Science & Technology Parks in China and Tax Free Zones in the U.S.

I recently sat in on a great panel about doing business in China hosted by the Manufacturer’s Association of Central New York (MACNY) put on by a client of mine, Tech Bridge International, Inc.  Tech Bridge is an international business development and quality consulting company.  It provides consulting services, connections and introductions to Chinese businesses and government officials for companies seeking to do business there (it also operates in Japan).

The conference was interesting for many reasons, but mainly because of the discussion regarding the industrial, science & technology parks in China and the innovation they were driving there.  I had intended to write a post on this a while back, and that’s why I was pleasantly surprised to hear Governor Cuomo’s Tax Free NY proposal yesterday, which he announced in a few Upstate New York cities (Albany, Buffalo, Syracuse). Read more

Series LLCs

If you are one of those people who is tired of having to form seperate entities (LLCs or corporations) for each type of business you operate, or for each piece of real estate that you own, a Series LLC may be useful to you. Nearly a decade ago, the state of Delaware introduced a legal entity that would become known as the Series LLC. Despite its origins in Delaware, several other states have now started to permit the usage of Series LLCs.  Read more

The Marketplace Fairness Act of 2013 a/k/a the Internet Sales Tax Act

As you may have heard, the Senate is working on a bill which looks like it may be passed on May 6th called the Marketplace Fairness Act of 2013.  If passed into law (it looks like the House will also approve it, but we’ll see) it would allow state governments to force Internet retailers to collect sales tax from their customers and remit the proceeds to the state and local governments where the purchaser lives. The States would have to provide free software to Internet retailers which would allow them to do the calculations, and Internet retailers with revenues under $1M would be exempt.  That’s some small relief.

There are seemingly two goals of the legislation.  The first is to fund state and local governments which are, for the most part, starved for cash and seeking any new revenue sources (ie tax moneys) they can find. Second, brick and mortar retailers claim that they are at a disadvantage because customers can come in and look at items in their stores, check the price of the item on their smart phone and then order the same item online and not have to pay any sales tax on it.

My thought is that the effect of the legislation, if passed into law, would be more economically stifling (from a nationwide perspective) than it would actually serve the goals it presumes to address. Read more

How to form a Single Member LLC in New York State

There are a lot of small businesses out there operating as sole proprietorships, that is they operate the business through the individual(s), and there is no formal entity.  Many sole proprietors tell me that they’ve filed a d/b/a with the local county (here, the counties of Onondaga, Tompkins or Monroe), and therefore believe that is all they need to ensure that they are not personally liable, but this is not correct.

The main reason people incorporate or organize LLCs is to limit liability.  Debts and contractual obligations are not something that you want to owe personally if you can avoid it.  Setting up an LLC will create a seperate legal entity from yourself that you will operate the business through, own business assets, and contract through.  Not much has to change when you form a single member LLC.  LLC’s are also useful because the IRS will let you choose how you want the LLC taxed (either as a disregarded entity, S corp or C corp).

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IRS’s “Check the Box” Regulations for LLCs

There are many reasons why LLCs can be great for business owners.  For those types of businesses that have revenue and don’t need outside investors or to issue stock options (although LLC profits interests can work), LLCs are a good choice.

For a lot of startup companies, a corporation may be the right choice, especially if it will be seeking investors, plans to be acquired by a larger player in the industry at some point, or would like to have an IPO or other offering. The choice for a lot of companies especially in the high tech sector is the corporation. But if those aren’t your goals, if you have a business plan, target market, product and are ready to sell and make revenue then an LLC may be the right choice for you. Whatever industry you are in, an LLC can be a beneficial entity to use. LLCs can do complex and sophisticated things with respect to splitting profits, can have interesting classes and structures, require less paperwork than would a corporation, and are by far more flexible. (I’ve kind of beat the LLC v. Corp. horse to death earlier so will get to the point now). One of the other great advantages of the LLC form is that it can elect (i.e. choose) to be taxed as either disregarded entity (if one member then a sole proprietorship, and if multiple members than a partnership), an S-corporation or a C-corporation.

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Stock Appreciation Rights

Another way to compensate employees of a corporation is to issue them Stock Appreciation Rights (“SARs” – not “sars – severe acute respiratory syndrome”, that’s something else).   SARs grant employees, usually higher level executives, the right to receive stock and/or cash at a future date in an amount pegged to the increase in value of the corporation’s shares of stock over a certain time period.  If the company’s share value increases, so to does the value of the SARs.   SARs often are offered along with traditional stock options, although they are granted seperately (if done with stock options, sometimes you will see them called “Tandem SARs”). Read more

New York’s Proposed Angel Investor Tax Credit

I’ve been following a bill proposed by New York Assembly member Kellner for a while now.  It is an Angel Investor Tax Credit, available to investors in “qualifying businesses”.   New York Bill No. A09958.  Investors would receive a credit based on 25% of their investment, but the maximum investment you can obtain the credit for is capped at $250,000.

