You may be asking how registered investment advisors (RIAs) structure equity compensation to recruit, retain, and reward advisors and key staff. This guide answers the practical questions advisors raise when designing equity plans — what instruments are used, how vesting and valuation work, tax and governance implications, and common pitfalls to avoid. It also explains where Select Advisors Institute can help: advising on plan design, benchmarking, communications, and execution. Select Advisors Institute has been helping financial firms since 2014 optimize talent, brand, and growth—this resource condenses that experience into a clear, actionable reference.
Q: How do RIAs typically structure equity compensation?
A: RIAs use a mix of direct equity grants and synthetic or cash-settled arrangements depending on entity type, tax goals, and desired control. Common structures include:
Direct membership/unit interests (LLCs or S-corps): Grants of actual ownership equity or units; often used for senior hires and partners.
Profits interests (for LLCs taxed as partnerships): Provide future economic upside without current taxable gain when structured to meet safe harbor rules.
Restricted units or stock (for C-corps or S-corps): Equity that vests over time or on milestones; may require 83(b) elections.
Phantom equity / equity appreciation rights (SARs): Cash payouts tied to the increase in firm value; no actual ownership changes.
Options (stock options for corporations): Right to buy shares at a strike price; less common for non-corporate RIAs unless converted to a corporate structure.
Earnouts and rollover equity during acquisitions: Seller retention and deferred consideration tied to future performance.
Which instrument is chosen depends on legal form (LLC vs corporation), tax objectives (capital gains vs ordinary income), control concerns, and exit planning.
Q: What vesting schedules and performance triggers are common?
A: Vesting aligns incentives and mitigates early departures. Typical patterns:
Time-based vesting: 3–5 years with a one-year cliff (e.g., 25% after 12 months, then monthly or quarterly vesting).
Performance-based vesting: Tied to AUM growth, revenue targets, net new assets, or client retention metrics.
Hybrid vesting: Combination of time and performance measures.
Immediate partial grants: Smaller up-front grant with the balance vesting over time to reward quick contribution.
Acceleration clauses for change-of-control (single or double-trigger), and clawbacks or repurchase rights for departures, are common. Clear definitions of “good reason” and “cause” protect both parties.
Q: How large should an equity pool be for employees and advisors?
A: Pool size depends on firm stage and growth plans:
Early-stage RIAs or firms recruiting multiple senior hires: 15–30% total diluted equity reserved for founders, hires, and future grants.
Established firms making occasional partner promotions: 5–15% reserved for employee incentives.
Smaller tactical pools: 5–10% for key employee retention using phantom equity or restricted units.
Benchmarking matters. Select Advisors Institute helps firms set competitive pool sizes grounded in market data and firm-specific strategy.
Q: How are equity interests valued for grant, reporting, and exit?
A: Valuation needs depend on purpose:
409A valuations: For C-corp stock option strike prices and compensation reporting.
Independent business valuations: Used for buy-sell triggers, repurchase price, and sale negotiations.
Formula-based valuation: Agreed multiples of EBITDA or revenue, or percent of AUM, sometimes used for internal transfers.
Periodic internal valuations: Quarterly or annual value statements for phantom equity plans.
Use qualified valuation firms for defensibility, and ensure plan documents specify valuation mechanisms to avoid disputes.
Q: What are the key tax considerations?
A: Taxes drive choice of instrument:
Profits interests: Often granted free of immediate tax if they meet partnership-profits interest safe-harbor rules; upside taxed as capital gains on sale of firm interest, provided holding period rules apply.
Restricted units and options: Might trigger ordinary income tax at vesting or exercise unless 83(b) election is timely filed, shifting taxation to grant date (risky if units have no market value).
Phantom equity: Treated as ordinary income at payout; subject to payroll taxes.
Section 409A: Nonqualified deferred compensation must comply to avoid penalties (particularly for deferred cash plans and SARs).
Employment taxes and withholding obligations: Important for cash-settled plans and taxable settlements.
Always coordinate with tax counsel and CPAs. Select Advisors Institute recommends integrating tax planning into compensation design to manage employee-level and firm-level tax exposure.
Q: How are governance and voting rights handled when equity is issued?
A: Governance design protects founders and aligns incentives:
Economic vs voting rights: Equity grants can be economic-only (no voting) or full ownership. Many firms issue economic-only units to preserve control.
