Keys to Issuing Equity for Small Business Owners

issuing small business equity

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2.   Taxes and the Issurance of Equity

While, generally, issuing equity interests in an enterprise does not become a taxable event until the interests are liquidated, this is not always the case.

For example, where an investor has provided services in exchange for stock in a corporation, the exchange would be considered taxable to the investor unless the ability to transfer the stock were restricted or the stock were subject to forfeiture.

In the context of a partnership or limited liability corporation, where an investor contributes services, such exchange would be taxable to the investor, unless the exchange is for a profit interest, i.e. exchanged for a percentage of an income stream derived, inter alia, from gross revenues or net profits.

Where an investor contributes an appreciating asset to a business, again, complex tax rules can apply.

With respect to businesses that are partnerships or limited liability companies, a contribution of appreciating property is not in itself a taxable event, although the later liquidation of that property and distribution of the resultant proceeds is likely to give rise to a range of tax consequences.   

On the other hand, contributing an appreciating asset to a corporation in exchange for stock may be considered taxable to the investor unless the investor and others who are parties to the same transaction collectively would control, after the transaction, at least 80% of the equity of that corporation. 

The take away:

  • Business owners should vet proposed conveyances of equity interests to determine if the securities laws apply and, if they do, what, if any, disclosures need to be made and how;
  • Ascertain the potential tax consequences of an offering of securities, including the tax consequences associated with contributions of property and/or services;
  • Have a legal and financial team in place to make sure that you know what you should know about contemplated equity transactions. 

Related articles: 

Eli Mendoza on Equity and Financing [video]

Equity Crowd Funding Is Coming

Equity Crowd Funding 101

Small Business Funding Options - Equity or Debt

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About the author

Robert Goodman

Robert Ian Goodman, Esq. represents clients worldwide in the areas of complex commercial immigration and international and domestic commercial law. Mr. Goodman also provides general counsel services to entrepreneurs and start-up businesses and counsels foreign businesses interested in establishing a presence in the U.S. marketplace and U.S. businesses interested in expanding abroad. Mr. Goodman is principal of Goodman Immigration. He is also Special Counsel to the international boutique law firm, Sharma & DeYoung LLP ("S&D"), where he directs the firm's commercial immigration practice. He also co-chairs that firm's Technology and Emerging Companies Practice Group and is a member of S&D's Commercial Litigation and Arbitration Practice Group. 

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