Sparking Creativity

Sparking CreativityJoin DWT under the Teatro Zinzanni tent to learn the secrets of how innovative Northwest employers have turned creativity into success. Be inspired by new ways to generate ideas and solve problems. In the first half of the program, you’ll hear from our stellar list of panelists, including:

  • Alayne Fardella, President and COO, The Seattle Times
  • Andres Hermosilla, Manager, Innovation and Rapid Store Testing, Starbucks Coffee Company
  • Steve Secrist, Vice President and General Counsel, Puget Sound Energy
  • Gary Wright, Senior Vice President, Business, Seattle Sounders FC

In the second half of the session, you’ll get a chance to practice in our own “CreatiConfab.” Your delight is guaranteed! Plan to stay for the cocktail reception that follows.

Register

Cost

$75

When:

Wednesday, April 16th, 2014

3pm – 5pm

Where:

Teatro Zinzanni

222 Mercer St

Seattle, WA 98109

Posted in Startup Events | Tagged , , , | 1 Comment

Legal Perspective At Seattle Grind

Startup GrindGuest Post by Michael Grabham

Countless hours of building a company can be compounded by more hours figuring out taxes and legalities, as well as investor and compensation rules. It can seem like a grind and at some point you’ll need help. That’s why the organization is called “Startup Grind.”

Startup Grind is a volunteer-run effort designed to inspire, educate and connect entrepreneurs. Since 2012, we’ve been hosting fireside chats with local VC’s and startup founders in the Seattle area. It’s become known as a highly interactive and engaging networking event within the startup ecosystem.

You will meet fellow entrepreneurs working on their first or next startup.  With locals like Dan Levitan, Oren Etzioni, Michelle Goldberg and others, it’s become a place where you can count on meeting great people and enjoy a nice glass of wine or beer.

Meet Joe Wallin

This month, Joe Wallin from Davis Wright Tremaine will be discussing his experiences as a long time startup attorney. He is an authority on the recently introduced crowdfunding law in Washington State, which opens a new funding channel for Startup founders.

The format is unique. After some quality networking time, we gather for a fireside chat with local startup experts.  My questions reflect my inherent curiosity and lead a discussion that allows the audience to get useful answers to questions they have about their startup.  You get real life stories of how or why something was done within the context of starting or running a company.

On any given month, 75-90 budding entrepreneurs converge to meet people, talk tech and give their elevator pitch to an audience member. A favorite part of Startup Grind Seattle is the introduction of the guest speaker for the fireside chat. I will not spoil the secret, but you will not be sitting down when you see it. I hope to see you there!

Register Here

Space is limited, so sign up ASAP

When:

Wednesday, March 26th, 2014

6pm – 9pm

Where:

Surf Incubator’s Dice Cabana

821 Second Ave.

Seattle, WA, 98104

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Angels Descend on D.C.

angel investmentThe Angel Capital Association is hosting its annual summit two weeks from now in Washington, D.C. If you are interested at all in angel investing, I think this will be a great conference to attend.

(Disclosure: I am on the ACA’s Public Policy Advisory Council)

The folks at the ACA have been critical in helping positively influence public policy on angel investing in the last several years.

Just to give you one example that you may or may not recall, but the first iteration of Dodd-Frank would have re-set the “accredited investor” financial thresholds for inflation going all the way back to the 80’s. That proposal, if it had been enacted, would have wiped out literally 3/4ths of all angel investors. The second iteration of Dodd-Frank was worse—it would have required all Rule 506 offerings to first be submitted to the SEC for 120 days for review, and if the SEC didn’t review then states would have been given the chance to review before offerings could go forward.

But for the involvement of the ACA, and folks like Dan Rosen and Senator Maria Cantwell, these things could have happened. Being involved is important. The upcoming ACA summit will be a great way to get started, if you are looking for a way.

