Obama proposes no capital gains tax on qualified small business stock
May 13, 2009
This week, the Obama Administration released the first comprehensive summary of its budget proposal. The budget proposal is wide ranging, and includes, for example, proposed changes with respect to the taxation of “carried interests” in partnerships, as well as sweeping reform of the international tax area. One proposal would dramatically improve the treatment of “qualified small business stock” issued after February 17, 2009.
The budget proposal would modify IRC Section 1202 to provide for a complete exemption from capital gains tax for qualified small business stock issued after February 17, 2009 and held for five years, and the amount excluded would not be added back for alternative minimum tax purposes. If enacted, this would significantly enhance the tax incentives currently available for qualified small business stock. Under current law, the exclusion for purposes of the regular income tax system of 50% of the recognized gain on the disposition of qualified small business stock (which was increased by the recent American Recovery and Reinvestment Act to 75% for issuances in 2009 (after February 17, 2009) and in 2010) is substantially undercut by the combination of the high rate of tax (28%) applicable to the non-excluded portion of the gain under the regular income tax and the interplay between the AMT rules and Section 1202. Thus, historically, the principal federal tax benefit of qualified small business stock has been the ability to achieve “rollover” treatment of the proceeds from the sale of qualified small business stock under IRC Section 1045.
In light of the potential for this significant benefit associated with qualified small business stock, all venture financings should be analyzed very closely from a qualified small business stock standpoint. In addition, post-financing transactions, particularly stock redemptions, that potentially could undermine qualified small business stock status should be carefully reviewed.
The relevant provisions of the summary of the budget proposal related to qualified small business stock are below.
ELIMINATE CAPITAL GAINS TAXATION ON INVESTMENTS IN SMALL BUSINESS STOCK
Current Law
Taxpayers other than corporations may exclude 50-percent (60 percent for certain empowerment zone businesses) of the gain from the sale of certain small business stock acquired at original issue and held for at least five years. Under ARRA the exclusion is increased to 75 percent for stock acquired in 2009 (after February 17, 2009) and in 2010. The taxable portion of the gain is taxed at a maximum rate of 28 percent. Under current law, 7 percent of the excluded gain is a tax preference subject to the alternative minimum tax (AMT). The AMT preference is scheduled to increase to 28 percent of the excluded gain on eligible stock acquired after December 31, 2000 and to 42 percent of the excluded gain on stock acquired on or before that date.
The amount of gain eligible for the exclusion by a taxpayer with respect to any corporation during any year is the greater of (1) ten times the taxpayer’s basis in stock issued by the corporation and disposed of during the year, or (2) $10 million reduced by gain excluded in prior years on dispositions of the corporation’s stock. To qualify as a small business, the corporation, when the stock is issued, may not have gross assets exceeding $50 million (including the proceeds of the newly issued stock) and may not be an S corporation.
The corporation also must meet certain active trade or business requirements. For example, the corporation must be engaged in a trade or business other than: one involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services or any other trade or business where the principal asset of the trade or business is the reputation or skill of one or more employees; a banking, insurance, financing, leasing, investing or similar business; a farming business; a business involving production or extraction of items subject to depletion; or a hotel, motel, restaurant or similar business. There are limits on the amount of real property that may be held by a qualified small business, and ownership of, dealing in, or renting real property is not treated as an active trade or business.
Reasons for Change
Because the taxable portion of gain from the sale of qualified small business stock is subject to tax at a maximum of 28 percent and a percentage of the excluded gain is a preference under the AMT, the current 50-percent provision provides little benefit. Increasing the exclusion would encourage and reward new investment in qualified small business stock.
Proposal
Under the proposal the percentage exclusion for qualified small business stock sold by an individual or other non-corporate taxpayer would be increased to 100 percent and the AMT preference item for gain excluded under this provision would be eliminated. The stock would have to be held for at least five years and other provisions applying to the section 1202 exclusion would also apply. The proposal would include additional documentation requirements to assure compliance with the statute.
The proposal would be effective for qualified small business stock issued after February 17, 2009.
What is TheFunded Founder Institute?
May 4, 2009
Adeo Ressi, the founding member of TheFunded, recently announced the establishment of TheFunded Founder Institute.
The Founder Institute helps founders launch innovative companies by providing training, services, and company-building assignments, such as incorporating the business, filing provision patents, and setting up books and records. The Institute offers a four month program, called a Semester, hosted initially in the Bay Area and then expanding to locations around the world. The program participants, the Founders, receive extensive training in weekly sessions overseen by three Mentors – two seasoned CEOs and one domain expert for each topic.
The driving beliefs behind the Institute are that (1) great founders are often overlooked by the current entrepreneurial ecosystem, and that (2) innovative startups have a dramatic positive effect on the global economy. Startup companies consume resources intelligently, put people to work in efficient ways, and produce market driven products at lower costs. Helping smart people start new companies should, in fact, help the global economy.
