Manager Managed LLC Operating Agreement: What Founders Should Put In Writing Early

Many US founders choose a limited liability company (LLC) for its flexibility and liability protection. But even after forming an LLC, one of the most common mistakes is not putting the management structure and key rules in writing early. If you are considering a manager-managed LLC, your operating agreement is the document that spells out who is in charge, how decisions are made, and how ownership works. Relying on handshake deals, oral understandings, or generic templates can lead to confusion, disputes, and even legal or tax problems down the line.

This guide will help you understand what a manager-managed LLC is, why the operating agreement matters, and what founders should include to avoid costly mistakes. We will cover federal and state considerations, practical examples, and checklists so you can set up your LLC with confidence.

What Is a Manager-Managed LLC?

At the federal level, the IRS treats LLCs as pass-through entities for tax purposes by default, but it does not regulate how your LLC is managed. The choice between a member-managed and manager-managed LLC is determined by state law and your LLC's formation documents. Understanding the difference is crucial for founders and investors.

In a manager-managed LLC, the members (owners) appoint one or more managers to run the day-to-day business. The managers can be members themselves or outside professionals. This structure is often chosen when:

• Some members want to be passive investors with no role in daily operations
• The business wants to hire an external manager or CEO
• There are many members and centralized control is needed
• Founders want to separate ownership from management, similar to a corporation

By contrast, in a member-managed LLC, all members have authority to act for the business unless otherwise limited. In a manager-managed LLC, only the designated managers have this authority, unless a specific action requires member approval.

State law sets the default rules for LLC management. For example, in Delaware, the default is member-managed unless the Certificate of Formation or operating agreement states otherwise. In California, you must specify the management structure in your Articles of Organization and file a Statement of Information listing the managers. Texas and New York have similar requirements. Failing to follow your state's rules can result in your LLC being treated as member-managed by default, even if your internal understanding is different.

Practical example: Three founders start a tech company. Two want to focus on product development and not deal with daily business decisions. They agree to appoint the third founder as the sole manager. If they do not document this in their operating agreement and state filings, banks, investors, and even the IRS may not recognize the manager's authority, leading to confusion and delays.

Why an Operating Agreement Matters for Manager-Managed LLCs

An operating agreement is the contract that governs the internal affairs of your LLC. While not always required by state law, it is strongly recommended for every LLC, especially those with a manager-managed structure. Here is why it matters:

• Defines roles and authority: It spells out exactly what managers can do on their own and what requires a vote of the members. This prevents power struggles and confusion.
• Clarifies ownership and profit sharing: It lists each member's ownership percentage, capital contributions, and how profits and losses are allocated.
• Reduces disputes: Without a written agreement, disagreements about management, voting, or buyouts can quickly escalate and end up in court.
• Supports business operations: Banks, investors, and the IRS often require an operating agreement to open accounts, issue an EIN, or review for due diligence.
• Protects limited liability: A written agreement helps show that your LLC is a real, separate entity, which is important for maintaining limited liability protection for members.
• Customizes state default rules: State law provides default rules, but your operating agreement can override many of them to fit your business needs.

Common mistakes include using a template that does not match your state's rules, failing to update the agreement as your business changes, or relying on oral agreements. These mistakes can lead to legal gray areas, disputes, and even personal liability for founders.

For example, if your operating agreement does not clearly state that the LLC is manager-managed, and you have not filed the correct documents with your state, a disgruntled member could challenge a manager's authority to sign contracts or make decisions. This can delay deals, scare off investors, or even result in lawsuits.

Key Terms to Include in a Manager-Managed LLC Operating Agreement

Every manager-managed LLC operating agreement should be tailored to your business, but there are several core terms founders should address. Here is a checklist of what to include, with practical examples and state-law caveats:

