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andrewljohnson 1217 days ago | link | parent

I talked about this with my investors and my lawyer (I'm lucky enough to have Grellas counsel me).

If you are like my company, and you have some small amount of convertible debt, and you are ramen-profitable but don't have a valuation, there are many reasons why this may not be worthwhile.

I'll leave it to Grellas to explain... note that this was prior to the extension of the law:

The “qualifying small business” (QSB) stock rules let anyone who invests in qualifying stock (meaning stock in a C corp) by December 31 of this year, and who subsequently holds such stock for at least 5 years, avoid any capital gains tax and also any AMT on the eventual sale of that stock...

... Pricing the stock also has implications for the grant of future equity incentives to other key people and so you need to consider not only pricing but also issues such as having to do a 409A valuation the next time you grant options to anyone in the company.

... The company would need to authorize their conversion in the absence of a qualified funding and will need to authorize a form of preferred stock into which they can convert. It is possible, of course, to have the notes convert into common stock but this puts a very high value on the common and makes it difficult to grant future incentive stock to key people without pricing it at a high level (the law allows as much as a 5 to 1 pricing differential between preferred and common and so, if preferred stock is used instead of common, you can still make future incentive grants at 1/5th the price of the preferred).

This led me to conclude that it's not worthwhile to convert, and George confirmed:

I think it is marginal for the company and its noteholders at this point and makes sense only if there is a fairly strong sense that people will hold for 5 more years. It would inject at least several thousand in costs (at least $10K, with some $5K to $7K out of pocket as a lump sum, if a 409A appraisal should be needed to price option grants and the like) and would add tax complications in terms of stock pricing in the short term – and so, yes, I would say you should likely skip it.

That said, if you are looking to invest in a great start-up and this tax break is meaningful to you, shoot me an email, and I'll send you my pitch :)




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