TechCrunch initially reported on the Founder Institute in March 2009. The Founder Institute has recruited 25 executives to serve as mentors for the founders participating in the program. The mentors will also lead weekly evening training sessions on company-building tasks. Founders are not expected to quit their day jobs to participate in the program, which starts on May 19, 2009 and ends on September 8, 2009. Sessions will be held in the San Francisco Bay Area at locations such as Stanford and Wilson Sonsini Goodrich & Rosati. Class sessions and course material will be available online. Although founders outside of the San Francisco Bay Area are welcome, founders in the Bay Area who are able to attend sessions in person are likely to benefit the most from interactions with mentor and other founders. Future semesters are expected to be held in other locations.
The Founder Institute will assist founders in setting up meetings with potential investors and other parties throughout the semester.
Applications
The Founder Institute intends to accept between 75 and 100 founders for the initial semester, although the size may be limited. Applications are due by May 10, 2009. Applicants must:
- Have a preliminary idea and a passion to build something
- Have not yet incorporated, though the Founder Institute will make some exceptions for existing businesses
- Focus on a high tech or innovative sector, such as biotech, cleantech, and information technology
- Possess reasonable training or domain expertise
- Pass basic background and reference checks
The application fee is $50, which only partially offsets costs associated with processing applications. If accepted, the founder must pay a $450 course fee to cover material and administrative costs. Microsoft BizSpark has provided a limited number of scholarships to the program. If a founder’s company raises more than $50,000 in debt or equity financing, excluding funds from the founder, within 18 months of formation, then the founder must pay a tuition fee of $4,500, which is used to cover the Institute’s expenses in providing the program.
Mentors
The Founder Institute has assembled 25 executives to serve as mentors for the participants and to lead weekly sessions. Mentors for the Summer 2009 Semester include:
- Trip Adler – CEO, Scribd
- Michael Arrington – TechCrunch
- Joe Betts-LaCroix – CTO, OQO
- Jason Calacanis - CEO, Mahalo
- Russ Fradin - CEO, Adify
- Scott Heiferman - CEO, Meetup
- David Higly - CEO Higley & Company LLC
- Jay Jamison – Founder, Moonshoot
- Philip Kaplan – Entrepreneur
- Eugene Lee – CEO, Socialtext
- Bubba Muraka – Business Development, Facebook
- Scott Painter – CEO, Zag
- Aaron Patzer – CEO, Mint.com
- Peter Pham – CEO, BillShrink
- Mark Pincus – CEO, Zynga
- Alain Raynaud – CEO, FairSoftware
- Ken Ross – Founder/CEO, ExpertCEO
- Munjal Shah – CEO, Like.com
- Jen Shelby – Managing Director, Astia
- Jeff Stewart – CEO, Urgent Career
- Brian Thatcher – CEO, Empressr
- Joe Zawadzki – CEO, MediaMath
Additional mentors will be announced shortly.
Curriculum
The evening training sessions will be held weekly with various company-building “homework” assignments. The curriculum is as follows:
Your Vision & Idea Types
May 19th, 2009: Identify a vision for your business
Description: How to articulate your vision and your passion. Does it involve intellectual property, model innovation, speed to market, market positioning? What is required for different types of ideas?
Mentors: Trip Adler | Philip Kaplan | Mark Pincus | Paul Harkins |
Basic Research
May 26th, 2009: Validate your idea with industry professionals
Description: Know your market, your competitors, and your idea. Can it be done? Will it work?
Mentors: Trip Adler | Mark Pincus | Jason Calacanis | Joe Betts-LaCroix |
Naming
June 2nd, 2009: Name your future business
Description: What’s in a name, and how do you choose a good one?
Mentors: Bryan Thatcher | Mark Pincus | Jay Jamison |
Intellectual Property
June 9th, 2009: File your provisional patents
Description: Practical strategy to getting your first patents quickly, cheaply, and with the necessary protections.
Mentors: Alain Raynaud | Eugene Lee | Joe Betts-LaCroix |
Roadmap
June 16th, 2009: Develop a plan to build your idea
Description: What it takes to get from an idea to an offering. What are common planning mistakes and how do you to avoid them?
Mentors: Trip Adler | Philip Kaplan | Munjal Shah | Jason Calacanis | Bubba Murarka |
Revenue
June 23rd, 2009: Create a revenue model for your business
Description: How to get it. How to grow it. How to track it. How to scale from the first sale to the millionth.
Mentors: Munjal Shah | Eugene Lee | Jay Jamison | Jen Shelby |
Books and Records
June 30th, 2009: Set-up accounting practices
Description: Set-up an accounting system to grow with your needs. What do you start with? Where do you end up after scaling?
Mentors: David Higley | Ken Ross |
Budgeting and Cash Flow
July 7th, 2009: Develop budgeting practices for your model
Description: What is right for a new business: annual, quarterly, or monthly budgets? What does a good budget process look like?
