Profits interests are a special form of equity compensation issued by limited liability companies. They provide a share of future “profit” in the company and are used as an incentive to attract, retain, and reward employees.
Profits interests are a relatively new form of equity compensation that are specific to limited liability companies. Their use has increased with the growth in and benefits of limited liability companies as an alternative to traditional C or S corporations.
Under U.S. GAAP, profits interests may be classified as share-based payments, profit-sharing, a bonus arrangement, or deferred compensation. The classification is determined by the specific terms and features of the profits interest. In nearly all circumstances, the fair value basis of the award must be recorded as an income statement expense. Profits interests can also result in the recognition of a liability on the balance sheet and require footnote disclosures.
This article provides a discussion of profits interests and summarizes general guidelines on accounting requirements for this type of equity compensation.