Startup America Suggestions

Startup AmericaSuggested Legal and Regulatory Changes To Make Life Better For Startups From a Startup Lawyer Joe M. Wallin Seattle, Washington @joewallin joewallin@dwt.com

What Is Startup America? President Obama announced Startup America on January 31, 2011. One of the goals of the initiative is to "reduce regulatory barriers for high growth firms." Startup America is an acknowledgment that most job growth in America comes from young companies. I am a startup lawyer. The following is a collection of recommendations for the Startup America Initiative Team to "reduce regulatory barriers for high growth firms." The opinions expressed in these slides are my own. I cant take credit for all of these ideas, but any mistakes are mine.

First, Make It Easier For Startups ToRaise Money There are current regulatory burdens that make it difficult for startups to raise funds from private investors. These regulatory burdens take a number of forms. One impediment is the definition of the term "accredited investor." Most startups will limit their fund raising to raising money only from "accredited investors" because to do otherwise results in onerous and unacceptable legal and accounting compliance costs. So, what is the problem?

The Government Is Making It HarderTo Be An Accredited Investor The Dodd-Frank Act made it harder to qualify as an accredited investor. Dodd-Frank requires that an investors primary residence not be considered as an asset in determining an investors net worth, and requires the SEC to consider raising the thresholds to qualify as an accredited investor every 4 years. Before Dodd-Frank, the thresholds to qualify had been stable for 20 years. I do not believe that the government should be increasing the financial thresholds to qualify as an accredited investor. I believe we should make it easier to qualify so that more people can invest in startups and startups can more easily raise money.

Allow Startups To Advertise That TheyAre Fundraising Right now in order to comply with securities laws startups have to work by word of mouth only in trying to raise funds. They cant publicly announce that they are raising money. This makes it difficult for startups to raise money and drives startups into the arms of intermediaries and brokers. Why not allow startups to advertise that they are raising money? Why not allow startups to post on their web sites that they are raising money? Why not allow a free and open and competitive market for funds and investment opportunities, rather than the inside game that is played now? Lets end the insider game of angel investing.

Provide Angel Investment Tax Credits Investors in startups frequently have to wait for years for either (i) a liquidity event in which they either make or lose money, or (ii) a business failure, in which case they can take a tax loss. In other words, angel investors have to wait a long time to recover the tax basis in their investments. Lets give angel investors a tax credit when they invest in small companies that are creating jobs. Senator Mark Pryor of Arkansas has introduced a bill, S. 256, which deserves our support.

Make Internal Revenue Code Section1202s 100% Exclusion Permanent Section 1202 provides a 100% tax exclusion from gain on the sale of qualified small business stock held for more than 5 years. But this exclusion is only good for stock bought before the end of this year. To be meaningful, this tax exclusion needs to be made permanent. Lets make the Section 1202 exclusion permanent.

Fix Internal Revenue Code Section1045 Internal Revenue Code Section 1045 allows taxpayers who havent met the 5 year holding period under Section 1202 to rollover their gain on the sale of qualified small business stock to continue to try to meet the 5 year holding period. The problem is Section 1045 only gives investors 60 days to find rollover investment opportunities. This is too short of a time frame to find rollover investment opportunities in qualified small businesses, especially because these investment opportunities are typically learned of via word of mouth. Lets extend this rollover period to something more on the order of 365 days.

Repeal The New 1099 Rules Under rules to become effective 1/1/2012, if you are in business, you will have to issue a Form 1099 to any corporation from whom you buy more than $600 in goods during the year. This rule literally means that if you are a freelance coder, and you buy a new PC from the Microsoft store, you are going to have to issue a Form 1099 to Microsoft, or face severe IRS penalties. Or if you are self-employed and your monthly supply costs at the local office supply store are more than $50 on average, you are going to have to issue your local office supply store a Form 1099 at the end of the year. These rules make no sense; lets repeal them.

Make Incentive Stock Options WorkAgain Incentive stock options are a great idea, because if they were allowed to work the way they were originally envisioned employees could more easily participate in the equity of small companies while minimizing the tax burden of doing so. The problem is, because the alternative minimum tax applies to the spread between the fair market value of the stock received on the exercise of a stock option and the strike price on the options, ISOs are now not such a good deal and dont work at all like they were originally intended. Lets repeal the alternative minimum tax as it applies to incentive stock options.

Fix Section 83(b) Elections Section 83 of the Internal Revenue Code allows founders to avoid tax when their founders shares vest, but only if they file an election within 30 days of first receiving their stock. This rule applies even if the founders paid fair market value for their stock! This is a very short time deadline and a trap for the unwary. There is no ability to extend the 30 day period. If you miss it, you are stuck. Lets fix the rules to not require an 83(b) election when no tax would be due.

Repeal Internal Revenue Code Section409A Internal Revenue Code Section 409A imposes taxes, including a 20% penalty tax, on "nonqualified deferred compensation plans." It was enacted in response to executives at large public companies deferring tens of millions of dollars of salary income into the far future. But it has been applied to startup company stock options, making it more difficult for startups to grant equity incentives to employees and contractors. Regulatory guidance pushes small companies to obtain costly third party appraisals before granting stock options. The abuses that led to the enactment of Section 409A dont exist at small companies. Lets repeal Section 409A as it applies to small companies.

Repeal Rule 701s Mathematical Limits Rule 701 is the federal securities law exemption for granting stock options and other equity incentive awards to employees and independent contractors. It contains mathematical limitations on how much startups can grant in compensatory equity awards. Why make it harder for startups to offer equity incentives to employees and contractors? Lets simplify Rule 701 by removing its mathematical limitations.

Make It Easier To Go Public Startups need a vibrant IPO market. We need to make it easier for companies to do initial public offerings. We need to consider how we can make the process of going public and being a public company less burdensome.

Startup America Suggestions

by Joe Wallin

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