
Tell HN: Company returned 3X, but I (investor) may lose money - beagle3
[US Tax Payer here]<p>I invested X into the company, with a post-money valuation of Y (a minor investor). The company was bought for 3Y. Sounds good, right?<p>However, the deal was structured such that 1Y was paid in cash, and 2Y was paid in stock of the buying company. (1X and 2X is my respective share of the deal)<p>So, I got my cash back; the 2X is considered immediate ordinary income, taxed at 35% federal + 13% NYC. So, I'm 48% down on the 2X already.<p>Enter SEC rule 144 - I'm not allowed to sell these in the first 6 months. That might have been ok, if the buying company didn't go down some 40% since then.<p>So, I'm still more than break even, but not a lot more. If the company goes down (in total) more than 52% in those 6 months, I'm going to be losing money on a successful investment.<p>Thanks to US security and tax laws.
======
ldd-
Sounds like you're in the same boat as everyone else in your round, right?
It's simply a function of the timing of the deal (less than a year since you
invested, apparently) and the deal structure (cash vs. stock).

Stock inherently requires the acquired company to share the risk of the deal.

If the stock goes down further, you should be able to claim the loss on your
taxes when you sell, which should mean you would need more than a 52% total
decline to go in the red on the deal.

Are you an accredited investor? If not, you may have some legal outs to demand
your money back, but you'd need to chat with a lawyer. If you were to pursue
that route, though, you'd likely ruin any credibility to make future
investments in other companies.

Kinda stinks that there's the gap between tax law and SEC regs timing, though.
Good luck with the investment!

~~~
beagle3
> Sounds like you're in the same boat as everyone else in your round, right?

5% of the investment is accounted for by US tax payers. The rest are not, so
I'm not in the same boat.

> If the stock goes down further, you should be able to claim the loss on your
> taxes when you sell, which should mean you would need more than a 52% total
> decline to go in the red on the deal.

No. The tax event is on the grant, not a capital gain (therefore capital loss
does not cancel). Furthermore, if I fall under AMT (very likely), I can't
deduct anything.

> Are you an accredited investor?

Yes.

~~~
ldd-
>No. The tax event is on the grant, not capital gain (therefore capital loss
does not cancel). Furthermore, if I fall under AMT (very likely), I can't
deduct anything.

Ooph . . . sorry. However, just so I understand, if your shares were to rise
above the transaction price, would you not be subject to capital gains tax on
the gain? It would seem a bit misaligned if you could be taxed on gains but
not benefit from losses (however, I wouldn't put that past the codes and that
still wouldn't account for AMT issues).

Good luck with it!

~~~
beagle3
> if your shares were to rise above the transaction price, would you not be
> subject to capital gains tax on the gain?

Yes. The way the IRS views it, I was given a an ordinary income bonus which
consisted of new shares, and which was valued at $Z during the grant (and
taxed as such, at that second). From now on, I own shares, so capital
treatment goes into the future. If the stocks drop, I will have capital loss
when I sell them -- but I need some other capital gain to net against.

------
hluska
Sorry you're going through this, but it is a great example of how certain tax
and security laws create unhealthy barriers to the free market. Personally,
I've never understood the logic of paying tax on stock that you receive before
you dispose of it. Seems that tax policies like this do nothing but keep small
investors out.

~~~
antimora
And the sadder part is that richer investors know their way around those taxes
better than new comers because they have access to accountant professionals
who can advise to pay less tax.

~~~
sa5
I'm not a tax expert so this assumption may be wrong, but if the 2X is being
taxed as ordinary income at 35% wouldn't that imply that beagle3 is making at
least $379,150 + 2X this year? I would consider someone with that kind of
income to be rich.

Also, if the stock has gone down 40% can't you claim that as a loss when you
sell and lessen your overall tax burden?

~~~
anamax
> wouldn't that imply that beagle3 is making at least $379,150 + 2X this year?
> I would consider someone with that kind of income to be rich.

So what?

Seriously - do you think that the US govt or NYC is likely to do better with
that money than he would have? Based on what?

~~~
sa5
In my comment I did not state whether I agree or disagree with the current US
tax laws and that was not the point. I was responding to the post above mine
which I think made some incorrect assumptions concerning beagle3's income
level and ability to afford professional accountants.

------
maxharris
It's obvious, but this fact escapes so many people today: we do not have
capitalism in the US.

What does a free market mean, anyway? Free of what? It means freedom from your
neighbors, no matter if it's just one of them breaking into your house at
night, or a whole bunch of them voting for laws to take what's rightfully
yours by day. To put it another way, in a free market, others can't control
when you buy or sell, nor can they take your money by force or fraud, even if
they call it "taxes."

