Customizing multiple LLC equity types for different groups of employees

Kevin Vela is managing partner and Candace Groth is a senior attorney at Vela Wood.

Any opinions, analyses, and conclusions or recommendations expressed in this article are those of the authors alone and do not reflect the views of their employer or eShares, Inc. DBA Carta, Inc.

Growing businesses frequently have a need to incentivize different types and groups of employees. Two common groups are upper-level management or C-suite employees, and mid- to lower-level employees. Upper-level management will tend to want capital interests in the company or at least options; mid- to lower-level employees may be just as happy with an equity-like structure as long as they receive a large payment upon the sale of the company. 

Frequently the two or more groups of employees have different incentives, performance goals, and retention schemes that do not easily fit into one type of LLC equity plan.

Rather than pick an ill-fitting plan for one of the two groups of employees—or worse, no plan at all—a company can choose to implement more than one type of LLC equity plan, customized to each type of employee group.

How it works

This structure requires careful planning between the business and its legal counsel to design not just one, but two types of plans. 

• Incentive Unit Plan (aka “profits interest” plan): for upper-level/C-suite management who expect to receive equity in the business as a performance incentive. 

• Parallel Unit Plan (aka “synthetic equity” plan or “ phantom stock” plan): For mid- or lower-level employees whom the business wants to incentivize for the long term with a stake in the sale of the business. 

Typically the vesting schedules for each type of plan will be different. For example, the Parallel Unit Plan may incentivize longevity with the company by vesting over time, while the Incentive Unit Plan may be tied to company financial goals more readily obtained by a CEO, CFO, or other C-suite individual. Both types of plan can be set up with a variety of vesting schemes. The plans may be implemented side by side, or may be announced at different times, depending on business needs. 

Pros and cons of a dual equity structure

This overall structure works best for a company where there is a high degree of difference between the compensation structures for C-suite individuals, and those at a mid-level/lower-level of employment. Here are some advantages and disadvantages of this solution for each employee group below:

Other important factors

Companies should be aware that juggling two types of LLC equity plans adds complexity to overall compensation structures and is not for every company. Each type of plan, and its pros and cons, should be considered prior to implementation. 

In addition, here are some additional items to note for each type of plan:

Parallel Unit Plans

• Full value of the company or appreciation value (above a threshold) can be used

• Compliance with Section 409A is required, and permitted trigger events are very specific

• Termination or changes to the plan are difficult due to Section 409A and its associated  regulations

• A valuation (or 409A valuation) is generally only needed if non-sale trigger events or an appreciation (rather than full value) plan is used

Incentive Unit Plans

• Participants are owners of the company, and generally cannot be employees of the LLC. Instead, participants must file quarterly tax filings with the IRS, and withhold/pay their own employment taxes.

• Not generally deductible to the company when issued or paid 

• Subject to capital gains treatment for the participant if held for more than one year

• Although technically incentive units could receive distributions, most plans do not result in any distributions being issued to participants

• 409A valuations are generally required every 12 months, or after a material change, to stay compliant

With both Parallel Unit Plans and Incentive Unit Plans, the value of the award is generally based on a set percentage or value of the company and its equity, and can therefore be calculated accordingly.

We hope that this article has been an informative introduction to the use of multiple LLC equity plans. We recommend you talk to a lawyer to create a plan or plans that work best for your particular situation and company. With employee equity and equity-like awards, the company is in the driver’s seat.

DISCLAIMER: This publication contains general information only and Carta is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services nor should it be used as a basis for any decision or action that may affect your business or interests. Before making any decision or taking any action that may affect your business or interests, you should consult a qualified professional advisor. This communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Carta does not assume any liability for reliance on the information provided herein.