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Ask HN: How do I minimize the taxes from selling my startup?
84 points by exitingfounder on May 1, 2011 | hide | past | favorite | 52 comments
I'm about to sell my company. Because the company has existed for less than 1 year, I'm subject to short-term capital gains tax - about 35%.

The tax code stipulates that, if I invest the proceeds in a "qualifying small business" and leave it there for just a few more months, the proceeds of the original and the new investment are treated as long term capital gains - 20%.

Even better: if the proceeds stay in a QSB for more than 5 years, the whole thing is tax free, due to this: http://www.cpa2biz.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2010/CorpTax/TaxExclusion_Expanded.jsp

I'm fairly certain that there's a win/win/win here: a way I can use my proceeds to invest in a small business, create jobs (the goal of the tax break), make the economy better, but not take on the kind of risk that comes with a traditional tech startup angel investment. I've thought about buying a diversified portfolio of franchised businesses, for example, or creating a holding company that makes many small investments.

But I'm not a financial genius, there's always gotchas, and I don't want to re-invent the wheel. I've talked to two startup lawyers, a financial planner, and two CPAs, and while they can explain the mechanics, none of them have good suggestions about implementation.

Does anyone know of solid strategies for sheltering investment proceeds in a QSB without taking too much capital risk? This information would be really helpful to anyone here who successfully sells their company!




For legal advice, you apparently have money, so talk to the people who trade money for legal advice.

Are you positive that selling your company is the only mutually beneficial transaction you and the acquiring party can arrange? There are many possible options, with VASTLY different tax consequences but only minorly different changes on the ground. Stock sale != asset sale != IP licensing agreement != sudden decision of all key employees to change jobs.

Consider BobSoft, a hypothetical company with three engineers and some IP which is 100% owned by Bob. If BobSoft gets acquired by Google via Google buying all the shares from Bob, Bob has capital gains up the wazoo. If on the other hand Google buys all the assets of BobSoft, BobSoft continues to be a going concern. It continues paying Bob a salary for a few more months, puts around doing whatever BobSoft would do in the absence of their main line of business, hits the magic day on the calendar, and then buys all stock in itself back from Bob, who now has long-term capital gains. BobSoft then spins down in an orderly fashion.

Ask your competent legal advisers for how to work this such that you don't trigger the ire-RS. This is what they do.

More broadly: every tax cutout, no matter how well-intentioned, distorts the economy by paying smart people to spend more time figuring out how to hit the algorithm versus doing whatever they would otherwise do to earn money.


> More broadly: every tax cutout, no matter how well-intentioned, distorts the economy by paying smart people to spend more time figuring out how to hit the algorithm versus doing whatever they would otherwise do to earn money.

Worse, the smart people often figure out a way to go beyond whatever tax break was intended, then other smart people have to spend time figuring out how to tweak the tax code. The tax code then grows.

My favorite example. Once upon a time a large company (I think it was General Motors) was preparing to pay a dividend, which would count as ordinary income for the shareholders. One of their smart people got the bright idea of instead of a dividend, doing a stock split to slightly increase the number of shares (say, a 50 for 49 stock split), then having the company do a buyback to reduce the number of shares (say, buy back 1/50th of the shares). The split was not a taxable event, and the buyback could then be reported by the shareholders as capital gains. Ta-da! Ordinary income converted to capital gains.

So now there are something like three pages of regulations and tests to determine how to classify a stock buyback to stop that trick, but not to penalize buybacks that aren't for tax avoidance, and to anticipate possible loopholes in those rules or close loopholes that have been found in them.


Good suggestion. I've had two well-regarded startup attorneys look at the situation, and the acquirer has had their counsel look at this as well (we're not their only acquisition in this set of circumstances). There's no solution that does not trigger other issues.

Besides, my goal isn't to avoid the taxes, period; it's to put the money in to something that the government and I both agree is a worthwhile alternative: creating economic value through continued investment. I'm just looking for a way to do so with modest risk and return, instead of the very high risk and return of a typical startup investment.


Does this strike anyone else as... well, greedy?

I don't quite mean "greedy" --- I mean dangerous. The OP is about to "win at life". Why tempt fate?

What I'm saying is, if PG hadn't sold Viaweb at all, then YCombinator would never have existed. But if he had sold Viaweb for, say, 15% less than he did... then there's a good chance YC would have been created anyway, because he would still be wealthy.

So again, why tempt fate? It seems like the best advice is "just get the deal done".


Wanting to keep the proceeds of what you've created greedy? No. And he sounds like the sort of person who'd do something far more useful to society with the extra 15% than the federal government would.


you're assuming a 7 figure exit. this might not even be a six figure exit.


which still sounds good for less than a year of work!


Less than six figures sounds good for almost a year of building a successful company? Seriously?