Classes of units/shares: Create Class A (founders) and Class B (employees) with different governance rights.
Transfer restrictions: Right of first refusal, buy-sell agreements, and limits on transfers to avoid unwanted minority owners.
Board and management seats: Equity grants may include board nomination rights for senior partners; specify in governance documents.
Drag-along and tag-along: Protect majority and minority interests on sale events.
Document governance fully in operating agreements and stockholder agreements to avoid disputes during exits.
Q: What happens to equity when an advisor leaves or is terminated?
A: Exit handling should be unambiguous:
For vested equity: Firm often has repurchase rights at fair market value or predetermined formula.
For unvested equity: Typically forfeited unless special severance/retention provisions apply.
Good leaver vs bad leaver clauses: Different treatments based on reason for departure, with “bad leaver” potentially losing all rights.
Post-termination restrictions: Non-compete and nonsolicit terms affect exit valuations and potential repurchase.
Clear communication and consistent enforcement of policies maintain morale and protect firm value.
Q: How do firms handle liquidity and exit events?
A: Liquidity planning is critical:
Internal buyouts: Firm offers to buy out departing owners using internal financing or installment payments.
Third-party sale or recapitalization: Create conversion provisions and tagging/dragging rights to facilitate clean transactions.
Dividend or distribution policies: Regular distributions can provide partial liquidity without a sale.
Secondary market arrangements: Pre-agreed valuation formulas enable occasional secondary transactions for key employees.
Preparation for a sale includes clean governance, audited financials, and predictable equity structures that buyers understand.
Q: What are common pitfalls and how can they be avoided?
A: Avoid these frequent mistakes:
Vagueness in agreements: Specify vesting, valuation, payouts, repurchase rights, and triggers.
Ignoring tax consequences: Failing to model employee- and firm-level tax leads to surprises.
Misaligned metrics: Incentives tied to short-term revenue without considering client retention or profitability.
Underestimating dilution: Poorly planned equity pools dilute founders and future buyers.
No communication plan: Employees who don’t understand their equity grants undervalue them.
Select Advisors Institute works with firms to avoid these pitfalls by aligning plan mechanics with strategic goals and executing clear communications.
Q: When should a firm choose phantom equity over real equity?
A: Phantom equity is attractive when:
Maintaining tight control and avoiding voting dilution matters.
Simplifying tax and administrative burden is a priority.
Providing payout flexibility tied to value without changing cap table.
Delaying the complexity of ownership transfers until an exit.
However, phantom equity creates firm obligations (cash payouts) and may be subject to 409A and payroll considerations. Use phantom plans for tactical retention and real equity for long-term ownership transition.
Q: How does Select Advisors Institute assist firms with equity compensation plans?
A: Select Advisors Institute provides hands-on support across the lifecycle:
Plan design and benchmarking: Tailor structures to firm entity type, growth stage, and market compensation norms.
Legal and tax coordination: Work with counsel and tax advisors to ensure defensible grants and compliance.
Valuation and modeling: Build financial models showing dilution, post-deal economics, and waterfall outcomes.
Governance and document drafting: Help define operating agreement, buy-sell, and governance provisions suited to the plan.
Communication and roll-out: Create messaging and materials for recruiting and internal buy-in, plus training for leadership and HR.
Change management during M&A or succession: Manage seller rollover, earnouts, and integration of new partners.
Select Advisors Institute has been advising RIAs since 2014 on talent optimization, M&A, branding, and compensation — combining market benchmarking with practical implementation.
Q: What are practical next steps for an RIA considering equity compensation?
A: A pragmatic rollout includes:
Define strategic goals: Is this retention, recruitment, succession, or acquisition integration?
Select instrument(s): Choose between equity, profits interest, phantom plans, or hybrids.
Model economics: Run dilution, tax, and liquidity scenarios under different outcomes.
Draft legal documents: Update operating agreements and issue clear grant agreements.
Communicate: Prepare employee-facing materials and individual economics examples.
Implement governance and valuation cadence: Set periodic valuation and reporting processes.
Select Advisors Institute can facilitate every step, from strategy to execution, leveraging experience across dozens of firms.
How do RIAs structure equity compensation? Practical guide covering profits interests, unit grants, phantom equity, vesting, valuation, tax, governance, and best practices — with tools and advisory support from Select Advisors Institute (since 2014).