Passive Investors In An LLC

I received a user question from my commercial site yesterday regarding how to structure the admittance of passive investors into an existing single person LLC. In a basic, member-managed LLC, the members serve three rolls when compared to corporations: shareholder, board director, and corporate officer. In order to curtain the authority of certain members (and enhance the authority of others), I have seen LLCs adopt corporate style bylaws then name certain of its members as "officers" of the LLC. That muddies the waters IMHO. This situation can be handled within the framework of the operating agreement.

The first step is to switch the LLC from one managed by all members to one that has managers. For an existing LLC, this quite often entails amendment of the LLC articles of organization which is not a complicated task. Most states have pre-printed forms for amending the articles. Remember that LLC managers can also be members. The operating agreement is then amended allowing the members to name managers (or one manager if that be your desire). The passive members are not named as managers. The tricky part comes with spelling out the level of authority of the manager and those acts for which a vote of the LLC members is required. The amount of authority that can be delegated to the managers by the members in an operating agreement is quite extensive. Section 404 of the Uniform Limited Liability Company Act (upon which all states have modeled their LLC acts) sets forth 10 acts which require unanimous consent of all members. The comments to Section 404 give further insight into the relationship between managers and members:

In a manager-managed company, the members, unless also managers, have no rights in the management and conduct of the company's business unless otherwise provided in an operating agreement. If there is more than one manager, manager disputes as to any matter relating to the company's business may be resolved by a majority of the managers unless the matter relates to a matter specified in subsection (c) (unanimous member consent required). Managers must be designated, appointed, or elected by a majority of the members. A manager need not be a member and is an agent of the company with the apparent authority to bind the company in the ordinary course of its business.

Here is a sample member-managed LLC operating agreement setting up boundaries of manager authority by reserving certain decisions for the members. As you might expect, there are tax implications to being a passive LLC member. For example, here is an article discussing the deductibility of LLC losses by a passive member.