

Start-up accounting quandry I know you've faced. - DonCarlitos

What is the best way to structure your start-up to avoid the tax hit involved with taking founder's stock for sweat equity?
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HelgeSeetzen
Caveat: I am not a tax lawyer, nor accountant. Moreover, I am writing this
from Canada so your local tax law might be different.

It sounds like you have already created a non-zero valuation for your equity
(a fair market value established by your funding round). So that creates a
corresponding tax liability if you just award equity to your new co-founders
(without liquidity).

Option A: If the share value is still fairly low and the amount of equity that
you want to award is modest then I would just take the tax hit. The company
could cover the employee via an interest free loan that is offset by any
future liquidity gains.

Option B: If we are talking about a huge equity/value piece but an early stage
company then you might consider setting up a new company, assigning founder
equity at near zero valuation and then transfering all assets of the old
company to the new one. This creates some accounting and legal work but might
be worth it if you are early stage and are looking at major equity changes.
Just watch out that previously accummulated tax liabilities, tax credits and
subsidies of the old/current company get captured properly.

Option C: Issue stock options at fair market value instead of equity. This is
probably the simplest option but won't give your new co-founders as much
control (which might or might not be a good thing).

Definitely best to spend a bit of money with a small business tax guy though.

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jhancock
Distribute equity to co-founders from day-1 or close enough to when the
company has a small value. Its very legit to justify a small value of say
$1000 (total share value) if you have no income and no investment yet without
regard to when you incorporated. Equity comes with reverse vesting params.
Each year, you vest 1/3 shares or tie vesting to hours worked, whatever
fits...attach other params to taste, like "for-cause" termination, accelerated
vesting for acquisition, etc. Bottom line is the shares are transferred prior
to the company having much value...Whatever doesn't get vested gets sold back
at the original purchase price (pennies to hundreds of dollars, small
change)...tax problems gone.

I am not a lawyer. This is a summary of what a lawyer setup for a past company
of mine. This stock structure worked well and passed many rounds of due
diligence from subsequent investors.

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DonCarlitos
Thanks. Unfortunately we entered the market with some value, then sold a few
shares to friends & family with a set price. Now we appear to be constrained
by the value we set on the few shares we sold.

~~~
jhancock
If the value you have is too high to enable "founders" to buy in, you probably
have to issue them options instead. These contracts and accounting get more
complicated. Best dig through a couple of the free startup legal kits that
have been published on HN from time to time.

Here's one:
[http://www.orrick.com/practices/corporate/emergingCompanies/...](http://www.orrick.com/practices/corporate/emergingCompanies/startup/index.asp)

You can search searchyc.com to find others.

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eengstrom
There are two people I love more than cats, despite conventional hatred of
them as a class of people:

My CPA and my Attorney

While it may seem expensive now, spending $2500 in consultation will save you
a heck of a lot more in tax liability or legal action down the road.

One of the first markers for success is the willingness to pay for experienced
and informed advice. Don't mess around and call an EA/CPA/accounting service
tomorrow.

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evo_9
'Quandry' is actually spelled Quandary.

~~~
DonCarlitos
thanks, a process of my stress around the tax hit I'm evidently going to take
:-) Ack, reboot.

~~~
evo_9
No problem - I actually just bought a website name with that word in it
(ExistentialQuandary.com - not up yet though) for a new blog I'm working on
and that's when I discovered I'd been misspelling it for years. Otherwise I
doubt I would have ever noticed either.

Talk about a major 'd'oh' moment... nobody mentioned it to me before, figured
others were probably unaware of its odd spelling as well.

