Understanding: Member-Managed vs. Manager-Managed LLCs
Limited Liability Companies (LLCs) offer a flexible and appealing structure for entrepreneurs and small business owners. Among the important decisions when establishing an LLC is defining its management structure. This decision revolves around whether the LLC will be member-managed or manager-managed. As you will see a manager-managed LLC is the preferred management structure for almost all businesses.
To grasp the disparities between member-managed and manager-managed LLCs, let’s delve into the distinctions, found in C.R.S. §7-80-405.
Member-Managed LLC:
When an LLC’s articles of organization stipulate management is vested in its members; each member becomes an agent of the company for business purposes. Meaning every member has the authority to act on behalf of the LLC in ordinary business matters. Essentially, actions of any member, including executing contracts or agreements, are binding on the LLC.
Let’s illustrate this with an example:
Suppose Smith, Jones, and Patel form an LLC named “XYZ Ventures” to operate a digital marketing agency. According to the articles of organization, management is vested in the members. In this scenario, any member, say Smith, has the authority to sign contracts with clients or vendors on behalf of XYZ Ventures. If Smith enters into an agreement with a client to provide marketing services, that contract can be legally binding on the LLC. Even if the other two members didn’t agree to it.
Manager-Managed LLC:
Conversely, when an LLC’s articles of organization designate management to one or more managers, the members do not possess inherent agency authority. In this setup, only the appointed manager(s) have the authority to act on behalf of the LLC in its business dealings.
To further clarify, let’s consider another example:
Imagine Smith, Jones, and Patel establish a new LLC, “ABC Holdings,” to invest in real estate properties. However, this time, they opt for a manager-managed structure and appoint Smith as the manager. In this scenario, only Smith has the authority to negotiate property acquisitions or enter into lease agreements on behalf of ABC Holdings. If Smith purchases a property for investment purposes, his actions legally bind the LLC. Conversely, if Jones entered into the same agreement, her actions would not bind the company, since she does not have the authority to contract on behalf of the company.
Why This Is Important:
The distinction between member-managed and manager-managed LLCs lies in the allocation of agency authority. In member-managed LLCs, all members are agents with authority to act on behalf of the company.
Having multiple people contracting on behalf of the company could lead to chaos, confusion, and lawsuits. An extreme but plausible example is the scenario in which a 1% ownership member of the company, sells the business, lock, stock, and barrel out from under the other 99% owners. And then takes the money and runs!
One the other hand, the situation above is easily avoided with a manager-managed LLCs. Giving a small number of managers agency authority will give the company the an administrative layer which would otherwise be non-existent. All companies regardless of size require this layer to thrive and grow.
Understanding these differences is important for business owners to make informed decisions regarding their LLC’s management structure as well as to navigate their roles and responsibilities.