Now is a critical time for angel investing in America. The SEC is currently evaluating a number of different issues that will have a dramatic impact on angel investing, such as:

  • The definition of “accredited investor.” It is possible that the SEC will propose to modify this definition to “define out of the game” a huge swath of the population that currently qualifies as accredited. See the ACA’s letter to the SEC.
  • The proposed Regulation D and Form D rules, that will require advance filings of Forms D and onerous consequences to companies if they file to advance file before they “generally solicit” their offerings.

(If you want to see the former Chair of the ACA, Catherine Mott in action, read the transcript of this SEC open meeting in which she questioned the SEC on whether demo days constituted “general solicitation.”) 

Policy makers need the input of people who are active in the early stage company ecosystem.

“We are hosting this meeting in Washington, D.C. for a reason,” ACA’s Chair David Verill said. “The Securities and Exchange Commission is not only assessing the underlying definition of who can be an accredited investor, but is also reviewing significant rules around the JOBS Act involving general solicitation and online crowdfunding platforms. Now more than ever is the time to join with angel colleagues to learn about, to shape, and to nurture this powerful economic engine.”

2014 ACA Summit

Angel Impact: Entrepreneurial and Economic Success

March 26th – 28th

Review the Agenda

If you plan to attend, please let me know and I can try to connect you to friends who will be there.

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The Unbearable Lightness (of Being an LLC)

LLC Stock OptionsI had a client press me recently about converting from an LLC (taxed as a partnership) to a corporation.  The client had been considering raising money from angels and wanted to grant traditional corporate-style stock option to employees.

I suggested that if he wanted to raise money from third parties (whether angels or venture funds) and grant traditional stock options to employees and service providers, that it would probably make sense for him to convert to a C corporation.

“Most investors don’t want to invest in a pass through company. Either an LLC or an S corporation,” I told him. “They don’t want to receive a Form K-1.  Plus, stock option style equity grants in an LLC are not easy; they require book ups and complex capital account maintenance accounting.”

He and his co-founder changed their minds about raising angel money. The client didn’t think they needed or wanted to raise money from third parties, but still wanted to give employees traditional equity incentives. Their concern was, if they converted to a C corporation and decided to sell down the road, the future buyer might only want to buy the company’s assets and not the stock – thereby giving rise to the dreaded double tax.

“It is possible that if you convert your LLC to a C corporation that you could spend several years growing the business, and then have a buyer demand to buy the assets and not the stock,” I said. “If that happened and you went ahead and had the C corporation sell the assets, there would be a corporate level of tax owed that you would have avoided had you remained an LLC.”

“However,” I added, “there are still a number of good reasons to be a C corporation, and the likelihood of what you described happening is, in my experience, not common. You see, most ‘up’ deals are stock deals, or structured one layer of tax transactions, such as reverse triangular mergers.”

The client remained uncertain. I couldn’t tell the him that what they were afraid of was out of the realm of possibility, because frankly, it was a possibility. I have seen it happen on a few occasions in my career (granted, it’s been a long time).  On at least one occasion in the past, a C corporation received an acquisition offer on its assets.  The buyer wouldn’t budge on its demand to buy assets and not stock. In that case, due to the adverse tax consequences, the C corporation had to pass on the deal.

“Well, we want to remain an LLC then,” the client said.

“OK,” I said “but keep in mind that if in several years an acquiror company wants to acquire your company in an all stock transaction, you won’t be able to defer your gain on a stock deal until you sell the stock.”

“What do you mean?”

“Well, it is not uncommon for some acquirors, especially public company acquirors, to purchase other companies in all stock or mostly stock transactions.  Meaning, your stockholders will receive a portion of the deal (at least 40%) in stock, which might not be liquid.  In that case, they won’t be able to sell it for some time.  But if you are an LLC, such an acquisition could not qualify as a ‘reorg’ under the tax law, thus you would be taxed on the stock as if you received cash and turned around and bought the stock.”

“That sucks,” he said.

“I know,” I replied.

“What do I do?”

He wanted me to make the decision for him; to end his agonizing over the decision. I couldn’t do it.  It was his business; his decision.

“If I just stick as an LLC,” he said, “just how bad will it be again?”

“Well,” I said, “you will have to worry about book ups, and capital account maintenance, and a complex LLC agreement. But there are worse things that could happen to you than spending quality time with your tax lawyers and tax accountants. Just enjoy.”

