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Bet Early. Win Big. Tax Plan Accordingly.

March 16, 2016

There is an abundance of digital media coverage, and discussions at leading venture funding events about the huge opportunities for investors and founders alike to win big financially – by creating and scaling innovative start-ups.

Early-stage investors dominate the CB Insights list of the top 20 venture capitalists, often creating handsome returns from companies they fund – that go public or are acquired. But in the rush to find these promising start-up companies and “get the deal done” critical tasks around smart tax planning from the start may be ignored.

In the end, this rush-to-riches can create unwelcome tax liability surprises or missed cost savings opportunities, and undermine the long-term viability and value of the start-up companies involved.

The New York Times recently reported in the digital edition of their Technology column that “Top start-up investors are betting on growth, not waiting for it.” The story details the big opportunities early-stage investors find in start-ups during the early rounds of financing. The headline of the print edition of the same story simply read “Bet Early. Win Big.”

Peter Fenton

The story highlighted the success of people like Peter Fenton of Benchmark; who invested in Twitter when the social media company had only 25 employees. It also included Jim Goetz at Sequoia Capital who bet early, and won big, with his investment in WhatsApp. This was well before the company was acquired by Facebook for a mind-numbing $21.8 billion.

WHAT ABOUT TAX PLANNING?

A related business topic that was not mentioned in this article was importance of smart tax planning (from the very beginning) for early-stage start-up companies.

Founders and early-stage investors alike would be wise to consider these key tax-planning related issues as the start-up is conceived, structured and funded; as it goes about running its day-to-day business, and then scaled:

  1. Choose the right structure for the new entity: Corporation vs. S-Corp vs. LLC. Addresses issues like pass-through vs. double taxation and limitations on pass-through entities.
  2. Seek ways to employ a sound defense against tax liability risks and plan for ways to minimize cash outflows, to help reduce the start-up’s burn-rate.
  3. Play smart offense to take full advantage of tax benefits and increase current or future cash inflow.
  4. Scrub down the term sheet term sheet with a qualified CPA in preparation for an equity or debt fund raise, by closely evaluating the short and long-term financial implications.
  5. Focus on the start-up’s financial statements for improved outcomes before an audit, exit talks or an IPO, to optimize the company’s valuation.
  6. Take advantage of tax incentives to enhance the start-up’s ROI.

WHAT THE INVESTORS ARE TALKING ABOUT

Screen Shot 2016-03-16 at 11.25.44 AMSan Francisco based law firm Orrick, Herrington & Sutcliffe recently held another in its event series called Orrick Total Access in New York City – a highly informative effort billed as “providing entrepreneurs with today’s tools for tomorrow’s success.”

This event focused on how to fundraising today and what’s going on in the marketplace. It feature an all-star panel of investors from leading firms such as Bessemer, Greycroft and Red Sea Ventures.

The investment topics discussed were loaded with tax-related issues / implications for entrepreneurs and founders. But again any discussion of tax planning and the role of a good CPA in the process was conspicuously absent.

Here is some of the commentary from the event, with tax planning implication sub-titles now included:

Ellie Wheeler (Partner / Greycroft )

“For Series A funding today – the appetite to fund really high burn rates, that are kind of more momentum plays, is going away.”

 Subtitle:

Demonstrating sound fiduciary responsibility (including smart tax planning) will help start-ups with future funding efforts and overall valuations.

Charles Birnbaum (VP / Bessemer Venture Partners ):

“Managing expectations on valuations with founders can be tricky… ‘We like your business, but at a lower price’… we have this conversation early…like what kind of dilution are you expecting?

Subtitle:

Be sure to have a qualified CPA review your term sheet to identify both potentially favorable and unfavorable terms. Then if possible you should work to negotiate better terms that will deliver positive financial outcomes in the long run.

Scott Birnbaum (Founder / Red Sea Ventures )

“We’re telling our portfolio companies to hoard their cash, be careful of their burn-rate, to move aggressively towards positive unit economics, to not over-invest in growth.”

Subtitle:

Start-ups that can focus on conserving cash, and avoiding unnecessary expenses (that can come in part from smart tax planning) will be viewed more favorably by potential investors.

This material has been prepared for general informational and educational purposes only and is not intended, and should not be relied upon, as accounting, tax or other professional advice. Please refer to your advisors for specific advice.