A Washington State Capital Gains Tax?

Could Washington State soon have its own capital gains tax?

It is possible. Two Senators have proposed a bill that would impose a 5% capital gains tax on capital gains in excess of $10,000 for persons filing individual returns or $20,000 for persons filing joint returns. You can view a copy of the bill here: http://apps.leg.wa.gov/documents/billdocs/2013-14/Pdf/Bills/Senate%20Bills/5738.pdf The purpose of the tax is to provide funding for education.

When Would The Tax Go Into Effect?

The tax would go into effect on January 1, 2014. But it would apply to unrealized gains from before that date that were recognized after that date. For example, say you had bought that Microsoft stock back in 1997 and were still holding it… Before the bill becomes law, several things have to happen. Both the House and the Senate have to pass the bill, the Governor has to sign it, and the taxpayers have to approve it.

Taxpayer Vote

Section 501 of the bill requires the Secretary of State to submit the tax to a vote of the people at the next general election to be held in the state. When submitted to the voters, the tax bill would be described in the following manner.

“The legislature has passed Bill No. ____, concerning creating a capital gains tax to fund results in education. This measure would impose a 5.0% state excise tax on capital gains above ten thousand dollars per person, exempt gains on most residences, and provide that all capital gains tax revenues must be deposited into the education legacy trust account to fund education.”

What Is Exempt?

The law has some exemptions. For example, gain from the sale of a principal residence to the extent excluded under the Internal Revenue Code would not be taxed. There is no exclusion for qualified small business stock under Section 1202 of the Internal Revenue Code. So, if this law passes, Washington would follow California in imposing a tax on capital gains that is excluded under the federal law.

To Whom Would the Tax Apply?

The tax would only applies to natural persons–or individuals.

Good Idea/Bad Idea? Would this new tax in Washington be a good idea for our startup community? I don’t think so, but perhaps I am in the minority. I would love to hear what advocates on both side have to say. The best arguments I can think of against this tax?

  • It sets a bad precedent that once set will result in the rates creeping up over time (the slippery slope argument).
  • It would scare away investment capital at the margin.
  • It would remove one of our competitive advantages vis-a-vis Oregon and California.
  • There is no exemption for investments in startups (no corollary to federal tax code section 1202).
  • The tax would probably not be nondeductible federal income tax purposes.

The best arguments I can think of in favor of this tax?

  • It taxes individuals (as opposed to businesses) who most likely can afford the tax, and we need more money for education.
  • A 5% tax isn’t going to scare anyone away. It is a small “tip for the waiter.”
  • In fact, if the money improves our schools, our state will become a more attractive place in which to invest, despite the tax.

Conclusion

A new tax of this magnitude deserves a healthy public debate. I look forward to hearing your comments.

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Fund Raising as a Sales Process

Guest Post by Bryan Brewer of Funding-Quest.com.

Some entrepreneurs arrive on the angel funding scene with a Field of Dreams attitude: “If I build it, they will come.” In this case, “they” refers to investors.

Truth is, it usually doesn’t work that way. Since you are literally selling stock in your company, I suggest you will have a better chance of success if you engage in a true sales process.

Here are the five steps:

Step 1 – Maximize Your Fundability. In this first step, which could span a year or more, you build your business and your team in anticipation of approaching investors.

Do your best to optimize the basic building blocks of your business: good match between problem and solution; large and growing market; high-margin revenue model; cost-effective go-to-market strategy; competitive advantages; strong management team; and defensible financial projections. (This entire step is covered in detail in my new Fundability Scorecard™ assessment tool, which I am introducing at my Funding Quest One-Day Workshop on Feb. 5, 2013.)

In other words, you are developing and refining your business as the “product for sale.”

Step 2 – Structure a Term Sheet. Now you are ready to price your product. You determine the amount of money you need to raise, valuation, use of proceeds, milestones, and other deal terms. In this step, it’s essential to work with a competent corporate securities attorney, especially one who sees a lot of angel deal flow.