• Identification of managers: Name the initial managers and state how new managers are appointed or removed. For example, "The initial managers shall be Jane Smith and John Doe. Additional managers may be appointed by a majority vote of the members." In some states, like California, you must also file a Statement of Information listing the managers.
• Manager powers and duties: Spell out what managers can do without member approval (e.g., sign contracts, hire staff, open bank accounts) and what requires a vote of the members (e.g., selling the business, amending the agreement, taking on significant debt). For instance, "Managers may enter into contracts up to $100,000 without member approval."
• Decision-making process: Describe how managers make decisions (majority vote, unanimous consent, etc.) and how deadlocks are resolved. Some agreements require unanimous consent for major actions; others allow a simple majority.
• Member voting rights: Clarify what matters members can vote on, and whether voting is based on ownership percentage or another method. For example, "Members holding more than 50% of the ownership interests must approve any sale of company assets."
• Ownership structure: List each member's ownership percentage, capital contributions, and how profits and losses are allocated. For example, "Member A: 40%, Member B: 40%, Member C: 20%." In some states, failing to document ownership can lead to disputes if a member leaves or sells their interest.
• Admission and withdrawal of members: Explain the process for bringing in new members or allowing existing members to exit, including buyout terms and valuation methods. For instance, "A departing member's interest shall be valued at fair market value as determined by an independent appraiser."
• Transfer restrictions: Set rules for selling or transferring membership interests, including rights of first refusal or approval requirements. Many states allow you to restrict transfers to protect the company from unwanted outsiders.
• Meetings and records: Specify requirements for meetings, notice, and recordkeeping. For example, "Managers shall meet quarterly, and minutes shall be kept of all meetings." Some states, like New York, have specific recordkeeping requirements for LLCs.
• Indemnification and liability: State whether managers are protected from personal liability for actions taken in good faith on behalf of the LLC. For example, "Managers shall be indemnified by the LLC to the fullest extent permitted by law."
• Tax treatment: Indicate whether the LLC will be taxed as a partnership, corporation, or disregarded entity, and who is responsible for tax filings. The IRS requires you to choose a tax classification when applying for an EIN.
• Dissolution: Outline what triggers dissolution of the LLC and how assets are distributed upon winding up. For example, "The LLC shall dissolve upon a unanimous vote of the members or by operation of law."

Checklist for founders:

• Have you clearly named your managers and their authority?
• Does your agreement specify which decisions require member approval?
• Are ownership percentages and capital contributions clearly listed?
• Do you have a process for admitting or removing members and managers?
• Are transfer restrictions and buyout procedures spelled out?
• Have you addressed indemnification and liability protection for managers?
• Is your agreement consistent with your state's filing requirements?

Practical example: A Florida startup brings in an outside CEO as a manager. Their agreement states that the CEO can hire staff and sign contracts up to $50,000, but any sale of company assets requires a 75% member vote. This clarity helps avoid disputes and reassures investors.

Common Mistakes Founders Make With Manager-Managed LLCs

Even experienced founders can make critical errors when setting up a manager-managed LLC. Here are some of the most common mistakes and how to avoid them, with state-specific notes:

• Not filing the correct management structure with the state: Some states, like Delaware and California, require you to specify whether your LLC is manager-managed in your formation documents. Failing to do so can result in your LLC being treated as member-managed by default, which can undermine your intended structure.
• Using a generic or outdated operating agreement: Templates may not address your state's rules or your specific management structure, leading to gaps in authority or voting rights. For example, a template drafted for Texas may not comply with New York's publication or recordkeeping requirements.
• Leaving out key terms: Omitting details about manager authority, member voting, or buyout procedures can result in costly disputes later. For example, if your agreement does not specify how a manager can be removed, a problematic manager may be difficult to replace.
• Failing to update the agreement: As your business grows, you may add new members or managers. Update your operating agreement promptly to reflect these changes. In some states, like California, you must also file an updated Statement of Information within a set timeframe.
• Overlooking tax and regulatory filings: The IRS and many banks will ask for your operating agreement when you apply for an EIN or open accounts. Incomplete or inconsistent documents can delay these processes.
• Assuming all states treat LLCs the same: State law can affect everything from manager authority to required filings and annual reports. For example, New York requires LLCs to publish a notice of formation in two newspapers, and Texas requires an annual franchise tax report.
• Not documenting capital contributions: If members contribute different amounts of cash, property, or services, failing to document these contributions can lead to disputes over ownership and profit sharing.
• Ignoring buy-sell provisions: Without clear buyout terms, a departing member's interest may be hard to value or transfer, leading to deadlock or litigation.

Practical example: In Delaware, if you do not state that your LLC is manager-managed in your Certificate of Formation, the state will treat it as member-managed. This can create confusion if your operating agreement says otherwise. Always check your state's requirements and make sure your filings and agreement match.