Mentors: Joe Zawadzki | Ken Ross |
Hiring and Firing
July 14th, 2009: Implement hiring policies and practices
Description: When to hire and when to fire? When is it ‘too late’? Choosing co-founders, and forming a founding team with a well-rounded skill set…
Mentors: Scott Heiferman | Joe Zawadzki | Jay Jamison | Paul Harkins |
Recruiting Success
July 21st, 2009: Identify world-class talent
Description: Who are the best in your field? Can you sell them on your vision?
Mentors: Jeff Stewart | Scott Heiferman | Russ Fradin | Bubba Murarka |
Exit Strategies
July 28th, 2009: Build a value generation plan
Description: How to prepare for an exit long before it happens. How to keep your start-up in the sights of both partners and buyers. How to build enterprise value every day. Don’t get caught off guard with an opportunity.
Mentors: David Higley | Peter Pham | Russ Fradin |
Vendors
August 4th, 2009: Select key vendors
Description: What to in-source. What to outsource. How to hire the best vendors for the best rates. What tools does the business need?
Mentors: Munjal Shah | Alain Raynaud | Peter Pham | Joe Betts-LaCroix |
Incorporation
August 11th, 2009: Incorporate the business
Description: How to set-up the right company structure to attract great employees and investors. What corporate formalities are required, and when?
Mentors: Ken Ross |
Marketing
August 17th, 2009: Create a messaging plan
Description: How to sell the story of your company and your offering.
Mentors: Bryan Thatcher | Scott Painter | Bubba Murarka | Joe Zawadzki | Jen Shelby |
Publicity
August 18th, 2009: Start outreach to key media sources
Description: Getting your vision and company name out there. From blogs to radio, what works and what does not?
Mentors: Philip Kaplan | Jason Calacanis | Peter Pham | Bubba Murarka |
The Funding Lifecycle
August 25th, 2009: Create a funding plan with targets
Description: What are the typical stages of the funding life cycle for different types of startup businesses? What kind of specific milestones should one expect to meet in order to progress through those funding stages?
Mentors: Scott Painter | Scott Heiferman | Russ Fradin | Paul Harkins |
Presentation
September 8th, 2009: Create a perfect pitchdeck
Description: How to explain and present your business to target partners and investors.
Mentors: Bryan Thatcher | Scott Painter | Eugene Lee |
Warrants and Bonus Pool
Each founder participating in a semester’s program will sign a Founder Agreement, which includes an obligation to grant a warrant to the Founder Institute to purchase 3.5% of the founder’s company’s fully-diluted capitalization immediately after an initial equity financing raising greater than $100,000. The exercise price will be the price per share to other investors in the financing. The founder’s company may terminate the warrant on or prior to the initial equity financing by paying the Founder Institute $100,000. In addition, if the founder is removed or resigns as a director and does not certify to the reasonable satisfaction of the Founder Institute that such resignation or removal was voluntary, then the founder’s company must pay the Founder Institute $100,000. Forms of the Founder Agreement and the warrant are available on the Founder Insititute website.
30% of the proceeds from the warrants received within five years from the start of a term shall be set aside in a bonus pool for the founders participating in a particular semester. In addition, another 30% of the proceeds will be set aside for the mentors, with a portion of that based on founder reviews.
Founder friendly documents
The Founder Institute has developed Class F common stock, which provides founders with a maximum amount of control over the founder’s company. TechCrunch and VentureBeat recently reported on this innovation and Adeo Ressi provided his thoughts in PEHub. A form of Certificate of Incorporation that includes provisions for Class F common stock, along with a form of restricted stock purchase agreement are available on the Founder Institute website. The Founder Institute requires founders to use these documents, or other documents approved by the Founder Institute, when forming a company.
[Disclaimer: I represent the Founder Institute.]
How much should you pay an executive in a startup company?
May 1, 2009
CompStudy publishes an annual report of equity and cash compensation that provides compensation data on top management positions and Boards of Directors at private companies in technology and life sciences. CompStudy covers more than 25,000 executives at 5,000 companies and is the largest study of its kind.
Data is analyzed by: founder/non-founder status, company revenue and headcount, geography, business segment, and number of financing rounds raised. Additional detail is provided on compensation for the Board of Directors, general organizational changes over time and other compensation trends.
The survey consists of a Web-based questionnaire, which can be filled out by a single member of a company’s executive team and takes approximately 45-60 minutes to complete.
CEOs or CFOs of startups in the US, China, India, Israel, or the UK in the technology or life science industry should consider taking the survey. Participants who complete the survey will receive the full results at no cost.
The 2008 results are available on Altgate and are also embedded below.
For example, below are the 2008 results for average equity granted at time of hire in IT companies:
- CEO 5.40%
- President/COO 2.58%
- CFO 1.01%
- Head of Technology/CTO 1.19%
- Head of Engineering 1.32%
- Head of Sales 1.20%
- Head of Marketing 0.91%
- Head of Business Development 1.23%
- Head of Human Resources 0.24%
- Head of Professional Services 0.60%
TheFunded Founder Institute
Apply to TheFunded Founder Institute. More information is available at "What the TheFunded Founder Institute?"