Step 3 – Connect with Angels. With a product and a price, you can begin the sales process in earnest by first generating leads, i.e., finding angel investors who might be interested in your deal. I recommend you pursue three strategies to acquire leads:

  • Apply to angel groups so you can get exposure for you and your business.
  • Leverage your network of contacts, both business and personal, to reach out to potential investors.
  • Develop a strong online presence, including gust.com and angel.co, and use social media to connect directly with investors. (But beware – again, consult with your securities attorney; don’t advertise or make general solicitations to sell stock.  Your lawyer can give you advice on how to avoid running afoul of the general solicitation prohibition.)

It helps to implement a CRM system to keep track of all your activity with contacts as you nurture these leads.

Step 4 – Give Your Pitch. Now that you have a product, pricing, and prospects, it’s time to start pitching, either to angel groups or one-on-one. Ask your support team and others for honest feedback about your pitch. Make sure it’s simple and understandable. Weave a compelling story into your narrative so angels will relate to you personally. And practice, practice, practice!

Step 5 – Close the Deal. Now comes the tricky part – trying to the “herd the cats” and manage your anxiety while investors take their own sweet time to decide. You can help speed this process in several ways:

  • Create a plan to make a number of interesting announcements about your business so you have a good reason to communicate regularly with your prospects.
  • Host events or conference calls to increase engagement with these potential investors, and look for other ways to have additional meetings so investors can get to know you better.
  • If realistic, create a sense of urgency about the closing of your deal to induce investors to act.

Treat fund raising as a sales process, and you are more likely to be rewarded with positive results.

Don’t get discouraged. You will encounter lots of obstacles along your journey. Take these in stride and learn from them if possible. And remember that you can’t please everyone. As a client once told me:

“Raising angel funding is not about convincing skeptics; it’s about finding believers.”

Best wishes in your quest for funding!

Bryan Brewer
@fundingquest
www.funding-quest.com

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Now For Something Completely Different

Rarely do we get a break around here from the lofty world of startup law, corporate strategy, venture capital, SEC rules, M&A, etc. I received a submission from a friend who publishes ski/snowboard magazines and a fly fishing magazine. An interesting and funny guy who can throw together a good read. Enjoy! ~ Joe

Geek Vacations of the Future

tranquilityBy Jeff Galbraith

Several years into our small publishing endeavor, my wife and I launched a flyfish title to complement our other media properties (focused on skiing and snowboarding), as a means to create a “summer job” for ourselves and our staff. We soon discovered, like the winter sports, fly fishing has morphed from a classic approach – casting to rising trout; skiing down ski area runs – to a more adventuresome and often esoteric one – skiing Sicily’s active volcanoes; fishing for primordial looking Amazonian species.

It isn’t enough to provide readers stunning river vistas from Wyoming and New Zealand, today’s fly fisher’s want to go deep and get weird.

From the aggressive and mysterious mansheer of southeast Asia, to the taimen, or “river wolf” of Mongolia, to the golden dorado of Bolivia — going to far flung reaches of the earth, surviving monsoons, tropical swelter and occasional war zones has come to embody what one might be tempted to call “extreme fishing” if the phrase didn’t sound a bit like “extreme sunbathing” or other (choose your own) non-sequitur. That said, there is something particularly engaging about a journey to remote waters for a species that otherwise exists for most Americans only in taxonomy books and at the Smithsonian. The taimen, the world’s largest salmonid, gets upwards of 200 lbs and six foot-plus; it basically looks like a brook trout that made its way into Jurassic Park. My friends who have fished for them, employ flies that look like bedroom slippers and are meant to imitate squirrels. The golden dorado of Amazonian headwaters looks like a really pissed off goldfish, and like the taimen, hunt in packs.

You’re just not going to get that in the Catskills or the Cascades.

However I think that like the Teddy Roosevelt sportsmen of yesteryear, this new breed of fisher may be starting to run short on Paleolithic fish species to drag up, snap a photo with and plaster on their Facebook (the reason people fish). While I am certain there are untold strange sculpin in Kilimanjaro run-off streams and others like this, at some point in the future, fisherfolk are going to hit a critical mass with travel, fish and a finite planet.

Which got me to thinking about Jaron Lanier. Jaron Lanier is a Silicon Valley icon both revered and dismissed. With his beard, dreadlocks and stout build, he tends to look a bit more like he should be selling nitrous balloons at Phish show parking lots than the man who created and coined the term “virtual reality” more than twenty years ago. Sneaking into the Stanford Navy labs at age 15, grad students and government employees there simply figured he must be one of many teen prodigies on campus. Jaron was free to go nuts on the best computer equipment at the time, and he created another world.

