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Startup Basics: Money People and Technology

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The Royse Law firm offers significant advise that early stage startups should ensure they understand. The slides contain great considerations that startups should utilize. Our team is a full service firm that provides legal counseling to many startups. Please contact us so we can help you ensure the health of your startup. (01/2018)

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Startup Basics: Money People and Technology

  1. 1. Startup Basics: Money, People and Technology Silicon Valley, San Francisco, Los Angeles rroyse@rroyselaw.com www.rroyselaw.com
  2. 2. Roger Royse is the founder of the Royse Law Firm. Based in Silicon Valley, the Firm works with companies in a variety of industries, including clean tech, internet, life sciences, entertainment and new media, sports, real estate, retail and mobile devices and applications. Practicing business and tax law since 1984, Roger’s background includes work with prominent San Francisco Bay area law firms as well as Milbank, Tweed, Hadley and McCloy in New York City. Roger has also served as an adjunct professor at the Gold Gate University Masters of Tax program. He is a frequent speaker, writer and blogger for American bar associations, CPA organizations, and business groups.
  3. 3. THE STARTUP TRIANGLE PEOPLE MONEY TECHNOLOGY
  4. 4. TECHNOLOGY - IP • Trade Secret • Patent • Trademark • Copyright
  5. 5. TECHNOLOGY – IP STRATEGY • Joint Venture • Joint Development • License • Manufacture
  6. 6. CASHFLOW COMPARISON: LICENSING VS. MANUFACTURING POSITIVE CASHFLOW NEGATIVE CASHFLOW IDEA GENERATION DEVELOPMENT COMMERCIALIZATION SALES / REALIZATION PRODUCT LAUNCH MANUFACTURING L.ICENSING
  7. 7. TECHNOLOGY STRATEGY Market Entry Options Third Party Presence Sales Rep Distributor OEM/VAR Direct Presence Branch Office Subsidiary
  8. 8. PEOPLE - FOUNDER’S EQUITY  Dynamic Split  Equal Percentages  Subjective  Formula
  9. 9. Dynamic Split
  10. 10. Grunt Fund Source: http://www.slicingpie.com/the-grunt-fund-calculator/
  11. 11. Grunt Fund Detail Source: http://www.slicingpie.com/the-grunt-fund-calculator/
  12. 12. PEOPLE - ADVISOR FAST Model Valuation Milestones and Deliverables Vesting Stock v. Options
  13. 13. www.startuprounds.com  Who should vest  How long?  Acceleration?  Change of control  Termination without cause  Double and single triggers VESTING
  14. 14. Source: Founder Institute. http://fi.co/contents/fast#
  15. 15. Source: Founder Institute. http://fi.co/contents/fast#
  16. 16. ADVISOR CURRENCY • Options • RSUs • Restricted Stock • Phantom Plan Units
  17. 17. MONEY - EARLY STAGE FUND SOURCES • Founders • Family & Friends • Angel Investors • Private Equity Funds • Banks • Venture Capitals
  18. 18. MONEY - SEED FUNDING SAFE Priced roundsConvertible Debt
  19. 19. VENTURE CAPITAL
  20. 20. PwC Money Tree
  21. 21. PwC Money Tree
  22. 22. PwC Money Tree
  23. 23. PwC Money Tree
  24. 24.  VC or Institutional Investor  Preferred Stock  Valuation Methods  Score Card  Venture Capital Method  Berkus Method  Cayenne Calculator  Risk Factor Summation  Negotiation MONEY - THE PRICED ROUND
  25. 25. MONEY - THE PRICED ROUND  More Valuation Methods  (Patents + People) x $1 Million  Comparables  Discounted Cash Flow  Market Multipliers  Discount to Public Companies
  26. 26. www.startuprounds.com VC NEGOTIATIONS  When to mention valuation  Staged Investment  Liquidation Preference  Control  Blocking rights  Drags and tags  Anti-Dilution protection
  27. 27. OTHER FINANCIERS  Private Equity  Crowdfunding  Strategic Investors
  28. 28. CROWDFUNDING $34.4 billion raised worldwide in 2015 – an increase of 212% from 2014  Categories  Business and Entrepreneurship ($6.7 billion)  Social causes ($3.06 billion)  Films and performing arts ($1.97)  Real estate ($1.01 billion)  Music and recording arts ($736 million)  Split by type of crowdfunding  Donations and rewards  Lending-based crowdfunding dominates the industry ($11.08 billion)  Equity-based crowdfunding Source: Massolution Crowdfunding Industry Report
  29. 29. CROWDFUNDING
  30. 30. CROWDFUNDING Source: Massolution Crowdfunding Industry Report
  31. 31. EXITS
  32. 32. ACQUISTION
  33. 33. INTERNATIONAL TAX INTERNATIONAL TAX ISSUES FOR CHINESE INVESTORS