“Plus,” I added, “if you remain an LLC you will not have to worry about a double level tax on sale of the LLC and you can always convert to a C corporation later.”

Conclusion

Choice of entity is not always easy.  Sometimes it is agonizing.

Posted in Business Entities, Equity Compensation | Tagged , , , , , , , , | 1 Comment

Section 1202: Original Issuance

Section 1202 Original Issuance

Question

I am a small business owner and investor who read your informative blog post “Section 1202, Qualified Small Business Stock.”  However, I would like to ask for your clarification of an important requirement for the small business stock capital gain exclusion.

Concerning the “original issuance” requirement, you stated that “QSB stock means any stock acquired on original issuance by the taxpayer from a domestic C corporation…”

My understanding of the meaning of “original issuance,” is that it is stock issued by a corporation at the time of its incorporation, and does not include new stock subsequently authorized and issued by the corporation at a later time.  Practically speaking, this would mean that QSB “original issue” stock could be purchased from a new startup, but not from a corporation that had been in existence for a year, whose directors opted to raise capital by authorizing and offering a new issue.

Alternatively, does “original issue” simply mean stock an investor purchased directly from the issuing C corporation (or through its underwriter), as opposed to acquiring the stock from another investor, or from a broker?  Must an investor desiring the benefit of the gain exclusion provided under Section 1202 purchase only from a startup at its time of incorporation?

Short Answer

The short answer:  Section 1202 can cover shares issued at any time and from time to time after the incorporation of the Company, provided the various requirements of Section 1202 are met at the time the shares are issued and throughout the time the shares are held.

Not-So-Short Answer

Internal Revenue Code section 1202 defines “qualified small business stock” as any stock in a C corporation which is “originally issued” after the date of the enactment of the Revenue Reconciliation Act of 1993, if:

(a) as of the date of the issuance, the corporation is a “qualified small business,” and

(b) except as provided in subsections (f) and (h), such stock is acquired by the taxpayer at its “original issue” (directly or through an underwriter) –

(i) in exchange for money or other property (not including stock), or

(ii)as compensation for services provided to such corporation (other than services performed as underwriter of such stock).

The statute does not define “originally issued” or “original issue.”  But a plain English reading of the phrase would mean to me, as a lawyer, that the shares are supposed to come directly from the company – not purchased from another shareholder.  In other words, shares purchased on the secondary market wouldn’t qualify.

Nowhere does the statute say that the stock has to be issued at the time of incorporation.  If Congress had wanted to say that Section 1202 only worked for shares issued as part of the incorporation process, it could have easily done so.

Plus, there is language in the statute which would be completely incongruous with the meaning of “original issue” being  only at the time of incorporation.  For example, the reference to an “underwriter.”  Underwriters aren’t typically present at incorporation.  Similarly, Section 1202 (c)(3) says that stock acquired by the taxpayer will not be treated as qualified small business stock if at any time during the 4-year period beginning on the date 2 years before the issuance of the stock, the corporation issuing the stock purchased any of its stock from the taxpayer or a person related to the taxpayer.  If the statute only covered shares issued at incorporation, the inclusion of the 2year look back language wouldn’t make sense.

There are a number of things that have to happen in order for stock to be “qualified small business stock,” but none of them is that the stock has to be issued on the incorporation or in connection with the incorporation of the company.

In other words, stock issued several years after the incorporation of the company can qualify, if the various requirements are satisfied.

To give you a sense of some of the things that are required:

  1. The aggregate gross assets of the corporation before and after the issuance of the shares cannot exceed $50,000,000;
  2. The corporation must be a domestic C corporation;
  3. The corporation must be engaged in an active trade or business; and
  4. The corporation’s business must be a “qualified trade or business.”

So, to answer your question, there is no requirement in Section 1202 or the regulations under Section 1202 limiting the benefits solely to stock issuance at the time of incorporation.

Posted in Startup Jargon/Definitions, Startup Law | Tagged , , , , , | 3 Comments