I had the opportunity to hear him speak almost two decades ago at the Stanford Professional Publishing Seminar in Palo Alto, CA. While others at the time in Silicon Valley were ratcheting up the cash machine with Java, Sun Microsystems, etc. Jaron had effectively walked away from the whole thing. Disillusioned with the military applications DARPA and the Pentagon were now applying to his virtual reality, he created programs for gamers, as well as for surgeons to do virtual practice runs before diving into the real thing. Jaron then retreated to his music, a computer infused sort of world beat thing. Today, he continues to create and critique, his latest work “You are not a Gadget” both inflaming and inspiring electronic culture.

But the thing I recall most about the talk he gave, was his description of virtual realities of the future. He used jukeboxes as an analogy: “When you are walking down the street and hear music coming out of a bar, without looking in, you can almost always tell whether the music is live or recorded. But if you had never heard recorded music, you would not be able to discern. Such it is with virtual reality: if you could transport yourself 100 years in the future, the quality of virtual reality programs would be indiscernible from actual reality, but for someone who has grown up with it, they will be able to tell.”

Enter the colo claw fish. Now, understand, the colo claw fish does not, in the traditional sense, exist. At least outside of Lucasfilms Productions.

Featured in the first Star Wars prequel “The Phantom Menace,” the colo claw fish makes an appearance when Qui-Gon Jinn and a young Obi-Wan Kenobi (I’m going to choose to ignore the Jar Jar Binks character altogether) are running the underwater canyons of Naboo. According to Wookiepedia (yes, it is exactly what you think it is), the colo claw fish runs approximately 40 meters in length, has opposing claws to hold captive their prey and bioluminescent nodules along their sides to attract them. Qui-Gon and Obi-Wan were only able to escape certain death when their pursuing colo claw fish is munched by the sando aqua monster, a 200m-long carnivorous sea mammal.

All of which starts making the heat of Thailand or rough roads of Mongolia start looking like kid’s play. And taimen, mansheer or whatever fish from South America look like anchovies with puppy eyes.

The thought is, if Jaron Lanier can conceive it, George Lucas can create it and DARPA can build it, retired Microsofties and oil execs can fish it.

Which brings me to my friend Agent X. Agent X, aka Mark Farmer is one of those unique Americans who straddle the line between renegade and hero. A former Coast Guard rescue swimmer in Alaska, he has gone on at various times to work at gun shops, mount a viable campaign for mayor of Juneau, and consult on such films as “Independence Day” as well as to write and shoot for Jane’s Defense, Popular Science, and frequency: The Snowboarder’s Journal, about everything from advanced weapons systems to interplanetary snowboarding. X is the first person to shoot good, land-based photos of Area 51 as well as the inventor of the sport of “gumbysuiting” (running class 4 and 5 rapids in a CG survival suit and no boat). Although X is not a flyfisher by nature, he does seem like the ideal guide for colo claw fish.

Conscripting Agent X into leading clients in a new virtual-based fishing guide service won’t be the tough part. I suspect some snowboard gear, and healthy tips from the 1% would do the trick. The tough part will be wresting the coding from DARPA and licensing from Lucasfilms, but I would be surprised if both outfits don’t have crazed flyfishers with greater allegiance to fishing than anything else. There will be moles.

Regardless, rest assured the wheels are in motion and we’ll be taking bookings soon. The deal with Expedia will be significant.

Forget about Alaska, Bolivia or the mountains of Central Asia, it’s all about Naboo now.

Jeff Galbraith is the President of Funny Feelings LLC, publishers of The Ski Journal, Frequency: The Snowboarders’ Journal, The Flyfish Journal. He is an expert on the pursuit of non-existent piscine.

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Non-Accredited Investors & Integration of Related Offerings

By Keith Baldwin

A reader recently wrote to me asking what I thought of the following financing arrangement:

I want to form a company that would have multiple subsidiaries, each doing a Rule 504 SCOR (Small Corporate Offering Registration) offering, where all investors would be non-accredited.  When the maximum of $1 million is reached, a new subsidiary would launch another 504 to all non-accredited investors and raise another $1 million, and so on.  However, the raise would need to be restricted to just the SCOR states.  One could incorporate additional issuing entities in other states and continue this same process with everything rolling up under the parent company.  This potentially solves the no solicitation rule and the pre-existing relationship issue.