I don't understand why you'd characterize it as "greedy," "dangerous" or "tempting fate." Nobody's advocating doing anything legally or medically sketchy — that's why he said to get the plan approved by the people who know what's OK and what isn't.

I also don't understand what PG's cut of ViaWeb has to do with anything.


Assume for a moment that the OP has received an offer for a large amount of cash.

That cash isn't in his bank yet. The offer isn't final until the cash changes hands.

In that position, it seems like a bad idea to try to micromanage the details of the offer. Just take the money before they change their minds.

Who knows what the OP could accomplish next? I do: if the offer falls through, he'll accomplish whatever his current startup is designed to accomplish. In PG's case, that would've been online stores. YCombinator probably wouldn't have existed.


I'm not sure I follow. Are you saying that negotiating is always a bad idea if you would benefit at all from the current offer?


This doesn't necesarily help the poster in this case, but it's worth a read.

Derek Sivers (@sivers) sold CD Baby for $22,000,000. Before he did it he transferred the entire business to a trust. The trust received the $22 mill in cash, without paying tax. Derek receives 5% of that amount every year (1 mil)

Read about it here: http://sivers.org/trust


This is just a tax deferral scheme. It has some benefits, but it is not dramatically different from paying all taxes upfront.


I'm firmly in the camp of "pay for legal/CPA advice" rather than asking here.

But I've sort of been through this and the short answer is that the time to consider how you would minimize tax was when you formed the company.

Assigning the stock in the startup to a holding company you control vs personal ownership, getting into S-Corp vs LLC for the holding company, etc are all areas you could explore.

It's probably too late now, however.


How would a holding company help? Wouldn't the company just be subject to the tax then (at the corporate tax rate which would be even higher)?


I believe there are various things you can do (note IANAL, or accountant) such as take procedes taxed as a dividend (lesser tax rate) or even not take the money out of the company and reinvest or buy an asset and net out zero taxable profit.

And S-Corp would also come under your personal tax rate, I believe rather than corporate tax rate.


This won't be a popular option, but why not just pay the tax? Why try to invest or involve yourself in some complicated scheme just to save the 15%. If the sale is enough money to be somewhat comfortable, pay the tax and be appreciative of the folks who paid tax before you did - enabling you the opportunities to easily create and sell businesses.


I think I explained the answer to your question in the original post. The government has decided that in this case the money would be better spent creating jobs than going in to general funds. I agree. I'm looking for a mechanism for doing that which accomplishes the stated goal with less risk than a traditional startup. Win (for me), win (for the government), win (for society).


I think you want to ask this to a lawyer/accountant.


As I mentioned, I've asked two attorneys (one tax lawyer, one general counsel), a couple of CPAs, and a financial advisor or two for good measure. They all could explain the mechanics but none of them had much to suggest beyond traditional startup angel investments (which I'm going to do with some of the proceeds - but I need something lower risk for the rest).


Where are you located? If you are in sv, there are quite a few folks who deal with this kinda stuff on a daily basis. I would definitely take help from them. Even if the acq is small amount, most of them do help you verbally on a good faith basis for repeated business from you.

Have you received the LOI yet? http://en.wikipedia.org/wiki/Letter_of_intent Good luck.


If you have specific names of advisors who have dealt with this particular problem, please share them!

The usual suspects (highly regarded startup attorneys, startup CPAs) have been helpful in analyzing the situation but I haven't found any who has experience with the problem at hand, and I'd rather not be a pioneer here.

Yes, we've signed an LOI; the transaction is imminent.


I realize this won't be too helpful, but I just feel you are asking the wrong people. If you can't get an accountant to suggest a proper course of actions.


>use my proceeds to invest in a small business, create jobs (the goal of the tax break), make the economy better

I was all ready to run up in here hatin' on tax evaders, reel off some polemic about how schools and roads need to be paid for by everyone, but then I read this.

Descending cloud of morning depression: averted. Best of luck to you.


The vast majority of taxes go to far, far less legitimate things than roads and schools.

The tax system is a very, very crooked one (speaking for the US but probably everywhere), and nobody should be forced to sacrifice 35% (!!!) of their earnings to it.

My point here is that you shouldn't go around telling people that they have a moral duty to pay taxes. People who believe that have to choose between guilt, and self-sacrifice.


There is a moral duty to pay taxes when you live in and benefit from a civilisation founded upon taxation, public services, and shared wealth.

And self-sacrifice was a pretty good choice last time I checked.


(a) I'm getting a raw deal; I'm putting into taxes far, far more than I get back in "benefits."

(b) And, any system that sacrifices some people to others is barbaric, and ought to be ended.

To elaborate on (b):

The whole point of the rule of law (civilization) is to make it so that nobody can take what's mine from me by force, which is the very definition of barbarism (the state of nature).

