Unit appreciation rights

Plan - UARs

Unit appreciation rights

A contractual right to a cash payment upon the sale of the company, pegged to the growth in value from the time of the grant. Recipients can remain employees and not become partners of the LLC.

Typically issued to: Broad range of employees due to ease of rollout

Plan highlights

Free for recipients

Free for recipients

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

Share of future profits

Share of future profits only

The company’s threshold value is set at the time of grant, and profits above that are shared with the recipient

Tax Icon

Taxed as ordinary income

Cash payouts to employees are taxed as ordinary income and not at lower capital-gains rates

Payout protection

Payout protection for existing owners

Existing owners retain their share of the current value of the LLC; all payouts to new holders come from future growth

Maintains employee status

Maintains employee status for the holder

Employees can continue to receive W-2 form and employee benefits; employer will continue to withhold taxes

From the company’s perspective, UARs may be an easier option with a lower administrative burden; however, there are material downsides for the employee when compared to a profits interest.

Andrew Gilbert
Croke Fairchild Morgan & Beres

What are unit appreciation rights?

Unit appreciation rights, or UARs, are a type of phantom equity that holds some similarities to profits interest units—in both cases, employees are incentivized to help grow the company’s value because the value of UARs and PIUs are both tied to the future growth of the company, starting from the time of the grant.

In addition, UARs, like PIUs, don’t dilute the legacy economic value of existing shareholders. UAR recipients also don’t have to pay for the privilege of holding these rights, just as PIU holders don’t pay for their equity.

The main difference between the two types is that UARs are contractual rights to a cash payment allowing the recipient to remain an employee of the LLC, rather than becoming a member or partner. This means UAR recipients do not receive Schedule K-1 tax forms, file self-employment taxes, or risk losing some employee benefits. However, any cash payments are taxed as ordinary income, rather than long-term capital gains, which can be obtained with PIUs.

UARs are often selected by companies as a suitable right for employees that can directly impact the company’s revenue, such as sales team members.


No buy-in needed

With UARs, no payment is needed from the employee—it is granted by the LLC and gives the recipient the right to benefit from the future growth of the company without a buy-in price.

Incentive alignment

Because UARs only provide the holder a slice of value that they directly helped create, they are incentivized to do their best work, stick around longer, and contribute more since they’re going to want to create as much value as possible to increase the value of their equity.

Easier administration

UARs are the easier option for a company to roll out from an administrative perspective, as fewer changes are required for the operating agreement.

Recipient retains employee status

This means employees continue to receive company benefits and W-2 tax forms, and their employer can continue to withhold taxes from their regular cash compensation, as they do not hold an equity stake and do not become members or partners.


The tax burden on the employee

UARs can result in a higher tax burden on the employee since they are taxed at ordinary income rates.

Difficulty communicating the equity value to employees

Unit Appreciation Rights are a less common form that some employees see as “not real equity” with uncertain potential value. This may make it more difficult to achieve the alignment companies seek via equity—the feeling that employees have “skin in the game” and are invested in the company’s success.

Little regulatory guidance for UARs

Because it is a less common form, there is less certainty about how the Internal Revenue Service or the courts will view UARs, compared to profits interests, which have more case law and related tax guidance. That’s why it is especially important to consult your legal and tax professionals when granting UARs—especially if the company is located in an employee-favorable jurisdiction such as California.

Time limits on UARs

UARs are generally drafted like options and are only valid for a period of 10 years, meaning there can be additional time pressure on the company-employee relationship if there has not been a change-of-control transaction within 10 years. Absent that transaction, the UARs become worthless unless the company reissues them at the time of expiration.

How it works

The amount the employee is paid out depends on the growth of value of the “units” after the unit appreciation rights are granted. The company must determine its valuation to determine the Fair Market Value or threshold of the units at the time of grant, usually by a 409A valuation. Then, when there is a change-of-control transaction, the company can determine the appreciation, or delta, between the value of the units at the time of grant and settlement.

These valuations generally don’t need to be conducted every time a new grant is issued, but they should be conducted fairly regularly, typically annually or following any material events that may impact this number.

This means that if the company were to liquidate (or enter into a change-of-control transaction at the same value as the equity grant) on the date of grant, the employee would be paid zero dollars. Said another way, the employee only participates in the added upside value of the company (if any) from and after the date of grant.

Tax treatment

For the company:

The amount paid out in cash to the UAR holder upon sale or change of control of the company will generally be deductible by the company as a compensation expense. The company will want to run any such payments through their payroll provider and withhold at the employee’s standard withholding rates. This amount will be included on their W-2 for the year as compensation.

For employees:

A disadvantage of UARs is that they are subject to ordinary income taxes (unlike PIUs, which can be taxed at capital gains rates). Since UARs are not actual partnership interests, the entire amount paid to the employee will be considered income to that employee.

The employee is only taxed on their UAR when they receive a cash payment upon the sale of the company. They are not subject to any taxes at the time the rights are granted, since there is no value at grant and they do not own a membership interest. The same is true at vesting.

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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