We could do 6 coordinated SCOR offerings covering 37 States and should be able to issue one SCOR offering for each subsidiary (each subsidiary raising $1million).

My response was that this plan raised serious securities regulatory issues.

Rule 500(f), at the very beginning of Reg D, states a principle that is a linchpin of the SEC’s exemption structure.  It reads as follows:

(f) In view of the objectives of Regulation D and the policies underlying the Act, Regulation D is not available to any issuer for any transaction or chain of transactions that, although in technical compliance with Regulation D, is part of a plan or scheme to evade the registration provisions of the Act. In such cases, registration under the Act is required. (Emphasis supplied.)

The SEC uses Rule 500(f), as well as its “integration” doctrine under Rule 502(a), to look through serial or concurrent offerings of the type suggested, especially where it appears that an issuer is trying to avoid the dollar limits or the limits on the number or types of investors.   The state regulators have a similar approach.  The integration doctrine looks at whether there is a common plan of financing that unites various offerings, whether the offerings are concurrent or serial, and provides a conditional safe harbor only where offerings are more than six months apart.  That rule should be read and interpreted very carefully, along with the SEC No-Action Letters on that topic.

There is a further risk if proceeds of a subsequent offering are used to refinance or “prop up” an unsuccessful prior offering.  The securities regulators are quick to call those kinds of arrangements “Ponzi schemes,” whether the term actually fits the situation or not.

In short, anyone looking at linking together offerings by different subsidiaries of the same company in order to avoid the restrictions of various exemptions should know this:  the securities regulators have seen it all, they take a dim view of anything that looks like a “plan or scheme to evade” the securities laws, and they back up their views with enforcement actions when justified by the facts.

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Section 1244 Stock

I was presenting to a group of angel investors recently on the topic of Section 1202 and Congress’s renewal of the 100% exclusion for investments made through the end of this tax year when the conversation turned to Section 1244 stock. The group had a bunch of questions on 1244 stock, and I thought I’d share the answers to some of those questions here.

First of All, What are the benefits of Section 1244?

If you are not familiar with Section 1244 of the Internal Revenue Code, it provides, for individuals, that losses on the sale or other taxable disposition of Section 1244 stock that would otherwise be treated as capital losses can be treated as an ordinary loss, subject to an annual limitation and certain additional requirements.

What is the Annual Limitation?

For any taxable year, the aggregate amount that can be treated as an ordinary loss on the sale or other taxable disposition of Section 1244 stock cannot exceed:

  • $50,000, or
  • $100,000 in the case of a husband and wife filing jointly.

What is Section 1244 Stock?

Section 1244 stock is stock in a domestic corporation if:

at the time of issuance the corporation was a “small business corporation;”

  • the corporation issued the stock for money or other property (other than stock or securities); and
  • the corporation, generally, during its 5 most recent taxable years ending before the date on which the loss on such stock was sustained, derived more than half of its aggregate gross receipts from sources other than royalties, rents, dividends, interests, annuities, and sales and exchanges of stock or securities.

What Is A Small Business Corporation?

For purposes of Section 1244, generally, a corporation is a small business corporation if the aggregate amount of money and other property received by the corporation for stock, as a contribution to capital, as paid-in surplus, does not exceed $1,000,000.

In the year the threshold is met, the corporation may designate (in accordance with a set procedure) which shares issued that year are Section 1244 stock.  If no designation is made, the applicable Treasury Regulations generally pro-rate any remaining Section 1244 benefit among the shares issued that year.

Can Preferred Stock Be Section 1244 Stock?

Yes, preferred stock can be Section 1244 stock if it otherwise meets the requirements, but not if it was issued on or before January 18, 1984.

Congress amended Section 1244 in 1984 to remove the requirement that Section 1244 stock be common stock. There are still on the books Treasury Regulations which state that Section 1244 stock has to be common stock, but these Treasury Regulations pre-date the 1984 amendments.

In the General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, the Joint Committee on Taxation had this to say:

“The Congress believes that to encourage new venture capital, an ordinary loss deduction should be available on preferred stock, as well as common stock, of small business corporations.”

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