PIUs with catch-up provision

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PIUs with catch-up provision

A type of profits interest that allows the holder to receive the tax advantages of regular PIUs while potentially also receiving greater economic benefit by being “caught up” to their full pro rata share of the current company value, as if they held a capital interest in the business.

Typically issued to: Key hires, existing longtime employees

Plan highlights

Free for recipients

Free for recipients

Employees can benefit from your company’s growth without having to pay to acquire this equity

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Taxed at long-term capital gains rates and only when cashed out, if handled correctly and applicable holding periods are met

Catch up

Recipient “catches up”

Holder can benefit from current company value; not limited to just their percentage share of future growth

Common variations

Profits interest units (PIUs)

The most common equity type for LLCs, profits interest units (PIUs) are a good way to incentivize employees to help grow the company.


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PIUs with separate holding co.

This version of regular PIUs can be useful if you want employees to continue receiving W-2s and avoid self-employment taxes.


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What are PIUs with catch-up?

A typical profits interest grant would normally give the recipient a percentage share of proceeds from the sale of the company based on the future growth of the company beyond the Fair Market Value or “threshold” of the company at the time of the grant.

In certain cases, an LLC might consider structuring the grant to allow the recipient to also participate in the existing enterprise value of the company—essentially, to enable that holder to “catch up” to existing shareholders. This is what is known as a “catch-up” profits interest.

This is accomplished by allocating profits that would otherwise be allocated to the existing members to the capital account of the holder.

Let’s take a look at a couple of examples, first showing what happens without a catch-up provision:

No catch-up provision

Let’s say an LLC with a current Fair Market Value of $10M makes a 5% profits interest grant to an executive, with no “catch-up” concept. If the LLC is sold over the $10M threshold amount, the executive would receive 5% of the proceeds above $10M.

As you can see, a typical profits interest grant is less valuable than a regular capital interest in the LLC because it only shares in proceeds above the threshold amount and receives nothing attributable to the threshold amount itself.

A catch-up provision would provide the grantee with an enhanced share of exit proceeds above the threshold amount until the grantee is “caught up” to their pro rata share, with any additional proceeds being shared pro rata.

Now let’s see what would happen for the executive if they had a “catch-up” provision in their profits interest plan.

PIU with catch-up provision

If the LLC subsequently sold for $10M or less, the executive still receives zero. But suppose the LLC is sold for anything greater than $10M. In that case, the executive receives 100% (not 5%) of the excess proceeds until the executive has received 5% of total proceeds (i.e. roughly $526,000 to the executive*), and 5% after that. Thus, if the LLC were sold for, say, $15M, the executive would receive $750,000, which is the same amount they would have received (i.e., 5% of the total) had they held a regular capital interest in the LLC, rather than a profits interest.

*$10M to the pre-grant members, and then $526K to the executive, which ensures that the executive “catches up” to 5% of total proceeds ($526,000 / $10,526,000 = 5%); example assumes that only the single executive holds a catch-up provision on their PIUs.


Great for recipients

With the catch-up provision, in the right circumstances, the recipient can be paid out as though they had a full capital interest in the LLC rather than a profits interest based only on company appreciation post-grant.


As with regular PIUs, there are two major tax advantages for the holders.

The PIU holders can typically minimize their tax obligation at issuance and at vesting with the timely filing of an 83(b). Additionally, at liquidity, the holders’ profits can be taxed at long-term capital gains rates if held for the applicable holding period.


Not a perfect solution

The LLC must still appreciate in value or generate profits after the grant in order for the holder to be “caught up.” If the LLC is ultimately sold for an exit price equal to or less than the threshold amount, the holder is still at risk of not receiving the same sale proceeds that a capital interest holder would have been entitled to receive.

Even still, the catch-up profits interest can significantly minimize the executive’s economic risks in this regard, while still preserving the beneficial tax treatment of the profits interest grant. This is because, in many cases, the LLC will only need to appreciate in value by relatively small amounts for the grantee to be caught up in full. For example, in the examples above, the LLC would only have to appreciate in value from $10M to $10.526M in order to fully catch up a 5% profits interest holder.

Tax treatment

For the company:

Because a profits interest grant is non-taxable to the grantee, the issuing LLC does not receive a tax deduction attributable to the grant. However, at the time of exit or other distribution on the PIUs, the PIU holder’s share of proceeds are directly taxable to that holder, thus providing an “effective” tax deduction to the other members.

For employees:

As with regular PIUs, there are two major tax advantages for the holders.

First, the PIU allows for potential tax savings by minimizing the tax obligation at issuance and at vesting. Typically the PIU holder files a protective 83(b) election (within 30 days of receiving the PIU grant) to elect to pay taxes on receipt, when the equity has no value, instead of at the time of vesting, when the PIUs value may have increased. By paying taxes on the total Fair Market Value of the award at the time of issuance, which is $0, they lower their tax burden.

At liquidity, typically the sale of a company or repurchase, holders’ profits can be taxed at long-term capital gains rates if they held the interests for the applicable time period.

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.

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