  34. 34. US BRANCH VERSUS US INCORPORATION • A “branch” is generally a fixed place of business (i.e. an office or factory) in a foreign jurisdiction in which a corporation carries on its business. A branch is not a separate legal entity. • Will be taxed on ECI, or “business profits” attributable to a permanent establishment, if the treaty is claimed. • Need US Tax ID and FEIN. • Branch Profits Tax may apply; branch rules compliance burdens. • No liability shield. 34 • Incorporating means a new legal entity will be established in the US. • Such entity will be taxed like any other US entity; i.e. on worldwide income. • Need organizational documents; bylaws, management, etc. • Need US Tax ID and FEIN. • No Branch Profits tax. • Transfer Pricing compliance burden may exist if US Sub engages in business with Chinese parent company. • Shields liability. US Branch US IncorporationChinese Entity US Branch Chinese Entity US Sub
  35. 35. EFFECTIVELY CONNECTED INCOME (ECI) • Applies to foreign entities with a “US Trade or Business” – If the Chinese Entity performs (or performs through the use of certain types of agents) “considerable, continuous, and regular” economic activity in the United States, depending on the facts, such performance will be considered a “US Trade or Business” (or US T/B). Passive investments usually do not rise to the level of a US T/B. • US tax on income “effectively connected” to the US T/B – The income, gain or loss is “Effectively Connected” when either (1) it is derived from the assets used or held for use in the Chinese Entity’s US T/B or (2) the activities of the US T/B were a “material factor” in the Chinese Entity’s realization of such income, gain or loss. • US - China Tax Treaty (“Treaty”) Effect – If the Chinese Entity qualifies for Treaty benefits and claims its benefits, the tax will be instead on the “business profits” attributable to its “permanent establishment” in the US, if any exist. 35
  36. 36. BRANCH PROFITS TAX • The Branch Profits Tax (BPT) operates to eliminate any tax preference a US branch may have over an incorporated subsidiary by treating the branch as if its profits were earned by a US subsidiary of the Chinese entity. • The additional 30% tax applies, generally, to “after tax E&P that is effectively connected” with the Chinese entity’s US T/B (“ECE&P”) to the extent such ECE&P is either (1) not reinvested in a US T/B by the close of the taxable year or (2) disinvested in a later taxable year. • US-China Tax Treaty eliminates the BPT for corporations that are “qualified residents” in China. A PRC resident enterprise is a qualified resident, unless (1) 50 percent or more (by value) of its stock is owned by individuals who are not residents of China and who are not United States citizens or resident aliens; or (2) 50 percent or more of its income is used (directly or indirectly) to meet liabilities to persons who are not residents of China or citizens or residents of the United States. 36 Chinese Entity US Branch ECE&P taxed at 30% If ECE&P is reinvested, no tax
  37. 37. EARNINGS STRIPPING • Operating group company structures, with an incorporated Chinese subsidiary in the US, may attempt to shift income away from the US Sub by issuing loans from the India parent to the US Sub requiring the payment of deductible interest back to the India parent. This “earnings stripping” causes the US Sub to have an overall decrease in profit (decrease in tax), shifting the additional profit to the India parent (not subject to US tax). • Section 163(j) of the US Tax Code is applicable if – (1) a domestic corporation’s debt-to-equity ratio exceeds 1.5:1 (i.e. it is “thinly capitalized”) and (2) the domestic corporation makes interest payments to a related person exempt from US taxation (i.e. a foreign entity). Section 163(j) denies the domestic corporation’s deduction for interest payments to the extent the total interest deduction would exceed 50% of the corporation’s income (before deducting the interest). 37 Chinese Entity US Sub Loan Interest Payments
  38. 38. WITHHOLDING TAXES • Foreign recipients will be subject to US withholding tax on payments of US-source income (as determined under US internal law) that are either (1) fixed or determinable annual or periodical (“FDAP”) income or (2) certain capital gains specified by Section 1441(b). • Generally, the withholding regime taxes all US-source income that is not already taxed in the “effectively connected” to a US T/B regime. FDAP income encompasses all types of income, except those specifically excluded by the regulations. • FDAP examples are: interest (excluding “portfolio interest”), dividends, rents and royalties. • FDAP tax is generally 30% on the gross amount of the payment. • Duty to withhold is on US payee, and such payee could be liable if amounts are not properly withheld. 38
