© 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Disclaimer
No information contained in this presentation is to be construed as legal advice.
No information contained in this presentation is intended or related to any
particular factual situation. Nothing herein forms an attorney-client relationship. If
legal advice or other expert assistance is required, the services of a competent
professional should be sought.
2

3

US Branch Versus US Incorporation
US Branch
 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.
US Incorporation
 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 foreign
parent company.
 Shields liability.
4
foreign
Entity
US Branch
foreign
Entity
US Sub

Effectively Connected Income (ECI)
 Applies to foreign entities with a “US Trade or Business”
 If the foreign 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 foreign Entity’s US T/B or (2) the
activities of the US T/B were a “material factor” in the foreign Entity’s realization
of such income, gain or loss.
 Tax Treaty (“Treaty”) Effect
 If the foreign 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.
5

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 foreign entity.
 The additional 30% tax applies, generally, to “after tax E&P that is effectively connected” with the
foreign 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.
6
foreign
Entity
US Branch
ECE&P taxed
at 30%
If ECE&P is
reinvested,
no tax

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.
7

Withholding Taxes – Treaty Effect
 Dividend & Interest Relief
 The Treaty provides for a maximum allowable 20 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
5 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 foreign 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 foreign 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.
8

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.
9

BEA Filings
 Survey of New Foreign Direct Investment in the United States (Form BE–13)
 Quarterly Survey of Foreign Direct Investment in the United States (Form BE–605)
 Annual Survey of Foreign Direct Investment in the United States (Form BE–15)
 Benchmark Survey of Foreign Direct Investment in the United States (Form BE–12).
10

Choice of Entity
 Limited Liability Company (LLC)
 S Corporation (S Corp)
 C Corporation (C Corp)
 Foreign Corporation
11

Advantages of a C Corporation
1. Operating Agreements
2. S Elections
3. Suspended Losses
4. 704(c) Allocations
5. Venture Capital
6. QSB Stock
7. Stock Option Plans
8. LLC Debt
9. Reorganizations
10. Fringe Benefits
11. Audits and Liabilities
12. Contingent Allocations
12

Qualified Small Business Stock – 1202 and 1045
General Requirements
 Original issue
 Five-year holding period
 100% post-Sept. 27, 2010
 C Corporation issuer
 Up to $10 million or 10 times basis exclusion
 1045 Rollover treatment
13
 $50 million Gross
Assets Test
 Active Business Test
 No significant
redemptions
Note: California does not follow federal income tax treatment of QSB stock under I.R.C. § 1202.

Splitting Founders Equity
 The founder’s first decision
 The case of Zipcar
 50/50 handshake deal
 Co-Founder 1 (Robin) built the startup, crafted its business plan, and cold called
customers.
 Cofounder 2 didn’t even quit her day job, and contributed little.
 Her rushed negotiation had compromised her team’s longer-term effectiveness by
causing her “a huge amount of angst over the next year and a half.”
14

Founder’s Equity
15
 Dynamic Split
 Equal Percentages
 Subjective
 Formula

Dynamic Split Models – General Concept
 Traditional fixed-split model: Equity given based on anticipated contributions.
 Dynamic-split model: Equity given based on actual contributions.
 Inputs to dynamic-split model: The dynamic model assigns a relative FMV weight to various
contributions from each participant, and contributions put into model:
 Outputs: Depending on the relative weighted contributions of each team member, that member is
allocated a corresponding percentage of outstanding equity.
 On “split,” members could return old equity, or be given new equity, to ensure each member gets appropriate
percentage of company.
16
 Time spent working
 Intellectual property
 Commissions
 Cash
 Facilities
 Equipment and Supplies

The Founders’ Pie Calculator
1. Created by Frank Demmler, professor, Tepper School of Business at Carnegie Mellon
University
2. A founder’s value add is divided into 5 categories: Idea, Business Plan Preparation,
Domain Expertise, Commitment and Risk, and Responsibilities.
3. Each category is given a value on a scale of 0-to-10.
4. The value is multiplied by the founder’s score to come up with a weighted score.
17

Founders’ Pie Calculator Example
18
Founder 1 Founder 2
Idea 70 21
Business Plan 10 2
Domain Expertise 15 30
Commitment & Risk 28 42
Responsibilities 12 18
Total Points 135 113 248
% of Total Founder
Equity Pool
54.43% 45.57% 100%
Frank Demmler, professor, Tepper School of Business at Carnegie Mellon University

