A Limited Liability Company (LLC) can be managed in one of two ways, either by the members who own it, or by managers appointed by the members to run it. In California, you create an LLC by filing Articles of Organization with the Secretary of State, and this is where you declare if you're a member-managed or a manager-managed LLC.
Typically you would choose a manager-managed structure for your LLC if it's too large for all parties to be involved in the daily decision-making, or if some of your members are investors with no part in running the company.
In a separate document, the Operating Agreement, you establish the interests and voting rights of members, along with the duties of any managers.
By default, members of an LLC receive ownership percentages according to their initial capital contributions. So if five people start a company and each puts in $20,000, each will receive 20 percent of the company, with a corresponding 20 percent voting percentage (although these percentages can be changed in the operating agreement).
What if an investor comes along with $100,000 to contribute, in return for half of the profits but no part of running the company? Now our five friends need to give the investor a non-voting "economic" interest in the company, and bind this arrangement in a contractual form that doesn't allow any ambiguity down the road. The cleanest way to do this with an LLC is simply to go to a manager-managed structure.
If the five members are already running the company as a member-managed LLC, they can switch to a manager-managed LLC simply by voting for it and creating a new or revised operating agreement. All members including the investor would sign the operating agreement.
In moving to a manager-managed LLC, the members have also added a layer of protection. Typically, in a member-managed LLC each member has the ability to bind the company, while in a manager-managed LLC, no members apart from the designated managers can bind the company. The manager-managed structure allows investors and possibly unqualified persons into the company without endangering it.
In a manager-managed LLC, the members can designate themselves as managers, as well as appointing outsiders if they wish to help run the daily operations of the company. Managers can be other LLCs and corporations, as well as individuals. Typically, certain decisions, such as merger or dissolving the company, by law cannot be delegated to managers and must be voted on by the owning members who hold voting rights. The voting owners of the LLC retain ultimate control of it always.
As well as member rights and requirements, the operating agreement can specify managers if known, and should spell out how and when members can replace managers or renew their terms, how managers vote, and so forth.
In the operating agreement the members can even establish a portion of the LLC as future membership interests ("units") that authorized managers can issue to new members and investors without current membership approval. This provides a very efficient growth mechanism for the company.
The flexibility of the LLC management and ownership structure adapts equally to the very small and the very large enterprise, and shows at its best in the manager-managed LLC. It’s important to remember however that the Operating Agreement is a serious and binding contract between the parties.
Managers may have different fiduciary obligations from members, for example, and this might matter if some members become managers and some do not. Rights and responsibilities should be hammered out and put in writing early in the game, and members of a manager-managed LLC may do well to consult an attorney for specific advice. Note that nothing in this article can be construed as legal advice.
Download our Free California LLC Operating Agreement to study an attorney-drafted, sample Operating Agreement for a Manager-Managed LLC. Also see our SunDoc Guides to the Member-Managed LLC and the Single-Member LLC. Read more about 10 Steps to form a California LLC, and click here to form a California LLC online.