  39. 39. WITHHOLDING TAXES – TREATY EFFECT • Dividend & Interest Relief – The Treaty provides for a maximum allowable 10 percent tax on gross dividends and interest paid by a resident company if the recipient is a resident of the other Contracting State and is the beneficial owner. – The reduced withholding rate does not apply if the beneficial owner maintains a PE or fixed base in the dividend/interest source country. – A total exemption from tax by the source country applies to interest derived by the government of the Treaty partner, its Central Bank, and any wholly-owned government financial institution in the Contracting State. • Royalties Relief – For most royalties, the source basis taxation is limited to 10 percent of the gross amount. – For rental income of industrial, commercial or scientific equipment [ICSE rental], an effective maximum rate of 7 percent applies to the gross rental, in recognition of the costs associated with leasing capital equipment. – A royalty is considered to be sourced in a Contracting State if paid by the government or a resident in that State. – The reduced withholding rate does not apply if the beneficial owner maintains a PE or fixed base in the other Contracting State. • Service Income Relief – An individual performing services in the US, (1) under Article 14, as an employee of an Chinese entity may avoid US taxation if the individual is present in the US for less than 183 days and the compensation is not borne by the Chinese entity’s “permanent establishment” in the US, and (2) under Article 13, as an independent contractor may avoid US taxation if the individual renders professional services, without a fixed base in the US, and without staying in the US for 183 days (or more) during the taxable year. 39
  40. 40. TRANSFER PRICING • Under Code section 482, the IRS can re-allocate income among “controlled” entities, such as a India parent and a US sub, to properly reflect income. The prices charged between such related parties (“transfer prices”) are required to be arm’s length. • Current regulations impose substantial penalties for understatements of US tax due to transfer pricing adjustments – 20% or 40% of the underpaid tax, depending on the size of the understatement. The US sub can avoid penalties, even if the IRS does not accept its transfer prices, by completing a transfer pricing study (“TPS”) before the income tax return has been filed. The TPS must meet the requirements of the regulations and apply the best method for determining the US sub’s transfer prices. • Most often, the TPS will utilize the comparable profits method for determining the appropriate transfer price. Such method determines the “arm’s length price” by referring to objective measures of profitability derived from uncontrolled taxpayers that engage in similar business activities with other uncontrolled taxpayers under comparable circumstances. • Article 8 of the US-China Tax Treaty states that when there is sufficient indicia of relatedness through participation in management, control or capital of the related enterprises, then the taxing authority has the power to re-allocate income, deductions and credits in accordance with an “arm’s length” standard. 40
  41. 41. The Innovation Network supports companies focused on creating new technologies for the ag and food industries Royse University: Providing business, tax, technology and personal finance ideas to founders and executives. Royse Law Presents: Supporting the Tech and legal community through events, networking, and webinars Royse Law Incorporator: Incorporate your company the Silicon Valley way. RoyseLawIncorporator.com RoyseUniversity.com RoyseAgTech.com RoyseLawPresents.com
  42. 42. 42 PALO ALTO 1717 Embarcadero Road Palo Alto, CA 94303 LOS ANGELES 11150 Santa Monica Blvd. Suite 1200 Los Angeles, CA 90025 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Palo Alto Office: 650-813-9700 CONTACT US www.rroyselaw.co m @RoyseLaw MENLO PARK 149 Commonwealth Drive, Suite 1001 Menlo Park, CA 94025 LOS ANGELES 445 S Figueroa St 31st Floor Los Angeles, CA 90071 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Menlo Park Office: 650-813-9700 CONTACT US www.rroyselaw.com @RoyseLaw

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