~~~
regularfry
Capitalism doesn't require a free market, and the definition of a free market
allows for tax collection by the government.

Your definition of both is simply wrong.

~~~
maxharris
I don't agree.

Here's the most definitive definition of capitalism (written by what many
today acknowledge as its greatest champion):
<http://aynrandlexicon.com/lexicon/capitalism.html>

From the link: _Capitalism is a social system based on the recognition of
individual rights, including property rights, in which all property is
privately owned._

Today, we don't come close to this ideal. One example of this is that the
government is the largest single landowner in the country:
[http://strangemaps.files.wordpress.com/2008/06/map-
owns_the_...](http://strangemaps.files.wordpress.com/2008/06/map-
owns_the_west.jpg) Need I mention Fannie Mae and Freddie Mac, the alphabet
soup of regulatory agencies, the Federal Reserve, the giant social programs
that redistribute forcibly? None of these things existed a century ago when
this country was on the rise.

 _When I say “capitalism,” I mean a full, pure, uncontrolled, unregulated
laissez-faire capitalism—with a separation of state and economics, in the same
way and for the same reasons as the separation of state and church._

This is something we've never had, even in the 19th century. When we do, the
human flourishing unleashed will make the lives for those who live it more
vibrant and fulfilling than anything seen before on Earth.

~~~
sorbus
> From the link: Capitalism is a social system based on the recognition of
> individual rights, including property rights, in which all property is
> privately owned.

The real definition, from wikipedia: "Capitalism is an economic system
structured upon the accumulation of capital in which the means of production
are privately owned and operated for profit, usually in competitive markets."
Ayn Rand's definition looks more like libertarianism ("a political philosophy
that upholds individual liberty, especially freedom of expression and action
... minimization of the state and sharing the goal of maximizing individual
liberty and freedom.").

------
turbojerry
Why didn't you invest the money via a loan to an offshore company that then
invested the money? That way you'd only pay tax when you paid yourself out of
that company.

------
anamax
Why wasn't some of the cash treated as tax-free return of capital?

If all of your investment was treated that way, you'd just be hosed on the
profit that you made on the deal. Yes, that ignores the time value of money,
but ....

------
dpe82
I always thought these deals were typically done as stock swaps so it doesn't
affect your capital gains?

~~~
beagle3
Only if done in very specific way (google "triangular merger", there are
several variations).

This deal wasn't, and I wasn't in the driver seat to make it that way.

~~~
dpe82
That's what I thought. How do they offer cash in that type of deal? As a fixed
price purchase agreement that hits after the holding period?

(I'm still learning how all of this works..)

~~~
beagle3
No, there can be a cash at the beginning, no larger than 20% or 50% of the
deal (depending on whether it is reverse or forward merger. Get a tax
specialist if these details matter to you and you are in the driver seat)

~~~
dpe82
With any luck perhaps some day I'll be in the driver's seat. For now I'm just
taking advantage of whenever I see an opportunity to pick up some knowledge.
:)

------
teyc
Couldn't you have written 6-month PUT options?

~~~
beagle3
I probably could. The stock went down during the week I was trying to get
clearance from my lawyer :( It used to be illegal to hedge against SEC rule
144; Apparently, it is now legal (but check with your lawyer before you hedge
-- don't trust an anonymous person on the internet)

~~~
teyc
Sorry, I should have mentioned IANAL and not even a US citizen. It'd probably
be seen as trying to circumvent laws wouldn't it? That'd be bad.

On the other hand, the major investors would lose out even more wouldn't they?
Didn't they build any protection into their sale clauses?

------
NonEUCitizen
Do SEC rules prohibit you from hedging?

~~~
beagle3
They used to explicitly prohibit you.

As far as I can tell, they don't explicitly prohibit you but they say
something like "we'll look at it badly if you do" in their publications. Make
of that what you will.

~~~
aquark
Why would they care? I really can't think of a rationale for that stance.

OTOH why would I presume one should exist?

~~~
beagle3
Well, it's basically a protection against intricate pump-and-dump schemes that
include mergers and acquisitions - the rule basically says shares allocated
(rather than _bought_ or invested into) need to be held for 6 months. (It is
sometimes known as "lockup period", and versions of it exist in many
countries).

However, the entire allocated stock in this deal is ~1% of the buying company;
so this protects no one. Even if all of the allocated shares were sold on day
1, the stock would not have moved more than ~5% as a result. However, the
market conditions has caused it to move 40% in a week.

------
damoncali
Ouch. Now you know what it feels like to work for a startup.

