I know you guys have competent professional advice, but I was a little worried about a scenario where somebody a little less tax accountant-y copy/pastes the entire plan except for that bit about excluding former employees. Boom! It totally didn't look like a SQL injection but it was important anyhow!

Equity compensation schemes are like programming language manuals and spellbooks of eldritch power: every word in here can kill you.

The bonus would, however, be taxed as income and not as capital gains. That's kind of a bummer.

Indeed. In a large exit, this could more-than-halve what employees net, moving the proceeds from a 15-20% long-term capital-gains rate up to a 35-40% regular-income rate.

But this is a true bonus, since employees are compensated fully in their paychecks, unlike options that typically replace some amount of salary.

How is 60-65% less than half of 80-85% ?

Yes, I mispoke, and should have said 'more-than-double what they pay in taxes', rather than talking about the net.

In a max-tax scenario (high-tax state like California, expiration of the Bush tax cuts in 2013), the bulk of a large exit would be taxed at about 53% if ordinary income, but only about 33% if long-term capital gains treatment can be obtained. So they'd be netting about 30% less due to the 'bonus' approach rather than equity.

(I'm counting medicare tax, which no longer phases out any income, but not social security, which isn't collected on income over ~$107K.)

If it is taxed as W2 income, you also need to pay social security and medicare, another 7.65%. State taxes may also differ, if the state has a separate capital gains rate. Also, the max federal capital gains rate is 15% as far as I know.

Same as non-qualifed employee stock options in that regard.

Very interesting employee "benefit." I wonder if it would be considered as an employee benefit subject to reporting requirements / oversight by the U.S. Department of Labor or other federal agency?