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Currently an LLC - suggestions sought for equity-oriented incentive methods

My company is an LLC a few years old with a few founders as members. We want to incent additional key employees who joined the company in recent years with an equity-oriented structure. We've considered profits interests, but admitting these key people as members means divulging the specific holdings of the founders and the new members to each other which is not appealing. We also want to have a vesting schedule and control over what happens if (and after what period of time after joining) a capital event occurs. Any thoughts on how to accomplish these goals while retaining the LLC structure or is another structure required?

Answers

Topic Expert
Regis Quirin
Title: Director of Finance
Company: Gibney Anthony & Flaherty LLP
LinkedIn Profile
(Director of Finance, Gibney Anthony & Flaherty LLP) |

Look into the LLP structure which is pretty common with Law firms. Historically, in these organizations, there are two levels of partners, i.e. equity partners and non-equity partners. All receive a K-1 (owners), but the control sits with the Managing Committee, which is a sub-set of the equity partners. The level of financial information shared with non-equities is different than with equities. I say historically as there is case law which may change this structure slightly, i.e. non-equity partners to receive W2 and not K-1. Check with your attorney to see if this structure will work for you.

Scott Kantor
Title: CFO
Company: In Transition
(CFO, In Transition) |

Are you certain that you would have to divulge the specific holdings of the founders to holders of profits interests? I am a profits interests holder in an LLC for which the Operating Agreement does not require financial information to be distributed to minority holders. As such, I simply receive a quarterly tax distribution and an annual K-1. I have no idea as to the holdings of the other Members / Holders of Profits Interests.

If still not interested in profits interests, there is always Phantom Stock.

Joe Purpura
Title: Partner
Company: G.R. Reid Associates, LLP
(Partner, G.R. Reid Associates, LLP) |

Is your LLC taxed as a partnership or corporation/s corporation? If it is a partnership, agreeing with Mr. Kantor and Mr.Quirin, structuring a profit interest(Non-equity holding) with language in the operating agreement conforming to the company's wishes can be obtained. S corps are a bit limited to the flexibility when compared to a partnership. Have you considered a company sponsored 401k plan? A 401k can accomplish your vesting requirements and provide for discretionary contributions. If the 401k is not the solution, creating an additional legal entity to become a partner within your LLC(assuming taxed as a partnership) can accommodate the company's intentions. You have options. Each need to be reviewed for the qualitative features, initial and annual cost associated to administering the solution.

Patricia Hickey
Title: Chief Financial Officer
Company: CCS
(Chief Financial Officer, CCS) |

You can structure the language of the new member interests such that you do not need to disclose the founder members' or each other's interest to each other.

Lawrence Stirtz
Title: CPA
Company: Lestirtz llc
(CPA, Lestirtz llc) |

A profits interest works from a tax perspective and usually at a practical level as it gives only future rewards. I designed one for a client, however it is very vanilla from a control standpoint i.e no bells and whistles with regard to information or vesting etc. so the specific design will dictate what you can do. I am sure you can restrict the information by disclosing those terms in the offering in that it just becomes part of the deal and participants give those rights up to receive the incentive.

Vesting and control at the payout can create complications, if it is a straight equity transaction the right can be valued and be charged to income in the year of grant, my guess is that vestin screws up this reporting and you would be faced with valuations each year as the interest vests. I had to argue long and hard with the auditors and attorneys for my client but ultimately received the one year charge treatment but we had no vesting or longevity requirements.

I have a personal bias to keep simple and give information, seems to create a better climate of trust.

Keep in mind that these usually require the same distributions that the other partner classes get. Maybe not required but again the cost of design and administration probably goes up.

Good Luck.

John Argo
Title: Consultant
Company: Independent Advisory Services
(Consultant, Independent Advisory Services) |

One strategy I've heard about but have not had a chance to thoroughly investigate is issuing phantom stock, which basically provides stock appreciation rights. The plan used a generally fixed valuation method to arrive at the value of the phantom stock. I have heard of a few large companies doing this but not smaller companies. I imagine there should be considerable guidance on this, as it seems to me to be a common question with LLC's.

Dan Kardatzke
Title: CFO
Company: Solstice Mobile
(CFO, Solstice Mobile) |

Following on John's comments above we rolled out a Phantom Equity plan with two flavors about a year ago. The first is traditional Phantom Units that are 409A compliant and the second is Unit Appreciation Rights. You do need to complete an independent valuation every year to stay compliant with the plan but it will give you a lot of options without changing the LLC structure or the Operating Agreement.

David Howell, ASA, MBA
Title: Principal, Plante & Moran, PLLC
Company: Plante Moran, PLLC
(Principal, Plante & Moran, PLLC, Plante Moran, PLLC) |

An experienced equity compensation attorney and/or compensation consultant should be able to craft an LLC plan to meet your needs. One of the nice things about LLCs is the considerable flexibility they provide in structuring equity incentives to meet your objectives. Let me know if you'd like an introduction to a professional that can help you.

David Howell
Principal, Plante Moran

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