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How Tax Changes Can Affect US Startups

Although US companies may be subject to massive tax cuts, most technology startups have few immediate reasons to rejoice. After all, the vast majority is not profitable. Thus reducing the corporate tax rate from 35% to 20%, as Congress has decided, has no effect on their short term finances.

That said, what is true of most new technology companies is not true of the broader startup ecosystem. Investors, employees, potential buyers and others should see a more immediate impact of tax code changes, which could, in turn, affect their start-up decision-making.

What changes could we expect on the horizon? It is too early to predict, because the Congress has not yet managed to reconcile the differences between the versions of the House of Commons and the Senate. But it is not too early to prepare.

In an effort to imagine how the pending tax bill could affect US startups and their investors, Crunchbase News reached out to tax experts in the technology industry. We discussed topics such as the mergers and acquisitions climate, the tax treatment of interest charges and whether the rising cost of living in high tax states will lead to an exodus to the United States. cheaper destinations. Combined with our own analysis, here are some thoughts on the potential impacts.

Increase in M ​​& A expenditures

Up to now, 2017 has been a pretty dull year for startup acquisitions in the United States. We saw just one big merger and unicorn acquisition deal: Cisco's $ 3.7 billion AppDynamics purchase in January.

One factor that has dampened mergers and acquisitions has been the uncertainty surrounding changes to the tax code, notes David Jolley, who heads the US growth markets division at Ernst & Young. Over the last year, many deep pockets have delayed the implementation of their strategic plans, of which mergers and acquisitions are often an important element. Next year, assuming tax cuts come into effect, they could become more active.

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Large cap technology companies do not suffer from a cash shortage, but having more will not hurt. The tax bill provides incentives for US companies with cash abroad to repatriate this money. Companies with the largest cash reserves abroad are also those with a history of acquiring startups, including Apple and Microsoft. The decline in corporate income tax rates will also put more money in the pockets of the most profitable technology companies.

Confusion for start-up employees

The generosity of the tax bill for profitable technology companies does not extend to many of their employees, especially those in high-tax states.

This could be a problem because start-up employees tend to be sought-after specialists. They do a risk-benefit calculation every time they take a job in a company. Usually, the choice is to accept a lower salary, longer hours and a high cost of living. In exchange, early employees will see a potential reward for stock options and the adrenaline rush of startup work.

The planned tax changes do not have a significant impact on these choices, but they will have some impact around margins. Plans to reduce state and local tax deductions, for example, make it a bit more expensive to live in high-tax innovation centers. like Silicon Valley, Boston and New York.

It is unlikely that an enthusiastic person with the idea of ​​joining the next big venture-backed company will be discouraged by this cost. But for those who are on the fence, this could be a factor. On the other hand, low-taxing states with important technological talents, like Texas and Utah, could see more start-up activities, predicts Jolley.

Provisions of the tax law that lower rates on so-called "pass-through" entities could also have an impact, according to CNBC:

Under current law, the profits of a small business "pass" to the owner and are taxed at his individual rate, which can reach 39.6%. The Senate bill will allow business owners to deduct 23% of their income, which will help them save on taxes.

The provision creates new incentives, where possible, for specialists to operate as a business rather than simply collecting a pay check. It remains to be seen how this will happen, especially given the legal complexities surrounding the way employers extend capital compensation and classify contractors relative to employees. But it's something to watch for.

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No more sloshing around the capital

Most of the tax savings achieved through the bill will go to wealthy investors and corporations. As novice investors tend to be wealthy fund managers, themselves backed by large asset managers, pension funds, endowment funds and family offices, it is reasonable to expect this to happen. more capital is invested.

This is not necessarily a good thing for the venture capital industry. Venture capital fund partners routinely complain that too much capital is looking for too few bids and pushing valuations to unsustainable levels. The proliferation of private unicorns, many of which have produced disappointing outflows, underlines these concerns.

Nevertheless, startups in need of money benefit from more abundant capital. Plus, if they ever arrive at the IPO, more money in the hands of asset managers means a ready bid from the public market buyers for their stock, as well.

Release date changes at the end of the stage

Hillary Clinton and Donald Trump were not of the same opinion. But one of the things the two campaigns talked about was the closing of the so-called deferred interest tax loophole, which allows fund managers to classify portfolio investment returns as long-term capital gains rather than as ordinary income.

Yet, despite the discussions, the infamous loophole of interest has survived with a little do-it-yourself. As proposed by the House and Senate, the gains attributable to deferred interest will be taxed at the higher short-term capital gains rate, unless the assets are held for more than three years. This is a change from the current rules, which allow the long-term treatment of the capital gain on all fixed assets if they are held for more than one year.

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The change will not have much of an impact on start-up and start-up investors, who typically hold shares in companies for more than three years. According to Natalie Jessop, head of PwC's venture capital practice, the tax change could affect the timing of investments in subsequent transactions, ensuring that the holding period of three years is respected.

Take-Out Food

A number of other tax changes could affect the financial planning of start-ups. In their current version, critics say the bill reduces the utility of tax credits for research and development. It also affects the calendars to postpone operating losses and use them to reduce future taxes.

Incidentally, a lower tax rate should also allow startups to increase their expected profits faster because they will not have to put aside so much tax.

Overall, the bill should give startups the opportunity to engage in a good chunk of what they do well: adapt to change and rotate their business models to take advantage of new opportunities.

It remains to be seen if everything that will allow to adapt and rotate will have a net profit on the net result.

Stock Image from the editor: milosducati / iStock