Yes, we need government force to protect us from arbitrary force (the state of nature), but it should not go beyond the minimal necessary application of force. It should not tax me for other people's education, for example. Let them pay it back once they get jobs. The market works in every sector where we've tried it.

If I have any duty, it's to oppose continuing such a barbaric system.


Society only works if some people pay higher tax than the value they get back, and some people pay less. If you're lucky enough to find yourself in a situation where you're having to pay more than average in tax, stop thinking solely about yourself and by glad that you're helping out people who pay significantly less than you in tax while living in poverty.

There are plenty of issues with tax systems in most (all?) countries, but the fact that some people pay in more than they get back from it isn't one of them.

Your argument of not wanting to be taxed for other people's education... just doesn't work. What if you had an education and then died, or never worked a day in your life, who pays for that? The only way that you got an education is because your parents and their generation were paying for it, and if your generation aren't paying for the education of those younger than you, no-one will get educated.

"The market works in every sector where we've tried it." I'm not sure anyone who has experienced the health service in many European countries, even here in the UK where the NHS has many big problems, would consider the market solution in America to be better than a free health service covered by taxes. And where do you stop? Should police only investigate crimes for a fee, and leave anyone who can't afford the prices on their own?


> Your argument of not wanting to be taxed for other people's education... just doesn't work.

I'm with you on that, and on the general moral obligation to pay taxes even if you are in the minority that (supposedly) gets less than they put in with their taxes.

However:

In the US, the taxes you pay essentially go to government official's cronies in the banking and military industries and to corrupt unions. Really. The US now borrows some 20-50% of what it spends (depending on who you ask and how you count spending on things like medicare, social security, etc)

In the US, you're not actually getting any health services (unless you're already dirt poor); good education is private in all age groups.

The moral argument is much, much weaker in the US.

And on the angle that I do agree with you -- I think most people who pay 35% taxes are actually paying much LESS than what they get for -- hiring your own guards is bound to be more expensive. That's the main service your taxes get you -- not getting robbed/killed every other day.


Everyone else already paid for your education. You owe it back now that you 'have a job.'


And if you don't have a "job" because you're working on making yourself rich by employing other people, try imagining for a moment that those "other people" you're hiring had no reliable access to education, or no assurance that they'd be able to pay to educate their kids.

There are an awful lot of benefits to everyone in giving the general populace a passable education and access to basic health care. Once folks' basic needs in life are met, they are rather more likely to dedicate themselves to the causes you recruit them for (political, business, whatever).

(So come on, USA, how about re-routing a fraction of the money you're burning in Iraq & Afghanistan into education & health care?)


You are actually benefiting a lot more than you realize. I assume that you are more an intellectual than a thug. If the laws didnt protect you physically you might be physically controlled by thugs. In addition you may be in the top % economically and invest in stocks. You are benefiting disproportionately from the SEC and strong legal system which has less economic benefit for working class folks.


| (a) I'm getting a raw deal; I'm putting into taxes far, far more than I get back in "benefits."

Good. Do you want to be elderly, disabled, cancerous, an injured veteran, jail-bird or a school kid (again)? You don't want those benefits until you need 'em. And you or your family will need 'em. If you're a self-made rich person, or one of your ancestors was, consider how they leveraged the taxes of others to get that way.

The "state of nature" concept as pre-societal (Hobbes, C17) is bogus and as out of date as phlogiston theory. The term was originally coined by Aquinas (C13) and specifically included society and culture until Hobbes removed them almost 500 years later. For humans, society is nature. Aristotle and Aquinas recognized this, and this is in line with current thinking, except apparently among libertarians who seem to believe that "red in tooth and claw" justifies their luck and screw you buddy to anyone less lucky.

But maybe you should get arrested every month just to get your money's worth. Make sure to tell the cops they are parasites.


I don't think anybody here is denying that. There's a big difference between tax evasion and tax avoidance.

I particularly like this quote on tax avoidance from Kerry Packer, 1991:

I am not evading tax in any way, shape or form. Now of course I am minimizing my tax and if anybody in this country doesn't minimize their tax they want their heads read because as a government I can tell you you're not spending it that well that we should be donating extra.


Open cheque book for the State then? My impression is that an increasing number of people in the UK and EU and I suspect in the US, certainly do not accept there is a moral duty.to pay these taxes though they do so for fear of the consequences.

Genuine needful social spending nothwithstanding, they beg to differ that the State can spend their money without seeming limit, borrowed money at that, better than they can. Just one illustration - the EU budget has not been passed by auditors for 13 years in a row. And when this was questioned from within the hierarchy, that person was sacked.


35% isn't much to pay in taxes compared to other counties.

