Member Managed LLC’s are a Bad Idea

Is a Member Managed LLC a Good Idea or a Bad Idea?

With rare exceptions, Member Managed LLC’s are a bad idea.  In spite of this, the most common form of LLC structure is Member Managed.  Sadly, almost all CPA’s and even some attorneys have no idea that a Member Managed LLC fails to accomplish the primary goal most people have in setting up an LLC.  Here are some of the reasons why Member Managed LLC’s should be avoided.

Managers & Members

The Owners of an LLC are called “Members.” The Officers that have operational authority to transact the business of an LLC are called “Managers.”

Every LLC is required to have at least one Manager. A Manager is the functional equivalent of a General Partner for a Limited Partnership or a corporate Officer such as a President for a Corporation.

Who the Members and Managers are have nothing to do with the tax status of an LLC.

Manager Managed vs. Member Managed

The Members may be the Managers, or not. In other words, Management of the LLC may be “reserved to the Members” or “vested in a Manager.” When Management is “vested in a Manager” the Manager may be a third party or any combination of the Members.

Member Managed LLC’s are a Bad Idea

Member Managed LLC’s are not a good idea for multiple reasons.

• When the Members are the Managers, all the Members must sign documents. Especially when there are multiple Members, this can be burdensome and frustrate the ability of the LLC to conduct its business. This can be a particular problem in family or closely related structures where, for example, a group of relatives are all Member Managers of an LLC that owns a property. To sell the property, they all must sign. If any one Member is either unable to unwilling to sign, the sale will not happen. If you are the contrarian family member who always likes to say “no” when everyone else is saying “yes” then you might prefer a Member Management structure.  But if you want to prevent your family members from fighting about such issues, don’t make them all Managers. This is one of the reasons why we sometimes see valuable properties lie dormant and undeveloped or unsold while the owners grow old without enjoying the benefits of the property.
• It can impair the asset protection of the LLC. One of the primary non-tax purposes for an LLC is to manage risk. A major part of that protection comes from the relationship between the Members and the Managers. For example, if the LLC has appropriate documentation (such as a well written operating agreement), the Managers can refuse to transfer a Member’s ownership interest to a hostile third party such as a judgement creditor. Think about it. If the Members and the Managers are one and the same, that protection is compromised. If the Member can be compelled to act, so can the Manager.
• People think, and are often told, that LLC’s protect their assets.  And yet, Member Managed LLC’s get penetrated every day in the civil courts and in bankruptcy.  It appears that the DIY LLC set up with low cost on-line services are the most vulnerable.  Why is this?  We have had the experience of a state agency, that isn’t supposed to give legal advice, tell people how to set up an LLC that then fails to accomplish the intended goal.  Go figure.  How could this happen?

Manager Managed LLC’s are a Better Approach

When Management is “vested” in a Manager, it avoids the problems of Member Managed LLCs.

• One or more Members can still be named as a Manager. However, they become Managers not be “reserving” that power as a Member, but by having that power “vested” in them.
• A Manager in trouble can be removed when management is vested. When Members “reserve” the power of Manager, every Member is automatically a Manager no matter what. When Management is “vested” it can be unvested.

When possible, we find it better to have a non-natural person serve as the Manager.  That means another entity such as a Trust, or Corporation, or even another LLC will be the Manager, not a natural individual.  For reasons beyond the scope of this article, we also find it “better” in terms of the LLC acting as a shield against liability to have more than one Manager, none of which are also Members.

Even with a Manager Managed LLC, a naked LLC is still not going to get the job done.  To do what most people want an LLC to do, it requires full documentation.  This is particularly important when an LLC is going to have a significant role such as the Family Office or the Family Bank.

Get Qualified Help

There is no “one size fits all” structure that works for LLC’s.  Every situation is different.  Getting the right fit with the structure will determine whether or not an LLC accomplishes what you want. We strongly recommend that anyone considering an LLC consult with qualified legal counsel of their choosing.