Checklist: What to Do When Setting Up a Manager-Managed LLC

To help you get started, here is a practical checklist for founders and operators, with state-law caveats and practical tips:

1. Choose your management structure: Decide if manager-managed is right for your business. Consider whether all members want to be involved in daily operations or prefer to appoint managers.
2. Draft your operating agreement: Include all key terms listed above, tailored to your business and state law. If you are in California, New York, Texas, or Delaware, check for specific requirements about naming managers or filing additional documents.
3. File formation documents: When registering your LLC, specify that it is manager-managed if required. For example, in Delaware, include this in your Certificate of Formation; in California, check the appropriate box on your Articles of Organization and file a Statement of Information.
4. Obtain an EIN: Apply for an Employer Identification Number from the IRS. You may need to provide your operating agreement to verify your management structure. The IRS EIN application asks for the responsible party and may request additional documentation.
5. Open bank accounts: Most banks will ask for your operating agreement and formation documents to open business accounts. Make sure your documents match your state filings.
6. Hold an initial meeting: Document the appointment of managers, initial capital contributions, and adoption of the operating agreement. Keep minutes of this meeting for your records.
7. Keep records: Maintain copies of your operating agreement, meeting minutes, and state filings. In New York, you must keep certain records at your principal office. Update your records as your business changes.
8. Review and update regularly: Revisit your operating agreement when you add members, change managers, or make major business changes. In states like California, you must file an updated Statement of Information within 90 days of certain changes.

Practical example: A Texas food startup appoints two managers and files its Certificate of Formation with the Secretary of State, checking the manager-managed box. The founders draft an operating agreement that gives managers authority over daily operations but requires a 75% member vote for any sale of assets. They open a bank account using the agreement and EIN, and keep records at their principal office. When a new investor joins, they update the agreement and file an amended Statement of Information.

FAQs

Is a manager-managed LLC operating agreement required by law?

Most states do not require you to file your operating agreement with the state, but having one in writing is strongly recommended. Some states, like New York, require every LLC to adopt a written operating agreement, even if it is not filed. Banks and the IRS may also require an operating agreement to verify your management structure. Always check your state's specific requirements.

Can a manager in a manager-managed LLC be someone who is not a member?

Yes. In a manager-managed LLC, managers can be members (owners) or outside individuals. This allows you to bring in professional managers or executives who do not have an ownership stake. Your operating agreement should specify how managers are appointed, removed, and compensated, and whether they have a vote as members or only as managers.

What decisions require member approval in a manager-managed LLC?

This depends on your operating agreement and state law. Common examples of decisions that may require member approval include amending the operating agreement, admitting new members, selling the business, taking on significant debt, or dissolving the LLC. Your agreement should clearly list which actions are reserved for members and which are delegated to managers.

How do I change from a member-managed to a manager-managed LLC?

You generally need to amend your operating agreement and, in many states, update your Articles of Organization or similar formation documents. Notify your state's Secretary of State or Division of Corporations and provide the required forms. It is also a good idea to inform your bank and any other parties who rely on your management structure. For example, in California, you must file an updated Statement of Information within 90 days of the change.

What happens if my LLC does not have an operating agreement?

If you do not have an operating agreement, your LLC will be governed by your state's default rules, which may not fit your business needs. This can lead to confusion about who has authority, how profits are shared, and how disputes are resolved. A written agreement gives you more control and reduces the risk of costly legal disputes. In some states, like New York, not having a written agreement can result in penalties or administrative issues.

Key Takeaways

• A manager-managed LLC operating agreement is essential for defining authority, reducing disputes, and supporting key business functions.
• Include clear terms on manager powers, member voting, ownership, and procedures for changes in membership or management.
• Check your state's requirements for formation documents, naming managers, and ongoing filings.
• Update your operating agreement as your business grows or changes, and keep records up to date.
• Do not rely on generic templates or oral agreements; tailor your agreement to your business and state law, and seek professional help if needed.

Setting up a manager-managed LLC is a smart move for many startups and small businesses, but only if you put the right terms in writing early. If you need help drafting or reviewing your operating agreement, or have questions about state-specific requirements, our team is here to help. Contact us at (888) 449-8437 or team@sprintlaw.com to discuss your next steps. Where legal services are required, they are delivered by licensed lawyers at trusted US law firms through the Sprintlaw platform.