By: Eric Evans
Entrepreneurs and early investors are faced with many business decisions and challenges. An overarching challenge is to scale a business using what is often limited debt and equity financing, prior to being cashflow positive.
The business’ U.S. tax structure can dramatically impact cashflow as well. For example, the U.S. corporate income tax rate is a flat 21%, while the small business flow-through tax rate can be upwards of 29.6% or more.
Given entrepreneurs’ limited tax technical background, they often-times rely on professional advisers to help them decide what US legal and tax structure to utilize. However, the considerations and factors required for an appropriate analysis, and in some cases a detailed-modeling exercise, can be extremely nuanced and fact-specific.
Over the lifetime of their venture, from launching their start-up through the final year exit the total U.S. and state employment and income tax burden incurred by the company and owners can vary by several million dollars or more, depending on the U.S. tax regime chosen.
Additionally, short-sighted advice at the outset can cost entrepreneurs and their investors after-tax cash, that for example, could have been invested in venture #2 on a tax-deferred basis. Specifically, there is an ability to “roll” sales proceeds into subsequent ventures under Sec. 1202, not unlike Section 1031 real estate property exchanges.
Finally, with a combined holding period of five years for one or more Sec. 1202 venture businesses, entrepreneurs and their investors can realize $2.5M (or possibly exponentially more) in permanent U.S. and state income tax savings under the provisions of Section 1202.
Please reach out if you would like to learn more, I would be happy to discuss further with you or your portfolio company founder to ensure each shareholder can take advantage of an optimal tax structure.
Eric Evans, Tax Partner