A qualifying business is one that:

  1. has gross revenue of less than $1M for the year before the investment;
  2. has no more than 20 full time employees (60% must reside in NY State);
  3. has operated in the State of NY for no more than seven consecutive years; and
  4. has received no more than $2M in investments (eligible for the credit from one or more angel investors)

To be eligible for the credit, the angel investor must be an accredited investor as defined in Rule 501 of Regulation D, except for those that either 1. control fifty percent or more of the company being invested in, or 2. any company whose normal business activities include venture capital investment.

First, the idea is noteworthy.  A number of other states have passed similar credits to encourage angel investing.  In Wisconsin, they passed such a credit and angel investments increase from $30M in 2005 to $180M in 2010.  That’s staggering.   I would prefer to see that the credit be available for seed/angel and venture capital companies, however.  I think excluding them is a bad idea.

There are some critics of state angel investor tax credits.  They are usually out of state VC funds and investors.   They say that these types of credits would discourage interstate investing, such as Boston based VC’s investing in New York startups, and other such situations.  I don’t know if those critiques are warranted, however, as out-of-state investors aren’t penalized in any way other than having more competition in New York State.  As investors in-state are now sure they will at least recoup 25% of their investment in the year after they invest, as well as having the possibility for large returns (i.e. the home run) down the road.

The bill was referred to the ways and means committee in April and held for consideration there in June.  There hasn’t been much action on it since then and won’t be until at least 2013.  It is something to keep in mind however as any incentive that can be put on the table to get the economy moving, especially the startup community is a good idea.  Access to capital is a big issue for many young companies.

Using “Convertible Equity” instead of Convertible Debt

As I’ve discussed, an option for startups to raise money is to do a convertible debt financing.   In this sort of a transaction, the investor gives the company a loan evidenced by a convertible promissory note.  The note is convertible upon a later financing round into the same type of securities that the financing round’s investors receive, and the note holder gets a discount on the per share purchase price.   The benefits of this are that it is generally much quicker and straightforward than a typical seed/angel round and the company and investor do not have to have the awkward and difficult conversation regarding valuation of the company.  The detriment to this type of transaction is that the company’s balance sheet is saddled with debt, and if the company does not raise another round of investment before the term of the convertible promissory note comes due, then the investor can essentially bankrupt the company if the investor does not want to extend the due date.  Also, there are a good amount of investors that do not like investing through a convertible note, as one of the important terms – how much of the company the investor will own – is up in the air.

Recently, TheFunded.com and the Founder Institute annouced the introduction of a new concept called “Convertible Equity”.  The concept and draft documents, were put together by Yokum Taku or Wilson Sonsini and a top accounting firm. TechCrunch has a good write up on it.

The form documents are available for free download here.

From a quick review of the documents it seems to be a great compromise.  There would be no more maturity date or interest due.  The startup will not have any debt on its books, and the investors would have the opportunity to qualify for the exclusion available on gains for holding “qualified small business stock”.  It will still leave open how much of the company the investor actually owns, however, but that can probably be resolved using a valuation cap or some similar mechanism that can be drafted into the convertible equity documents.

The documents appear to automatically convert into shares of the company stock upon a change in control or qualified investment.  There doesn’t appear to be an option for the investors to decide to convert at will or in any other circumstance, although certain provisions can be added for different situations.

This would be great if it gets adopted in the startup community, but like anything, it may take awhile.  I know I will be recommending it as an alternative to convertible debt.

Joint Ventures 101

In many industries there are opportunities for individuals or companies to team up with one another to accomplish a mutually beneficial goal.  This is most commonly accomplished by way of a joint venture.

A joint venture is somewhat amorphous as a concept as there are no bright line legal rules.  It is a contractual arrangement, either through an outright joint venture agreement, an oral agreement, an LLC through its operating agreement or something similar.  This post gives a broad overview of what it is and why it may be something that would work in your situation.  We’ll look at it in more depth in future posts.

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Pricing Stock Options – IRS Code 409A Treatment @ Paper this Deal

We’ve covered the bare basics of stock options on this blog before.  Here we will look into something that is all important when issuing stock options – that is the option’s exercise price.  The exercise price is the amount an option holder needs to pay in order to exercise the option to receive the share of underlying stock.  Most option holders will not exercise their options until the price of the underlying stock has risen higher than the exercise price, so that they can receive the shares and then sell on the open market for a profit.  The IRS got keen on the fact that a company could issue stock options with an artificially low exercise price, which would allow the option holder to immediately exercise the option to receive the shares with the greater value and sell those shares, which is in effect as if the company paid cash to the option recipient.  Hence Section 409A voted into effect in the American Jobs Creation Act of 2004.  The reason stock options can receive beneficial tax treatment is because they are treated as deferred compensation.  To get that treatment, stock options should only be granted with exercise prices at or above the fair market value (“FMV”) of the underlying shares of stock on the date of the option grant.

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