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How Can I Have Reverse Vesting in an LLC?

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I recently received, via Quora, a private question about setting up an LLC membership interest (rather than shares of a corporation) with reverse vesting (see Rewarding Key Personnel: Restricted Stock or Options?). That question, and my answer, are reproduced below with minor editing.

Q. I am starting a company and forming as an LLC. My co-founder will received a reverse-vested membership percentage. I’ve found plenty of sample restricted stock agreements, but nothing for LLCs and memberships. Do you have any suggestions where I can find a sample agreement?

A. Sorry, I know of no such document. I believe there are two somewhat-related reasons why this is the case:

  1. Reverse vesting is common in a corporation, rare in an LLC.
  2. Whereas corporations have well-defined structures, LLCs can wander far afield in their Operating Agreements, meaning that one cannot expect to find and rely upon supposedly-standard language.

Please pardon my directness: You cannot do this properly on your own. If your objective in choosing an LLC is to save money, given the reverse-vesting requirement you probably will be better off with a corporation.

Dana H. Shultz, Attorney at Law +1 510 547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

  1. 9/30/2012 | 3:16 pm Permalink

    Dear Dana,

    Love the articles and Quora. I sometimes see and draft LLC profits-only interests structured with reverse vesting-like provisions. It is a “designer document” for specific situations — I doubt you’ll find any safe boiler-plate on the Internet for this. There are some particular provisions that must be included in the operating agreement for the plan to be deemed valid by the IRS — failure would trigger a taxable event and probably penalties.

    Normally this comes up for low cap/no cap startups — the “shoe-stringers”. It allows someone (perhaps a founder or early adviser) to provide services in return for a “profits only” interest without triggering any immediate tax event (the provider must still file a 83(b) at $0). It’s also a good way to potentially reward employees — a little more straight-forward than phantom equity under 409(a). It’s a very contractually-flexible instrument.

    There are other ways of handling these issues, but a LLC with its looser controls and often lower minimum tax rates (check your state laws!) can confer substantial benefits — if the company intends to remain closely-held by its founding members. Obviously, the LLC structure will interfere with later capital investment opportunities and I’d structure it to be easily translatable to a corporation — particularly with equity crowdfunding coming our way in 2013!

    I think a LLC under this plan is ultimately headed for a corporate conversion somewhere down the road, but it’s not a bad launching point for shoe-stringers who plan on operating the business rather than setting it up for quick acquisition.

    But please, lawyers only on creating this kind of entity. As with all LLCs, very state-dependent.

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