Something to know before forming an LLC is how to manage an LLC. The answer lies in the LLC members, whether they are just members or managing members. There can be subtle nuances with these depending on the individual LLC.
Who are the LLC Members?
Limited liability companies are owned by members. The Operating Agreement will identify who the members are.
Members will have interests that are associated with various rights, including the right to share in the profits and losses of the company, to receive distributions from the company, and to participate in the management of the company. The company’s Operating Agreement defines nature of these rights.
An LLC can have more than one class of members. Different classes may have different rights. For example, one class of members may have preferred rights to distributions from the company that are superior to those of another class. Additionally, one class may have decision-making rights with another class having no decision-making rights or limited rights.
An LLC must have at least one member.
The operating agreement for a single-member LLC will be simple, as one member has all of the benefits and burdens of ownership and controls all decisions.
Examples of ownership structures include:
- Two or more family members owning a family business.
- Two or more unrelated parties joining to engage in a business venture.
- A single-purpose managing member together with one or more other members,
with the managing member satisfying the requirements of a CMBS lender, possibly including independent directors or managers.
- A member which is a real estate developer and a member which is a financial institution providing most of the equity for a project.
Membership interests may be owned indirectly. For example, in an LLC owned by two families, there may be one member for each family that is a separate LLC, and individual family members may own interests in the separate LLC.
Members may be organized in groups for decision-making purposes. Decision-making rights belong to the group, represented by a designated representative, rather than the members directly.
Who are the LLC Managers
The LLC’s Operating Agreement sets forth the Management of an LLC. Most LLCs fall into one of two categories: (1) Member-Managed or (2) Manager-Managed.
It is possible also to have management structures that borrow from corporate organizations. For example an LLC Operating Agreement can provide for management by a “Board of Directors” or “Board of Managers” who then appoint officers. The board is usually a committee of individuals elected by the members periodically to hold meetings and oversee the direction of the LLC.
It is important that the managers sign signature-blocks in contracts in their management capacity and not as simply “members”. This is similar to the corporate context where contracts should not be signed by someone as a “stockholder” because the stockholder has no agency authority. It is better to use the “manager” title or “managing member” title where appropriate.
An Operating Agreement that provides for management by managing members or managers can reserve certain significant decisions to the members, or provide for approval of certain items by members. The items are often called “Major Decisions”.
Examples of Major Decisions often found in Operating Agreements include decisions concerning sale of the property, financing, operating and capital budgets (and how much a managing member or manager can deviate from an approved budget without approval), major leases, major capital expenditures, new business ventures, and decisions regarding bankruptcy or insolvency.
Other examples of Major Decisions include admission of new members, or dilution of the interests of existing members.
The Operating Agreement will set forth the requirements for approval of Major Decisions. A particular Major Decision may require approval by a majority of the members, a “super-majority” approval such as two thirds, 75% or a higher percentage, or approval by all members.
It is common for decisions regarding bankruptcy or insolvency of the company to require a higher percentage of member approval than other Major Decisions, often 90% or 100% of the Members.
In situations involving joint management, there exists the possibility of deadlock if the managing members or managers do not agree. The Operating Agreement should anticipate this possibility and specify means of addressing it. In some cases, the decision could be left to one party and some disputes might be solvable with mediation or arbitration.
It is possible that some deadlocks are not susceptible to resolution. In those cases, it may be necessary to end the relationship.
What Is a Member-Managed LLC?
In a Member-Managed LLC, the members/owners also run the day-to-day activities of the LLC. They do not appoint a third party, non-member to make the decisions for the LLC.
In a single member LLC, the LLC commonly is managed by its single member. This person or entity is usually referred to as a “managing member.” It is also possible under an Operating Agreement to simply refer to this person as the “Manager” or under traditional corporate officer titles, should that be how the LLC Operating Agreement is written.
In a multi-member LLC, it is common to have only one person or entity named as the manager to simplify the operations of the entity. This is true especially if there are moneyed investors who are not involved in the day-to-day activities of the LLC.
What Is a Manager-Managed LLC
Manager-Managed LLCs need to be specific in their Operating Agreements about what is in the exclusive authority of the Manager through agency and what rights are retained or shared by the members. Usually in a Manager-Managed LLC Operating Agreement, the main management rights retained by the members are (i) the power to replace the manager and (ii) the ability to make “Major Decisions” (as discussed below). Third-party managers are common when the LLC’s members are not interested in operating the day-to-day affairs of the LLC. Usually these are paid executives who have experience operating businesses similar to the LLC.