Grunt Fund
19
Source: http://www.slicingpie.com/the-grunt-fund-calculator/

Grunt Fund Detail
20Source: http://www.slicingpie.com/the-grunt-fund-calculator/

Founder Protections
 Class F Stock is common stock with super-voting rights.
 Series FF Stock is common stock that is convertible into preferred stock in a
sale.
21

Vesting
 Who should vest
 How long?
 Acceleration?
 Change of control
 Termination without cause
 Double and single triggers
22
www.startuprounds.com

IRC Section 83
Taxable income equal to difference between value and cost
to service provider
 83(b) Election
 Timing
 Whose Obligation?
23

Advisors
24
FAST Model
Valuation
Milestones and
Deliverables
Vesting Stock v.
Options

Currency
 Options
 RSUs
 Restricted Stock
 Phantom Plan Units
25

Advisor Vesting
 How long?
 Milestone based vesting
 Change of control Acceleration?
26

Employment Law Considerations
 Employee vs Independent Contractor
 Wage & Hour Laws
 Intellectual Property Issues
 Prior Employer’s Facilities
 Invention Assignments
27

The Story of Homejoy
 Used an algorithm to connect homeowners with contract-for-hire cleaners and
to schedule visits
 Raised $40 million in venture funding
 Treated its cleaners as independent contractors, and not employees
 CEO said the “deciding factor” in failure to raise money and failure was
worker classification lawsuits (Recode July 17, 2015)
28

Dynamex Decision
 Dynamex Operations West, Inc. v. Superior Court of Los
Angeles adopts a three-factor ABC test, which presumes a
worker is an employee unless all of the following tests are
satisfied
 Worker is free from control and direction of hiring authority
 Worker performs work outside the usual course of the hiring entity’s
business, AND
 Worker is engaged in an independently established trade, occupation of
business of the same nature
29

AB-5
 California Assembly Bill 5 codifies Dynamex in the Labor Code and the
Unemployment Insurance Code “For purposes of the provisions of this code
and the Unemployment Insurance Code, and for the wage orders of the
Industrial Welfare Commission…”
 Numerous carve-outs
30

Wage and Hour
Federal partners’ exception to minimum wage
California minimum wage law
PAGA
Fee shifting
31

Violating 409A
409A Penalties: 20% plus tax and interest
1. Stock Option Pricing
2. Deferred Salary
409A Requirements: Nonqualified Deferred Compensation
Payable on separation from service, disability, death, fixed time or
schedule change of ownership or control, unforeseeable emergency
32

Using An Employer’s Facilities
California Labor Code § 2870
 Employee’s Time
 No Employer Facilities
 Not Related to Employer’s Business
 Doesn’t Result From Work Performed for Employer
33

Intellectual Property
Protect your intellectual property from employees, consultants, and/or
competitors
 PIAIA or CIAIA
 Broadly Drafted Invention Assignments
 Federal Defend Trade Secrets Act
 Provisional Patents
 Material contracts
34

Trademarks
Research existing names and logos.
Brand your company strategically and legally.
35

Early Stage Investment Sources
 Founders
 Family & Friends
 Angel Investors
 Private Equity Funds
 Banks
 Venture Capital
36

37
Seed Funding
SAFE Priced roundsConvertible Debt

Terms: SAFEs and Convertible Notes
 Convertible Notes
 Debt obligations that convert to preferred stock
 SAFE
 Convertible equity
 Conversion feature
 Valuation Cap
 Sets a maximum valuation at which note will convert
 Discount
 Early investors get a discount to the preferred price
 Change of Ownership
 Investors convert to common or get a multiple on a sale of the company prior to a
priced financing round
38

Cap Table
 Common Stock
 Options
 Warrants
 Convertibles
 Preferred Stock
39

Capitalization
40
Founders 5,000,000 38% 5,000,000 45%
Stock Pool 2,000,000 15% n/a
Series A 3,000,000 23% 3,000,000 27%
Series B 3,000,000 23% 3,000,000 27%
total 13,000,000 100% 11,000,000 100%
Fully Diluted % Issued %

Capitalization
41
Founders 5,000,000 50% 5,000,000 63%
Stock Pool 2,000,000 20% n/a
Series A 3,000,000 30% 3,000,000 38%
Series B 0% 0 0%
total 10,000,000 100% 8,000,000 100%

Capitalization
42
Founders 5,000,000 71% 5,000,000 100%
Stock Pool 2,000,000 29% n/a
Series A
Series B
total 7,000,000 100% 5,000,000 100%

Capitalization
43
Founders 5,000,000 100% 5,000,000 100%
Stock Pool 0% n/a
Series A 0%
Series B 0%
total 10,000,000 100% 5,000,000 100%

