Start-up accounting quandry I know you've faced. | Hacker News Reader

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

4 pointsDonCarlitos8 comments

What is the best way to structure your start-up to avoid the tax hit involved with taking founder's stock for sweat equity?

View on HN

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.

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.

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.

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/...

You can search searchyc.com to find others.

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.

'Quandry' is actually spelled Quandary.

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

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.

Reply on news.ycombinator.com