in complexity and sophistication, having members share equal responsibility for running the company can become untenable. If the company has a large number of members or takes on “silent partner” owners who invest in the business, for example, shared management can become difficult. At some point during company expansion, it might make more sense to delegate management duties to a manager or group of managers.
A manager-managed LLC can be run by one or more LLC members, or by an external manager or managers, or by a combination of the two (some internal managers and some external managers). A manager does not have to be a person—a business entity such as a corporation, trust, or even another LLC can serve as an LLC manager (consult your attorney on this point, as some states have restrictions on the types of entities that can be LLC managers).
Your business will undoubtedly run more efficiently and professionally (and hopefully more profitably!) with designated, competent managers. But remember: once you institute a manager-management structure, members give up considerable authority.
Members will typically retain some voting rights and could, for example, vote to amend the operating agreement, elect and remove managers, admit new members, call for a merger or dissolution, and make other similar important business decisions. But they will limit their say in day-to-day business decisions and may not bind the LLC as an agent.
Changing Your Management Structure Could Require Amending Articles of Organization
In New York, the basic structure of a company is laid out in the articles of organization, and the structure of your LLC is typically set at the time the founding documents are filed with the state.
To change the management structure from member-managed to manager-managed after the articles of organization have been filed, members should review their operating agreement to determine how to vote to authorize the change. Operating agreements in New York are required for all LLCs. Your state may require a unanimous vote versus a majority vote for this change to take effect. Be sure to update the operating agreement to reflect any new management structure.
When you form your LLC, you'll need to create not just an operating agreement that designates the management structure. You'll may also want to create certificates of membership, a schedule of assets, and a statement of authority, among others, dependent on your state law. It's absolutely critical that your LLC documents are prepared correctly to ensure the asset protection that LLCs generally afford their owners.
Do not rely on generic online templates to set up your New York LLC—this is a very dangerous way to start your business and it puts you and the organization at risk. Consult a trusted and experienced business attorney like those at The Browne Firm to ensure your documents reflect the specific needs of your business and fully protect you and your business partners. Schedule a free, no obligation consultation with us today so you can be confident you're making smart decisions from the very beginning about your business.