27 Jan Granting Equity to Key People: Should You Restructure?
At some point, many closely held business owners reach the same crossroads.
They’ve built a successful company as a sole 100% owner (possibly as a single-member LLC). Control is clear, decision-making is streamlined, and the structure has worked well. But now the business is growing, and the owner wants to reward and retain key people who are helping drive that growth.
The question isn’t whether to give them an incentive. It’s how to do it without giving up control or creating unintended tax or governance consequences.
That is usually when the owner asks:
Should I stay an LLC, or should I convert to an S-corporation or C-corporation?
What structure gives me more flexibility in granting equity?
The answer depends less on labels and more on understanding what each structure actually allows you to do.
The Starting Point: A Single-Member LLC
A single-member LLC offers simplicity. The owner controls 100% of the equity, profits, and decisions. For tax purposes, the LLC is typically disregarded, meaning income flows directly to the owner’s personal return.
When it comes to bringing in key people, however, the simplicity can become a limitation.
Granting true equity in an LLC usually means admitting new members. That changes ownership percentages, voting rights, and economic entitlements. Even when the operating agreement is carefully drafted, equity is equity. And once it is given, it is difficult to take back.
Many owners hesitate here because they want to reward key people without immediately creating partners in the traditional sense.
Staying an LLC: Flexibility With Complexity
LLCs can, in fact, be very flexible. An operating agreement can be drafted to create different classes of interests, restrict voting rights, and allocate profits in tailored ways. Profits interests, for example, can allow key people to participate in future growth without receiving current value.
That said, LLC equity arrangements tend to be more complex to explain, value, and administer. They can also create tax reporting issues for recipients, who may receive K-1s and taxable income without corresponding cash distributions (creating the so-called “phantom income” issue).
For some key people, that complexity is acceptable. For others, it becomes a barrier rather than an incentive.
Why Owners Consider S-Corporations
With an S-corporation, equity is divided into shares, and ownership percentages are easier to understand.
However, S-corps come with meaningful constraints. There can only be one class of stock, which limits flexibility in creating economic differences between owners. All shareholders must generally receive distributions on a pro-rata basis, and ownership eligibility rules apply.
In practice, this makes it difficult to grant equity to key people while maintaining differentiated control or economics. While voting and non-voting shares can sometimes be used, the overall flexibility is narrower than many owners expect.
The C-Corporation Option: Maximum Flexibility, Different Tradeoffs
C-corporations offer the most flexibility when it comes to equity incentives. Stock options, restricted stock, vesting schedules, and multiple classes of shares are well-established tools in the corporate world.
From a control perspective, this can be attractive. An owner can issue equity that vests over time, is forfeitable upon departure, and carries limited or no voting rights.
The tradeoff is taxation. C-corporations are subject to entity-level tax, and dividends are taxed again at the shareholder level. For some closely held businesses, this is a non-starter. For others, particularly those focused on growth rather than distributions, it can be an acceptable cost for the added flexibility.
Control Is Usually the Real Issue
When owners ask about entity conversion, the underlying concern is rarely tax alone. It is about control.
They want to motivate key people without losing decision-making authority. They want alignment without partnership paralysis. And they want to preserve the option to buy back equity if someone leaves or underperforms.
The right structure is the one that allows those outcomes to be designed clearly and enforced predictably.
Conversions Are Strategic, Not Automatic
Converting from an LLC to an S-corp or C-corp is not just a paperwork exercise. It can have tax consequences, affect existing agreements, and change how profits are taxed going forward.
For some businesses, staying an LLC and refining the operating agreement is the right answer. For others, converting to a corporation unlocks incentive tools that are otherwise difficult to implement.
What matters is not chasing flexibility for its own sake, but choosing a structure that matches the company’s growth stage, culture, and long-term ownership vision.
A Thoughtful Decision, Not a Default One
There is no universally “better” entity for granting equity. There is only a better fit for a particular business and owner.
The most effective equity plans are designed backwards, starting with control goals, economic intent, and exit strategy, then matched to the entity structure that supports them.
Our practice works with a limited number of family-owned and closely held businesses each year, advising owners on equity structures that balance incentives, control, and long-term flexibility. If we’re a fit, we’ll help you evaluate whether staying in your current business form (whether it be an LLC, S-corporation, or C-corporation) or converting to another form best supports your goals.
If you are considering bringing key people into the ownership picture, you can apply to work with us here: