Delaware LLC loan to member

A Delaware LLC has not elected S or C corp status. The manager owns most of the member interests. The operating agreement gives the manager complete control to do as he sees fit. The manager wants to reward a member whose activity benefited the LLC. Question: Can the LLC extend an interest bearing loan to the member to enable him to purchase more units? The debt would be repaid by subtracting it from the member's first payout.

I'll briefly review the non-salary compensation systems from a NZ viewpoint (sorry that's the only one I design for) as there are US tax implications which I'm not qualified to have an opinion on.

1. Share Grants
2. Partly paid shares
3. Performance Share Rights
4. Convertible note
5. Employee Share loans
6. Option

1 Share Grants

• Good - typically founders or keystone developers (or even license-in-tech) but may need vesting schedule. Capitalise upfront costs
• Bad - argument about fair allocation can lead to contentious arguments.
• Ugly - Highly illiquid and subject to shareholder agreements/dilution by outsiders

2 Partly paid shares - acquired at market value with balance called by company later

• Good - can be custom-designed to achieve performance hurdles - allow early employees to reinvest into company but recognising earlier risk
• Bad - potentially fringe-benefit tax (NZ)
• Ugly - for Aussies, subject to capital gains tax

3 Performance Share Rights - similar to options but no strike price converting rights to shares

• Good - objective performance base and no out-of-money risk to employee as rights lapse without hitting target
• Bad - potentially fringe-benefit tax (NZ)
• Ugly - Full value taxable to employee (treated as NZ-based income) cf bonus pool

4 Convertible note - loan to companyrepayable in cash or shares

• Good - flexible in allowing non-employees and suppliers to chip in at early stage
• Bad - still taxable unless on capital account, not easy to be fair as loan terms can vary
• Ugly - more complex to implement as debt provisions cover bankruptcy and change of control

5 Employee Share loans - company provides loan to employee to purchase share

• Good - relatively simple to understand
• Bad - assumes that company already strong cashflow
• Ugly - fringe benefit tax may apply depending on interest rate (or zero-rated) and terms

6 Option - exerciseable right to purchase share at set price in future

• Good - well understood in startup community, no risk as lapses if out-of-money, no Fringe Benefit tax liability
• Bad - this sets the company on a certain path IPO/tradesale which can be either a deathmarch or limits the pivot options
• Ugly - NZ tax free is only if market-value paid when share acquired (try valuing an early stage company with zilch revenue)

So the question is actually 3 parts

• what is a fair reward/incentive structure (reach milestones/targets) which is business dependent
• what structure maps the rewards to the risk ... no use having low-hanging fruit but also the old adage if you pay peanuts expect monkeys
• what would be the cashflow/tax implications for the employee

Now appears you are wanting an employee share loan but if dealing at arms length transaction, need to fairly value the share, then deduct the (interest) bearing loan upon issue. If you can get all 3 aspects right, you'd have a winner!

Yes, the LLC can do a loan to a member but typically the member would receive equity in exchange for contribution of IP or the like.