A limited liability company (LLC) is a business structure designed to protect the owners (also called members) and managers (if any) from some legal liability. LLCs can be owned by a single person or several people.
An LLC can be managed directly by the members. Or the owners can appoint a manager or small group of managers to manage the business for them (somewhat like a board of directors oversees a corporation). This arrangement is called "manager-management," and it can be a sensible choice if some LLC members (such as outside investors or family members) won't take part in decision-making. But LLC managers don't need to be members.
It's unusual for a very small business, but you can hire an outsider to act as a third-party manager for your LLC. Let's look at some features of manager-managed LLCs and how they work.
In a manager-managed LLC, only managers are authorized to make management decisions, enter into deals, and bind the LLC to contracts. If you're a non-managing member of an LLC, you don't have any say in how the business is run, but you're still entitled to a share of LLC profits. Depending on what your operating agreement says, either the managers or the owners can decide when profit distributions will be made to you and the other members.
You might want to give an outsider (for example, someone loaning money to the business) a say in management but not a membership in the LLC. In that case, you can choose manager-management and appoint that person as a manager along with all or some of the members.
For instance, you might borrow money from someone to establish a single-member LLC (with you as the sole owner). You don't want to share ownership, but you might need to include your lender in the company's management. Under a manager-managed setup, you can appoint your lender to be another manager (along with yourself). That way, the lender has some control of their investment, but you don't give up ownership of your company.
A manager-managed LLC needs to have an operating agreement that's customized for manager-managed LLCs. The operating agreement is similar to corporate bylaws. It should include:
The operating agreement should provide that management decisions will be made by the managers, and it should specify the vote required to make management decisions (such as a majority of managers or a unanimous vote of all managers).
The operating agreement should also include provisions for removing managers and appointing new managers, as well as rules for meeting informally and formally. It should also specify quorum requirements. (A quorum is the minimum number of managers who must be present for a vote to happen.)
Finally, a manager-managed operating agreement should state that managers aren't liable for the debts or liabilities of the business—assuming you want to extend the LLC's limited liability to the managers—and an "indemnification provision." An indemnification provision is an agreement by the LLC to pay for debts that a manager incurs on behalf of the LLC, perhaps including attorney's fees.
LLCs are "pass-through" business entities. The company doesn't pay taxes directly. Instead, the profits (or losses) are passed through the business, and the owners pay the tax on their individual tax returns at their individual tax rates.
If you run your own business, you're probably also paying self-employment tax. But non-managing members in a manager-managed LLC might not have to pay those self-employment taxes if they aren't active in the business. If you're in this position, consult a tax adviser to determine which taxes apply to your situation and which don't.
If you'll be the sole owner of your LLC and you don't plan to take investments from outsiders, your ownership interest in the LLC won't be considered a "security," and you don't have to concern yourself with securities laws.
On the other hand, if you choose to form a manager-managed LLC with multiple members, you might need to comply with federal and state securities procedures when setting up your LLC. Membership interests in a manager-managed LLC are sometimes classified as securities because non-managing members (owners who don't manage the company) are likely investing their money in a business in which they're not actively participating.
If your LLC's membership interests are considered securities, you must either register them with the federal Securities and Exchange Commission (SEC) and your state securities commission or qualify for an exemption from federal and state securities laws before the initial owners of your LLC invest their money. Registering LLC interests as securities is not easy. It involves filing complex forms with the SEC or your state commission and submitting financial statements and other material.
Fortunately, smaller LLCs usually qualify for securities law exemptions. For example, SEC rules say you don't need to register a private sale of securities if all the owners live in one state and all sales are made within that state. It's called the "intrastate offering" exemption.
Another federal exemption covers "private offerings." A private offering is an unadvertised sale that's limited to a small number of people (35 or fewer) or to those who, because of their net worth or income earning capacity, can reasonably be expected to be able to take care of themselves in the investment process. Most states have enacted their own versions of these popular federal exemptions.
If you don't qualify for an exemption to the securities laws, you must register the sale with the SEC and your state before your members take ownership of their interests in the company.
Single-member LLCs (including spousal single-member LLCs in states that have community property laws) can benefit from setting up manager-management and appointing the member as the manager.
In practical terms, there's not much difference between member-management and manager-management for a single-member LLC (SMLLC). But setting up a formal manager role for your LLC can make it easier to arrange for a successor manager to take over if you (the owner) become incapacitated or die. Keep in mind, you'll need to name the successor manager in your SMLLC operating agreement.
For help deciding whether to choose member-management or manager-management for your LLC, see Member-Managed LLCs Versus Manager-Managed LLCs.