Pre vs Post Money
Post-Money value = Pre-Money Value + Investment Amount
Investor’s ownership = Investment / Post-Money value
44

Pre vs Post Money
45
Photo Borrowed From The Full Ratchet

Effect of Option Pool
Investors will ask that Option Pool be increased pre close, so that founders take
full dilution for the option pool
46

Capitalization
47
Founders 5,000,000 38% 5,000,000 45%
Stock Pool 2,000,000 15% n/a
Series A 3,000,000 23% 3,000,000 27%
Series B 3,000,000 23% 3,000,000 27%
total 13,000,000 100% 11,000,000 100%

Effect of Valuation Caps
48
Founders 4,000,000 100% 4,000,000 100%
Stock Pool 0 0% n/a
total 4,000,000 100% 4,000,000 100%
Company sells a $1,000,000 SAFE with a $4,000,000 pre money valuation cap
That means that the SAFE will take 20% of the capitalization ($1,000,000/$5,000,000)

Capitalization
49
Founders 4,000,000 50% 5,000,000 63%
Stock Pool 1,000,000 13% n/a 0%
SAFEs 1,000,000 13% 2,000,000 25%
Series A 2,000,000 25% 3,000,000 38%
8,000,000 100% 10,000,000 100%

VC Negotiations
 When to mention valuation
 Staged Investment
 Liquidation Preference
 Control
 Blocking rights
 Drags and tags
 Anti-Dilution protection
50

Other Financiers
 Private Equity
 Crowdfunding
 Strategic Investors
51

Private Equity
 For more mature companies
 Deals often leveraged
 Usually have cumulative dividend
52

Crowdfunding
53

Crowdfunding Campaign Overview
 Campaign owner selects crowdfunding platform (e.g., Kickstarter.com, Indiegogo.com,
GoFundMe.com).
 Differences exist such as whether must hit target to get funds, whether for
business or personal, others.
 Campaign owner creates a campaign, telling the story of their product, idea, concept or
reason for fundraising.
 Third-parties “contribute” funds to the campaigns.
 Funds raised are distributed to campaign owner less any applicable fees assessed
(e.g., by the platform itself, credit card processors, foreign currency conversion, etc.).
 Some sites require that “target” be met to get the funds.
 Campaign owner, in exchange for this contribution may:
 Do nothing, including provide nothing in return to the contributors
 Provide a product or ownership interest
 Provide a nominal value perk such as a logo tee shirt/tickets to an event
54
Slide provided by:
Dawn Rhea, Moss Adams
Carolyn Lee, Morgan, Lewis & Bockius
Annette Nellen, San Jose State University

JOBS Act – Key Provisions
 Crowdfunding (Title III of the JOBS Act)
 Allows companies to raise a limited amount of funds from the general
public (Effective as of May 16, 2016)
 Investment must be through an intermediary broker or funding portal
 General Solicitation (Title II of the JOBS Act)
 The SEC has extended the exemption for private offerings under Rule
506 to allow for general solicitation providing certain requirements are
satisfied
 Can only issue securities to accredited investors and there are additional
filing requirements
 New Regulation A, nicknamed “Regulation A+” (Title IV of the JOBS Act)
 Preempts state registration, allow for what some call a “mini-IPO”
55

Crowdfunding
Exemption from Registration
 The private company issuer (aggregated with predecessors and companies under
common control) may sell up to $1.07 million of securities in a 12-month period
[adjusted for inflation]
 Individual investments in all crowdfunding issuers in a 12-month period are limited to:
 If either their annual income or net worth is less than $107,000, then the greater of:
 $2,200 or
 5 percent of the lesser of their annual income or net worth
 If both their annual income and net worth are equal to or more than $107,000, then
 10 percent of the lesser of their annual income or net worth (up to a maximum of
$107,000)
 Issuer may rely on intermediary’s calculation of investor limits, unless issuer knew
it was or would be wrong
 Process is likely to prove expensive and overly burdensome
 Effective as of May 16th, 2016
56

The ICO: Crowdfunding on Steroids
Utility
 Use of Token
 Secondary Trading
 Scarcity
 Voting + Democratized
Law
 Securities Law
 Regulatory
 Tax
 AML/KYC
 Anti Fraud
57
Issuer
$
Step 2: Build
Platform
Step 1:
Pre-Sale
$or
Crypto
SAFT
Investors
Step 3: ICO
Tokens
Investors

Initial Coin Offering (“ICO”)
 Community supported crowd sale of cryptocurrency tokens issued by startups
based on private Blockchain technology
 Creates liquidity and growth equity without giving up equity in a company
 Tokens are sold in exchange for Bitcoin, Ether, and government fiat
 No clear tax guidance
58

