Forming an LLC: Member-Managed or Manager-Managed?
After considering advantages and disadvantages of different forms of an entity, you have now decided that forming an LLC (limited liability company) would be the best option for your company. However, you have to go through one more step to be completely done with the entity selection process: Should you form a member-managed or manager-managed LLC?
Basically, you may choose one of two different management structures for an LLC: Member-managed vs. Manager-managed. Member means an owner of an LLC in this context. In Michigan, the default management structure of an LLC is member-managed, as is the case in most other states. However, you may choose to form a manager-managed LLC instead by designating it in the Operating Agreement.
Member-managed vs. Manager-managed LLCs
If you choose to form a member-managed LLC, all members have an equal right to participate in managing and operating the company unless the operating agreement states otherwise. A member-managed LLC essentially leaves no room for outsiders to jump in and interfere. Consequently, a member-managed LLC allows every member to vote in the decision-making process and enter into binding agreements and contracts on behalf of the company as its agent. However, members may choose to form an LLC with different classes of members where one class would have a different level of rights than the other classes. Also, the operating agreement can limit the scope of authority that each member has in a member-managed LLC. For instance, the operating agreement may require a majority or unanimous vote of members to make certain business decisions such as contracts and loan agreements.
Member-managed LLCs also do not have boards of directors unlike manager-managed LLCs. Also, member-managed LLCs tend to be more cost-effective than manager-managed LLCs due to their decentralized management structure.
Therefore, a member-managed LLC could be a better option for you if every member of your company wants to play an active role in running the business. However, a member-managed LLC also has some downsides due to its management structure: 1) it might be inefficient if the company is too large or complicated for all members to take a part in managing and operating the business; 2) it can also turn out to be inefficient if some members are not well-versed in business management; and 3) the expulsion of a member could be difficult since it would require an unanimous approval of all the other members unless specified otherwise in the operating agreement.
On the other hand, manager-managed LLCs have one or more managers to manage the company and arrange business affairs on the company’s behalf without getting the members’ consent or approval first. Only designated managers have the authority to make determinations on behalf of the LLC in manager-managed LLCs. Thus, manager-managed LLCs have a more centralized management structure and enable the company to be managed more like a corporation. For this reason, manager-managed LLCs would be preferable if your company is large and complex, since getting all the members together to vote and make decisions as a whole could be inefficient for large companies. Hence, a manager-managed LLCs would streamline the decision-making process and enable members to focus more on works of their choice in such cases.
Members may select one or more of the members as managers of the LLC, or they may hire professional managers who are not members of the LLC but have adequate expertise and qualifications. Having professional managers with experiences in business management can also be beneficial for your business in terms of protecting the company’s interest, attracting investors, and protecting the investors’ money. The members may specify details such as the number of managers, required qualifications, and resignation procedure in the operating agreement.
Since manager-managed LLCs allow managers to make decisions on behalf of the LLC without acquiring members’ consent first, this management structure would be more suitable if members of your company wish to take a more passive role. For instance, if some members of your company are investors and do not want to get involved in day-to-day management of the company, manager-managed LLC could be a better option for your company. If members of your company wish to select some of the members as managers, it would be advisable to designate more active members as the company’s managers. Members who are designated as managers may also receive a separate compensation as an employee.
Members of a manager-managed LLC as well as managers of a manager-managed LLC, including both professional managers and members who have been designated as managers, owe fiduciary duties to the LLC. In Michigan, a person who manages an LLC does not owe fiduciary duties to the members of the company. Fiduciary duties mean duties of trust that mandate people who owe such duties to place the company’s interests above their own or other parties’ interests. However, the members may agree to waive some fiduciary duties by specifying that in the operating agreement.
The two most important types of fiduciary duties owed to an LLC are 1) the duty of loyalty and 2) the duty of care. A person who owes the duty of loyalty to an LLC is expected to place the company’s interests above his or her personal interests and goals. He/she also needs to conduct any transactions and deals on behalf of the company in good faith. Also, he/she must not compete directly with the company or take advantage of the company’s internal information, commercial activities or business opportunities in an inappropriate manner to earn secret profits.
On the other hand, the duty of care requires one to act prudently in good faith and exercise reasonable care when performing their work on behalf of the company. If a member of a member-managed LLC or a manager of a manager-managed LLC makes a business decision with negative consequences for the company, that person would be protected from liability as long as he/she made the decision in good faith and exercise reasonable care during the process.