LLC vs Corporation: How Equity Deals Differ
Documents, vesting, tax elections, approvals, and cap table differences
Overview
Why Entity Type Matters for Equity
LLCs and corporations handle equity compensation very differently. The entity structure affects every aspect of an equity deal: the documents required, how vesting works, tax treatment, governance requirements, and cap table management.
Corporation Equity
- Formal equity plan required
- Board/shareholder approval
- Stock = immediate ownership
- Options are common
- 409A valuation required
- 83(b) election for restricted stock
- Clear employment tax rules
LLC Equity
- Operating Agreement governs
- Manager/member approval
- Units = partnership interest
- Profits interests are common
- Safe harbor valuation available
- 83(b) or profits interest treatment
- Self-employment tax complications
Document Requirements
Corporation Documents
Corporations typically use a formal equity incentive plan as the umbrella document, with individual award agreements for each grant.
Company-Level Documents
- Equity Incentive Plan (EIP)
- Board resolution adopting plan
- Shareholder approval (if required)
- 409A valuation report
- Form of award agreements
Individual Grant Documents
- Stock Option Agreement
- Restricted Stock Agreement
- RSU Agreement
- Exercise Notice (for options)
- 83(b) Election (if applicable)
An equity plan provides flexibility to grant awards without amending bylaws. Most startups adopt a plan early.
LLC Documents
LLCs govern equity through the Operating Agreement. Each equity grant typically requires amending the OA or using a unit grant agreement authorized by the OA.
Company-Level Documents
- Operating Agreement (amended)
- Unit/Incentive Plan (optional)
- Manager consent/resolution
- Member consent (if required by OA)
- Valuation memorandum
Individual Grant Documents
- Profits Interest Award Agreement
- Unit Grant Agreement
- Joinder to Operating Agreement
- 83(b) Election (capital interests)
- Capital account setup
LLC members receive K-1s. This creates tax filing obligations even before any cash distribution.
Vesting Enforcement
How Vesting Works by Entity Type
| Aspect | Corporation | LLC |
|---|---|---|
| Mechanism | Repurchase right at cost (or forfeiture) | Forfeiture of unvested units |
| Typical Structure | Stock issued upfront, company holds repurchase right | Units subject to vesting schedule in OA |
| Who Holds Rights | Corporation (or assignee) | LLC per Operating Agreement |
| Documentation | Restricted Stock Agreement | Operating Agreement provisions |
| Acceleration | Per equity plan terms | Per Operating Agreement |
| Unvested Treatment on Exit | Usually repurchased or cancelled | Usually forfeited or accelerated |
Reverse Vesting Considerations
Reverse vesting (issuing shares upfront with repurchase right) is common in corporations. LLCs can achieve similar results with forfeiture provisions.
Corporate Reverse Vesting
- All shares issued on day one
- Company can repurchase unvested at cost
- Recipient files 83(b) election
- Voting rights from day one
- Clear ownership record
LLC Equivalent
- All units allocated in OA
- Unvested units subject to forfeiture
- Profits interest = no 83(b) needed
- Voting per OA (may be limited)
- Capital accounts tracked from grant
Tax Elections
83(b) Election for Corporations
When a corporation grants restricted stock, the recipient can file an 83(b) election to be taxed on the current value (often nominal for early-stage) rather than the value at vesting.
With 83(b) Election
- Tax at grant on current FMV
- Future appreciation = capital gains
- Must file within 30 days (no exceptions)
- Risk: lose stock but already paid tax
- Best when FMV is low
Without 83(b) Election
- No tax at grant
- Tax at vesting on then-FMV
- Vesting spread = ordinary income
- May face tax without liquidity
- Safer if high forfeiture risk
Missing the 83(b) deadline is fatal. There are no extensions, no exceptions, no remedies.
Profits Interest for LLCs
LLCs can use profits interests to achieve tax-free grants. A properly structured profits interest has zero value at grant (only sharing future appreciation), so no tax is due.