ICOs (cont.)
 In certain cases, the tokens or coins will be securities and may not be lawfully sold
without registration with the SEC or pursuant to an exemption from registration
 Will depend on the facts and circumstances including the economic realities of the transaction
 Tokens can have different utilities and rights
 Regulation A, Regulation D, or Regulation CF can be used
 Potential CFTC and FinCEN Compliance
 US vs. Offshore Offering
59

STO - Security Coin Offering
 Tokenized Stock
 Token tied to asset or revenue stream
 Treated as security
60

STO – Pros and Cons
Advantages:
1. It’s not an ICO, which are not doing well due to regulations and bad press
2. Liquidity, can be traded
3. Removes middleman, speeds up process
4. Broad access to investors
Disadvantages:
1. Stigma due to ICO fallout
2. Regulatory uncertainty
3. Lack of governance
61

Security Tokens - Implementation
 Stock with tokens attached
 Stock with right to future tokens
 Stock convertible into tokens
 Tokens with rights of stock
 Asset backed tokens or centralized stable coins
62

The Exit
 Taking Money Off the Table
 Earnouts and contingencies
 Acqui- Hires
63

Taking Money Off the Table
1. Investor buys preferred shares from company and common shares from
founders
2. Alternatively, investors buys preferred from company and company redeems
common from founder
3. Founders common priced at above market
4. Tax issues for founder
64
Target
Target
Shareholders PEG
Target
Shares
Cash
Cash

Earnouts and Contingencies
 Purchase price based on performance (earnouts) should be baked into
formation documents
 Can structure for capital gains tax instead of ordinary income
65

Acqui – Hires
 Acquiring a company to recruit its employees
 The Marvell case
 Management carveouts
66

AUSTIN
600 Congress Avenue
Suite 1300
Austin, TX 78701
United States of America
T +1 512.867.8400
F +1 512.867.8470
CHARLOTTE
101 S. Tryon Street
Suite 2250
Charlotte, NC 28280
T +1 980.771.8200
F +1 980.771.8201
CHICAGO
180 N. LaSalle Street
Suite 2215
Chicago, IL 60601
T +1 312.216.1620
F +1 312.216.1621
DALLAS
2323 Victory Avenue
Suite 700
Dallas, TX 75219
T +1 214.651.5000
F +1 214.651.5940
DALLAS - NORTH
2505 North Plano Road
Suite 4000
Richardson, TX 75082
T +1 972.739.6900
F +1 972.680.7551
DENVER
1050 17th Street
Suite 1800
Denver, CO 80265
T +1 303.382.6200
F +1 303.382.6210
FORT WORTH
301 Commerce Street
Suite 2600
Fort Worth, TX 76102
T +1 817.347.6600
F +1 817.347.6650
HOUSTON
1221 McKinney Street
Suite 2100
Houston, TX 77010
T +1 713.547.2000
F +1 713.547.2600
LONDON
1 New Fetter Lane
London, EC4A 1AN
United Kingdom
T +44 (020) 8734 2800
F +44 (020) 8734 2820
MEXICO CITY
Torre Esmeralda I, Blvd.
Manuel Ávila Camacho #40
Despacho 1601
Col. Lomas de Chapultepec,
DF 11000
Mexico City, Mexico
T +52.55.5249.1800
F +52.55.5249.1801
NEW YORK
30 Rockefeller Plaza
26th Floor
New York, NY 10112
T +1 212.659.7300
F +1 212.918.8989
ORANGE COUNTY
600 Anton Boulevard
Suite 700
Costa Mesa, CA 92626
T +1 949.202.3000
F +1 949.202.3001
PALO ALTO
525 University Avenue
Suite 400
Palo Alto, CA 94301
T +1 650.687.8800
F +1 650.687.8801
SAN ANTONIO
112 East Pecan Street
Suite 1200
San Antonio, TX 78205
T +1 210.978.7000
F +1 210.978.7450
SHANGHAI
Shanghai International
Finance Center, Tower 2
Unit 3620, Level 36
8 Century Avenue, Pudong
Shanghai 200120, P.R. China
T +86.21.6062.6179
F +86.21.6062.6347
THE WOODLANDS
10001 Woodloch Forest Drive
Suite 200
The Woodlands, TX 77380
T +1 713.547.2100
F +1 713.547.2101
WASHINGTON, D.C.
800 17th Street NW
Suite 500
Washington, D.C. 20006
T +1 202.654.4500
F +1 202.654.4501
67

Legal overview star camp royse - may 2020 4839-7571-5260-1