Equity Incentives for LLCs: Capital Interest
This post discusses general legal issues, but it does not constitute legal advice in any respect. This post is not a substitute for legal advice and is intended to generate discussion of various issues. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel. Cara Stone, LLP and the author expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this post. The views expressed herein are personal opinion.
As a company grows, many business owners want to reward their key employees with equity in the business or rewards tied to the business’s performance. We’ve discussed several equity incentive plans for LLCs in prior posts. This post focuses on Capital Interest.
A capital interest gives someone a direct membership interested in the LLC. Like profits interest, granting a capital interest makes someone a partner in the company and will give the grantee certain informational and voting rights in the company. These informational and voting rights will vary based on the state the company is incorporated in, however, it will often mean that companies are required to provide financial and other sensitive information. Additionally, because capital interest represents a direct ownership in the partnership, any benefit the grantee gets from that ownership will not be tied to specific metrics, targets or performance (by the person or the company). One option to counteract this, is to use capital interest in connection with a bonus plan which is tied to specific business objectives.
Another consideration when grating capital interest, is that just like giving someone a car, a boat or a cash payment, granting someone interest in the company that they do not pay for will be treated as a taxable event by the IRS. This may not be substantial for a new business with little value, but for an existing company, the tax impact can be significant.
Capital interest is also similar to profits interest in that if you issue a capital interest to an employee, the employee gives up his/her W2 status and becomes a K-1 partner. This means that the company is no longer withholding taxes for them and can complicate tax matters on both the employee side and the company side.
Capital interest is most often seen at the management or executive level of an LLC. Even in those high level positions, it should be issued with care. Talking to an experienced attorney who can help structure the information and voting rights of individuals being grants capital interest is key. Companies should also speak with an experienced accountant or CPA about the tax consequences of those decisions.
This post discusses general legal issues, but it does not constitute legal advice in any respect. This post is not a substitute for legal advice and is intended to generate discussion of various issues. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel. Cara Stone, LLP and the author expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this post. The views expressed herein are personal opinion.
As a company grows, many business owners want to reward their key employees with equity in the business or rewards tied to the business’s performance. We’ve discussed several equity incentive plans for LLCs in prior posts. This post focuses on Capital Interest.
A capital interest gives someone a direct membership interested in the LLC. Like profits interest, granting a capital interest makes someone a partner in the company and will give the grantee certain informational and voting rights in the company. These informational and voting rights will vary based on the state the company is incorporated in, however, it will often mean that companies are required to provide financial and other sensitive information. Additionally, because capital interest represents a direct ownership in the partnership, any benefit the grantee gets from that ownership will not be tied to specific metrics, targets or performance (by the person or the company). One option to counteract this, is to use capital interest in connection with a bonus plan which is tied to specific business objectives.
Another consideration when grating capital interest, is that just like giving someone a car, a boat or a cash payment, granting someone interest in the company that they do not pay for will be treated as a taxable event by the IRS. This may not be substantial for a new business with little value, but for an existing company, the tax impact can be significant.
Capital interest is also similar to profits interest in that if you issue a capital interest to an employee, the employee gives up his/her W2 status and becomes a K-1 partner. This means that the company is no longer withholding taxes for them and can complicate tax matters on both the employee side and the company side.
Capital interest is most often seen at the management or executive level of an LLC. Even in those high level positions, it should be issued with care. Talking to an experienced attorney who can help structure the information and voting rights of individuals being grants capital interest is key. Companies should also speak with an experienced accountant or CPA about the tax consequences of those decisions.