Profits Interest Advantages
- No tax at grant (zero current value)
- No 83(b) election needed
- Capital gains on future sale
- Rev. Proc. 93-27 safe harbor
- Flexible vesting structures
Profits Interest Requirements
- Participation threshold at FMV
- Only future appreciation shared
- Cannot be for certain income streams
- 2-year holding for safe harbor
- Recipient treated as partner
Profits interests are the LLC equivalent of stock options, but often with better tax treatment.
Capital Interests in LLCs
If an LLC grants capital interests (share of current value, not just future appreciation), the tax treatment is similar to corporate restricted stock.
- Taxable at FMV on grant (or at vesting if restricted)
- 83(b) election available if subject to vesting
- Ordinary income on value received for services
- Capital account established at grant value
- Future appreciation can be capital gains
Capital interests are rarely used for service providers because they trigger immediate tax. Use profits interests instead.
Approvals Needed
Corporate Approval Requirements
| Action | Board | Shareholders | Notes |
|---|---|---|---|
| Adopt equity plan | Required | Usually required | ISOs require shareholder approval |
| Grant options/RSUs | Required | Not required | Within plan pool |
| Issue new shares | Required | If exceeds authorized | Charter amendment may be needed |
| Increase plan pool | Required | Usually required | Especially for public companies |
| Modify vesting terms | May be required | Not required | Individual agreement controls |
LLC Approval Requirements
| Action | Manager(s) | Members | Notes |
|---|---|---|---|
| Amend Operating Agreement | Depends on OA | Usually required | Threshold varies by OA |
| Admit new member | Depends on OA | Often required | Equity grant = new member |
| Grant profits interest | Usually sufficient | Per OA terms | If authorized in OA |
| Create incentive pool | Depends on OA | Usually required | Dilutes existing members |
| Modify vesting | Depends on OA | May be required | If amends OA terms |
A well-drafted Operating Agreement can pre-authorize manager to make equity grants, simplifying the process.
Cap Table Impact
Corporate Cap Table Structure
Typical Structure
- Common Stock (issued shares)
- Preferred Stock (if fundraised)
- Option Pool (reserved shares)
- Warrants (if any)
- Convertible Notes/SAFEs
Dilution Mechanics
- Options = dilution when exercised
- Pool carve-out pre-money
- Fully-diluted calculation standard
- Stock splits/reverse splits
- Anti-dilution provisions
LLC Cap Table Structure
Typical Structure
- Capital Units (with contribution)
- Profits Interests (service-based)
- Preferred Units (if fundraised)
- Class A, B, C Units (if multiple)
- Capital Account tracking
Allocation Mechanics
- Percentage interests (vs. share count)
- Distribution waterfall per OA
- Participation thresholds for profits interests
- Capital account true-ups
- Complex allocation provisions
LLC cap tables are more complex. Percentage ownership alone does not tell the full story - distribution waterfalls matter.
Side-by-Side Comparison
Complete Comparison Table
| Aspect | Corporation | LLC |
|---|---|---|
| Governing Document | Equity Plan + Award Agreement | Operating Agreement + Joinder |
| Common Equity Types | Options, Restricted Stock, RSUs | Profits Interests, Capital Units |
| Tax-Free Grant? | Options (yes), Stock (83(b) helps) | Profits interests (yes) |
| Valuation Required | 409A valuation | Valuation memo (less formal) |
| Recipient Status | Shareholder (may remain employee) | Member (partner for tax) |
| Ongoing Tax Filings | None until exercise/vest/sale | Annual K-1 |
| Employment Taxes | Withholding at vest/exercise | Self-employment tax (complex) |
| Investor Preference | Preferred by VCs | Less familiar to VCs |
| Conversion to Corp | N/A | Common before fundraising |
Decision Framework
When to Use Each Structure
Choose Based on Your Situation
Planning to raise VC funding
Corporation
Real estate holding company
LLC
Want employees to keep W-2 status
Corporation
Want tax-free equity grants
LLC (Profits Int.)
Service business with few owners
LLC
Planning to go public
Corporation
Recipients cannot handle K-1 complexity
Corporation
Profits interest + capital gains is priority
LLC
Standard startup equity playbook
Corporation
Many startups begin as LLCs and convert to corporations before raising institutional funding. Plan for this transition.