If you earn enough in Sweden you will end up paying a total of close 70% of your income in taxes. (income tax capped at 56% if I recall correctly and the rest if VAT etc)


:) Yeah. I don't want to move the proceeds to an offshore tax haven or something. If I can follow the letter and spirit of the law to create jobs instead of paying taxes, I think everyone wins. And the more HN readers who know about this and can do the same, the better!


Don't forget state taxes - if you are an internet-based company and have no central office, there is really nothing keeping you bound to whatever state you live in. Look into moving the HQ to a state like Nevada - you can pay people to be a "registered agent" which means your business mail MUST go to that person and they'll forward it on to wherever you are.

Consider this "gray hat" tax advice. The tax code isn't built to handle companies without a true physical presence. They look to see where your main office is - if you don't have any, you can pretty much claim whatever state you choose. There may be rules about how long the HQ has to be in a state to qualify for the tax year, but I think that's it. Certainly ask your accountant/lawyer for more details and about the letter of the law here.


Two different issues.

The sale of a company is a taxable event to the owner(s), not the company. It does not matter where the company is located, it matters where the owner is located.

That's why Arrington moved to another state while he was in talks to sell TechCrunch, but left TC in Cali.

Also, the danger with multi-state companies (i.e,. incorporated in one state but with operations in other states) is that they can subject themselves to the taxes of each state in which they have a presence. It is settled law that presence can include facilities or employees even if the business is HQ'd in another state.


I have a good tax attorney, contact me if you want contact info. Here is one possible method. There is a company that will let you buy income insurance which you can then expense wholly (for the whole amount of the sale of your company). At some later date when you have additional expenses or take a loss or with other specific triggers, the insurance company will pay out your losses. You would typically do this in a year when you take a loss and the income from the insurance company balances the expenses for that year. They charge around 5-7%

This is basically a way to smooth out and balance taxes over multiple years.


It'd sure be fun in cases like these to hear more about the company - after the deal is done, of course.


If you live in the uk you wouldonlypay 10% tax the first time you sell a company, up to £10m per person.


I think it's £1 million.

http://www.hmrc.gov.uk/cgt/disposal.htm


Nope, Julian was right the first time. Entrepreneur's relief was increased to £10m (from £5m) at the last budget: http://citywire.co.uk/new-model-adviser/budget-2011-entrepre...

A lot of what's on HMRC's own site is, sadly, stale or poorly dated.


Yes. And it used to be 10% with no limit until 2008. Those were the days.

Also it's not just the "first time you sell a company". It applies on as many company sales as you want, up to a lifetime total of £10m.


And not even company sales, as far as I understand it, but any group of complete business assets (that is, any set of business assets that defines a single "business" - an important point for sole traders like me ;-))


Why not just wait until 1 year passes to officially sell your company?


The window of opportunity to sell a company is narrow and if he waits, the buyer may move on and another one may not come for awhile or offer the same term. Of course it depends on how far off he is from closing the deal but I assume OP is asking because its not anywhere near the one year mark.


Great question. Would love to hear some of the HN veterans chime in here.


I've got bad news for you: that tax program expired in January. It was only a temporary extension to a small business incentive program that ran from 2009-2010. The law still exists, but the tax benefits are significantly reduced, and it only applies to C Corporations. (http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_0...)

Here are some thoughts (for free, so not in enough detail to act upon without further legal advice):

- Hire a tax lawyer. The amount you save in taxes will pay for itself.

- If feasible, delay the execution of the sale until you have held your company for more than 1 year.

- Consider selling your company for stock of the acquiring company instead of for cash. The transaction would be fully tax free if solely for stock, and taxable only to the extent of cash/non-stock received. (See IRC 368, and related sections.)

- If you made the S election, you must unelect for Small Business Sale Exclusion to apply. This has fun tax consequences.

And finally, DO NOT HIRE A CPA to do this for you. CPAs know how to add things up, but they frequently get the law wrong. Tax lawyers exist largely to clean up the mess created by CPAs.


To quickly run through these in order: 1) The program was extended. And regardless, the original company investment was made during the holiday, so as long as I roll over within 60 days, I'm OK. 2) I did hire a tax lawyer, which is why I understand the circumstances pretty thoroughly. What they weren't able to do was recommend a specific course of action based upon firsthand experience, which is why I'm asking here - either for someone who has that experience, or a pointer to a lawyer who's specifically experienced with this particular cranny of law - It's not feasible to delay without wrecking the deal - A stock transaction is not an option for the acquirer - We're a C corp - I asked a CPA as well since what I'm looking for is experiences and strategies. I concur with the gist of this advice and will have a tax attorney look over it if I come up with anything.

Thanks for taking the time to weight in.


Whoops. You're right about the second extension. The law itself (Sec 1202) was not extended, but other code sections that interplay with 1202 extended (and expanded) the scope of 1202.

That's what I get for commenting after midnight...




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