As a business grows, many owners will want to tie employee rewards or incentives to company profits. Limited liability companies (LLCs) that want to incentivize key employees have multiple options to give employees an owner-like stake in the business.

Option Plans for LLCs

The first option for equity incentives for LLCs is creating an option plan. Like in a corporation, an option plan gives employee and contractors the right to buy into your LLC at a fixed price. Often, the option will vest over time, meaning that the longer an employee or contractor stays with the company, the more of the company they will gain the right to purchase. Because you are giving people a right to purchase part of the company, option plans can give employees a sense that they are sharing in the appreciation and future value created by the company.

Profits Interest Grant

The second equity incentive option for an LLC is a profits interest grant. A profit’s interest is the right to share in the profits of an LLC.  If you do a profits interest grant there are certain considerations that you need to take into account which we’ll cover in a future post.

Phantom Unit Plan

The third option for equity incentive in an LLC is a phantom unit plan. A phantom unit plan is similar to an option plan but is more focused on the company’s exit. Under a phantom unit plan, the employee may be granted an “equity-like” bonus or some other profit share arrangement. Incentives vary based on how the plan is structured. The key takeaway is that the key incentive is granted at the company’s exit.

Bonus Plan

Another equity incentive for LLC’s is a bonus plan. Most businesses are familiar with a traditional bonus plan. Business owners can simply tie bonus incentives to performance. While this does not necessarily give employees an equity interest in the company, it can be less burdensome on employers.

More often than not there are considerations that occur with the other types of incentive plans that business owners don’t want to take into consideration for their employees. For example, anytime an LLC issues an actual profits interest or other kind of unit interest to a person, that person becomes a partner in the LLC if it’s taxed as a partnership. That means that the employee is no longer a W-2 employee but a partner. At that point, any salary that the company pays them will be reconsidered as a partner draw or a guaranteed payment under the tax code and that means that they’re self-employed. This can lead to several complications.  

Capital Interest

The final way an LLC can issue an equity grant is through capital interest in the LLC. This is the least common type of equity grant for LLCs primarily because of the complexity to the business and the employee. There are several tax matters that need to be accounted for if the company when the company grants capital interest.