Centralized management is one of the four possible elements required to form a corporation. In an LLC, however, only two of the four elements can be used. Basically, you can think of an LLC as a flawed corporation, because it should have only two of the four elements. If you are forming an LLC, you need to choose which two of the four elements you will use.
The other three elements are liability shielding, transferability of interests, and continuity of life. If you have more than two of these elements then technically you don’t have an LLC. So it is important to understand what each element offers, so you can choose the right elements for your situation.
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As I explain in the accompanying video, centralized management deals with whether the manager of your LLC is also required to be an owner/member or not.
In a corporation, the shareholders vote in officers and directors. Those people do not have to be “owners” or shareholders of the corporation. This means that the management is centralized in the officers and directors, not in the owners (stockholders). Put another way, the officers and directors manage the company, so management is “centralized” in someone other than the owners. The officers and directors do not have to be stockholders (even if they often are given stock as part of their benefits package).
In an LLC, who manages? It depends on what you choose when setting up your LLC. If your articles of organization or operating agreement say that the members will be the managers (officers and directors), then you do not have centralized management. This means that you are free to choose any of the other three elements (transferability, continuity of life, or limited liability). Obviously, everyone will choose limited liability or the “corporate shield” as one of their options.
While large companies are served well by having layers of management separate from ownership, little companies often do better to require management to be centered in the hands of those who also own the company as members. This makes it more difficult for creditors to gain control of the company.
Your choice of centralized versus member management should be spelled out clearly in your articles of organization (only if it is required by the state) and/or in the operating agreement, with language similar to the following:
The Company shall be managed by the Managers, who shall be elected to direct, manage and control the business of the Company. Except for situations in which the approval of the Members is expressly required by this Operating Agreement or by non-waivable provisions of the Act, the Managers shall have full and complete authority, power, and discretion to manage and control the business, affairs, and properties of the Company, to make all decisions regarding those matters and to perform any and all other acts or activities customary or incident to the management of the Company’s business.
The Company shall be managed by the Member-Managers, who shall be elected to direct, manage and control the business of the Company. Except for situations in which the approval of the Members is expressly required by this Operating Agreement or by non-waivable provisions of the Act, the Member-Managers shall have full and complete authority, power, and discretion to manage and control the business, affairs, and properties of the Company, to make all decisions regarding those matters and to perform any and all other acts or activities customary or incident to the management of the Company’s business. The Member-Managers shall herein be referred to interchangeably as Member-Managers or simply as Managers.
The first provision centralizes management in the managers, except for specific issues that require member approval. It may be used for an LLC that will have lots of member-owners and the company will be large enough that outside management will be sought out. The managers don’t need to be owners.
The second provision gives the owners full control over the management of the company. It will be used when the LLC is closely held, such as in a family business. If the operating agreement puts restrictions on the transferability of membership interests, it may be harder for an outsider to gain control of the company, because they have to be a member to be a manager of the company. Hopefully, the charging order protection acting in conjunction with the restrictions on management and transferability of membership interests will give the company and owners maximum asset protection.
There are times when you have no choice but to have a manager-managed LLC. For example, if you have a silent LLC partner who is putting in money but wants no part of the LLC management, and you are not able to manage the company yourself, you may need to choose centralized management. In that case, you must pick manager-managed and you will have centralized management as your second choice. But, normally in a family-owned business or a business with only a limited number of owners who all trust each other, the LLC should be established as a member-managed LLC. Because a member-managed company does not have centralized management, you have not chosen to implement one of the four elements. Thus, you can still choose transferability or continuity of life in addition to the essential limited liability option.
Guest post by: Lee Phillips. Lee is a business lawyer and owner of LLC Wizard Business Magic and LegaLees. Lee is a Counselor to the United States Supreme Court and has a law practice to help people structure their personal and business affairs, so they can prevent personal and business disasters. His two companies exist to educate people through a combination of seminars, boot camps, and publication of books and articles. Lee’s expertise area lies in Trust and Estate Planning, Limited Liability Companies, Living Revocable Trust, and Wills. The post originally appeared on his blog in January of 2015 and is reproduced here with the author’s permission.
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