Equity for Services (Sweat Equity): Agreements, Vesting, Taxes & Deal Structures

❓ The 6 Questions Every Sweat-Equity Deal Must Answer

Before drafting any agreement, nail down these six fundamentals. Skip one, and you'll face disputes, tax surprises, or legal headaches down the road.

1

What's Being Granted?

The type of equity determines tax treatment, voting rights, and exit payouts.

Common Stock Stock Options LLC Units Profits Interests Phantom Equity

2

When Does It Vest?

Vesting protects the company if the recipient leaves early and aligns incentives.

Time-Based (4yr/1yr cliff) Milestone-Based Hybrid Immediate

3

What Happens If They Leave?

Define the exit mechanics before day one to avoid messy departures.

Forfeit Unvested Repurchase Vested Call Options Put Options

4

Who Controls What?

Equity does not always mean control. Define governance rights explicitly.

Voting Rights Board Seats Protective Provisions Information Rights

5

Who Owns the IP?

Services create work product. Make sure the company owns what it pays for.

Full Assignment License Grant Background IP Carve-out Work for Hire

6

What's the Tax Posture?

Timing and structure determine whether you pay ordinary income or capital gains.

83(b) Election ISO vs NSO LLC K-1 Allocation 409A Valuation

📈 Three Macro Structures for Sweat Equity Deals

Most equity-for-services arrangements fall into one of three patterns. Choose based on your risk tolerance, tax goals, and how much you trust the recipient.

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1. Immediate Grant + Vesting

Grant restricted stock or units upfront, subject to time or milestone vesting. Standard for co-founders and early employees.

Recipient owns equity from day one
Company can repurchase unvested shares if they leave
83(b) election locks in low tax basis
Typical 4-year vest, 1-year cliff

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2. Earn-In on Milestones

Equity is granted only after specific milestones are achieved. Common for advisors, contractors, or uncertain contributions.

No equity until milestones hit
Clear, measurable triggers
Lower risk for the company
May use options or warrants

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3. Phantom / Profit Share

No actual equity changes hands. Recipient gets cash payouts tied to company value or profits. Cleanest for tax and governance.

No cap table complexity
Taxed as ordinary income when paid
No voting or ownership rights
Common for key contractors

🏛 LLC vs Corporation: Equity Mechanics Compared

The entity type determines which equity instruments are available and their tax treatment. Choose your structure before making promises.

Feature	LLC (Partnership Tax)	C-Corporation
Primary Equity Type	Membership Units / Profits Interests	Common Stock / Preferred Stock
Stock Options Available	No (use unit options or profits interests)	Yes (ISOs and NSOs)
83(b) Election	Complex (profits interests may not need it)	Straightforward for restricted stock
Pass-Through Taxation	Yes (K-1 to members)	No (double taxation)
Self-Employment Tax	May apply to active members	Not on dividends
VC / Institutional Investors	Rarely accept LLC structure	Standard requirement
Flexibility in Allocations	Very flexible (special allocations)	Pro rata by share class
Conversion Complexity	Taxable event to convert to C-Corp	Already standard structure

Read Full LLC vs Corporation Guide →

⚙ Document Builder Tools

Interactive tools to generate equity agreements, vesting schedules, and compliance documents. Customize, preview, and download.

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Equity Deal Builder Interactive

Build complete equity-for-services agreements step by step with guided prompts.

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Vesting Schedule Builder Interactive

Create time-based, milestone, or hybrid vesting schedules with cliff periods.

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Buyout Terms Generator Interactive

Define repurchase rights, call/put options, and valuation methods for exits.

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Document Recommender Interactive

Answer a few questions to get a customized checklist of required documents.

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IP Assignment Addendum Interactive

Generate IP assignment and work-for-hire clauses for any equity agreement.

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Cross-Border Issue Spotter Interactive

Identify tax treaties, withholding issues, and compliance for international recipients.

📖 Deep-Dive Hub Pages

Comprehensive guides on every aspect of equity-for-services arrangements. Start with what matters most to your situation.

2

Equity Types Explained

Stock, options, LLC units, profits interests, phantom equity compared

3

LLC vs Corporation

Which entity structure for your equity-for-services deal

4

Vesting Deep Dive

Time-based, milestone, cliff periods, acceleration triggers

5

Tax Basics & 83(b)

When to file 83(b), ISO vs NSO, LLC tax allocations

6

IP & Work Product

Assignment clauses, background IP, work for hire doctrine

7

Governance & Control

Voting rights, board seats, protective provisions, drag-along

8

Exit & Repurchase

Call options, put options, ROFR, valuation methods

9

Securities Compliance

Rule 701, Reg D exemptions, blue sky laws, accredited investors

10

Cross-Border Issues

International recipients, tax treaties, withholding, currency

11

Common Mistakes

The top errors founders make with sweat equity and how to avoid them

❔ Frequently Asked Questions

What's the difference between stock options and restricted stock?

Restricted stock is actual ownership from day one (subject to vesting). Stock options give the right to purchase shares at a set price in the future. Options have no value if the exercise price exceeds the stock value; restricted stock always has some value. Options are taxed at exercise (or sale for ISOs); restricted stock is taxed at vesting unless you file an 83(b) election.

When should I file an 83(b) election?

File an 83(b) election within 30 days of receiving restricted stock or LLC units that are subject to vesting. This lets you pay tax on the current (low) value rather than the (potentially higher) value when shares vest. Critical for early-stage grants. Miss the deadline and you cannot go back.

Can I give equity to a contractor without making them an employee?

Yes, but structure matters. Contractors can receive stock options (NSOs only, not ISOs), restricted stock, LLC profits interests, or phantom equity. Ensure your contractor agreement includes proper IP assignment. Be aware that large equity grants may trigger worker misclassification concerns.

What is a profits interest in an LLC?

A profits interest gives the holder a share of future profits and appreciation, but no claim to existing company value. When properly structured, profits interests can be granted tax-free (no income at grant). They're the LLC equivalent of stock options but with different mechanics and tax treatment.

Do I need a 409A valuation before granting equity?

For stock options in a C-Corp, yes. Section 409A requires options to be priced at fair market value. A 409A valuation from an independent appraiser creates a safe harbor. For restricted stock, profits interests, or phantom equity, 409A applies differently. LLCs have more flexibility but still need reasonable valuations.

What happens to unvested equity if someone is fired?

Typically, unvested equity is forfeited. For vested equity, it depends on your agreement: the company may have repurchase rights (at fair value or a formula), or the departing member keeps their vested shares. "Cause" termination often triggers harsher terms than "without cause." Define everything in the agreement upfront.