Attracting and retaining top talent isn’t just about salary,it’s about providing ownership-like opportunities that align employees with long-term company success. For LLCs, however, structuring equity-based incentives comes with unique hurdles compared to C- or S-corporations.
Further complicating matters, issuing true ownership interests (such as Profits Interests) could convert employees into partners for tax purposes, and therefore disqualifying them from tax-advantaged benefits such as group health insurance, subjecting them to self-employment taxation, and complicating their individual tax reporting due to the use of Form K-1.
The Two Primary “Appreciation-Only” Equity Solutions for LLCs
When structuring appreciation-only long-term incentives that align employee and company interests while maintaining the award recipients’ employee status, LLCs generally rely on two alternatives: Profits Interests (with an Aggregator Entity) and Unit Appreciation Rights (UARs).
1. Profits Interests (with an Aggregator Entity)
Profits Interests are a well-established method for allowing participants to share in future appreciation above a pre-established hurdle rate. Profits Interests are real equity and have the advantage of allowing the employees to have their realized gain taxed at the capital gains rate. However, without additional planning, these awards make recipients partners,eliminating the recipients’ employee status and creating complexity in tax withholding and reporting, and disadvantages in providing tax-advantaged benefits.
The Solution: The Aggregator Entity
By introducing a holding LLC (Aggregator) to hold the Profits Interests on behalf of employees, LLCs can deliver the economics of ownership while keeping participants on payroll as W-2 employees. In this structure, employees receive profits in the Aggregator entity, while the Aggregator entity itself holds a Profits Interest in the operating LLCs. While this resolves the W-2 issue, the employee will still receive a K-1 from the Aggregator. To simplify reporting, the LLC agreement can be designed so that only gains at exit are allocated, keeping the K-1 straightforward until such time. Employees thus hold contractual rights through the Aggregator without directly becoming partners in the operating entity.
Benefits and Considerations of Profits Interest (with an Aggregator Entity):
- Preserve W-2 Employee Status: Recipients retain status as employees of the operating LLC.
- Exit Event Alignment: Can be structured to settle only on exit.
- Flexible Design: Can allow for earlier settlement through liquidity windows (buyback offers by employer)
- Tax Treatment: Gains are taxed at the lower capital gains rate.
(For a detailed breakdown of how this works, read our companion article: Implementing Profits Interests Through an Aggregator.)
2. Unit Appreciation Rights (UARs)
UARs are another flexible alternative for providing value appreciation without granting ownership. Functionally similar to Stock Appreciation Rights (SARs), UARs allow participants to benefit from increases in the company’s value, with payouts typically made in cash upon vesting (or a specified date thereafter), a liquidity event or other defined performance triggers.
Benefits and Considerations of UARs
- Preserve W-2 Employee Status: UARs are contractual, not ownership interests.
- Exit Event Alignment: Can be structured to pay only on exit.
- Flexible Design: Can be tied to financial metrics (e.g., Revenue, EBITDA).
- Tax Treatment: Payouts are taxed as ordinary income, compared to Profits Interests, which are taxed at the lower capital gains rate.
Perception: May be seen as less compelling if there’s no clear exit path. In professional services or family-owned LLCs, for example, UARs may resemble deferred cash bonuses rather than true equity. This perception gap can reduce their motivational value unless paired with a well-defined growth story or financial metric.
Choosing the Right Path
The right solution depends on your company’s philosophy, administrative appetite, and growth outlook. Profits Interests through an Aggregator offer a more authentic ownership-like experience but require more infrastructure. UARs, while easier to implement, may feel more like cash bonuses to participants and do not offer favorable taxation ability.
Regardless of the approach, success depends on thoughtful plan design, clear communication, and robust administration. The most effective LLC equity compensation strategies integrate tax, legal, and accounting considerations while also addressing employee perception and engagement.
How Can Infinite Equity Help?
At Infinite Equity, we understand the unique challenges LLCs face when designing competitive, equity-aligned compensation strategies. Our team has worked with private and growth-stage LLCs across industries, helping them navigate Profits Interests, Aggregator structures, and UARs. This cross-disciplinary expertise, spanning valuation, accounting, and participant communication, sets Infinite Equity apart in delivering solutions that are both technically sound and easily understood by employees. Reach out to Infinite Equity to learn how we can help you.
