160527 itp austin presentation
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This document discusses revenue-based financing structures for impact investments. It explores why traditional equity and debt structures may not be appropriate, and examines redeemable equity and variable payment debt as alternatives. Redeemable equity could provide tax benefits to investors, allowing them to exclude capital gains from income or claim losses as ordinary losses. The document also profiles an impact investor to provide their perspective.
160527 itp austin presentation
- 1. TX dba: Campbell Tans Henry & Mikulencak Bruce Campbell | Chief Happiness Officer bruce@bluedotlaw.com Brian Mikulencak | Tax Alchemist brian@bluedotlaw.com +1 303.402.9284 www.BlueDotLaw.com dba Campbell Tans Henry & Mikulencak (in Texas)
- 2. Impact Terms Project (www.ImpactTerms.org) <BETA VERSION>
- 5. Measured overall impact performance (e.g. agreed-upon metrics, third- party standards, certification) Impact Terms Minimum standards Third-party audit
- 6. Why not use “straight” equity? Liquidity Terms – Why the need for special financing terms? Traditional equity financings assume an IPO or company sale In that sense, this structure is “too lenient” not requiring investor repayment prior to one of those events $$$ from sale to public (IPO) or buyer * *Earnings Before Interest, Taxes, Depreciation, and Amortization
- 7. Why not use debt? Liquidity Terms – Why the need for special financing terms? Traditional debt requires fixed, regular payments Non-payment could trigger a default Debt payments EBITDA
- 8. Liquidity Terms – Preliminary Conclusion EBITDA Debt payments Revenue-Based Financing (RBF) Investor repayments are tied to company revenues and may be either: Variable payment debt; or Redeemable equity
- 9. Liquidity Terms – Variable Payment Debt Similarities to “straight debt”: * Cap on investor return * Founders retain control * Transactions costs lower than equity * More investor downside protection * Higher tax rate than equity Differences: More flexible payments More complicated to negotiate/document Typically triggers complicated tax reporting rules for “phantom income”
- 10. Liquidity Terms – Redeemable Equity Similarities to “straight equity”: Can provide uncapped investor return May reduce founder control Transactions costs higher than debt Less investor downside protection Lower tax rate than debt (maybe zero!) and may avoid “phantom income” tax rules Differences: Structured redemption repayments (on flexible payment schedule)
- 11. Liquidity Terms – Example
- 12. Revenue-based financing could, if structured as equity: * Qualify for exclusions from taxable income, in a gain scenario; or * Qualify for “ordinary loss” treatment, in a loss scenario Redeemable Equity: Tax Preferences
- 13. What if equity is redeemed at a gain? Under the qualified small business stock (QSBS) regime: Investors can exclude 100% of gain (or $10 million of gain / year, if lower) from taxable income. Many requirements must be met to constitute QSBS, but most stock issued by early-stage US corporations qualify. Redeemable Equity: Tax Preferences
- 14. Redeemable Equity: Tax Preferences
- 15. Redeemable Equity: Tax Preferences Timeline: 1993 enactment of original QSBS rules 1997 reductions in capital gains rates rendered QSBS rules largely ineffective 2009 QSBS rules expanded in response to real- estate financial crisis 2010 100% exclusion enacted 2015 Congress makes 100% exclusion permanent (with heavy SV lobbying); first 100%- excluded sales occur Today (2016) first tax returns filed with full exclusion Investors might pay zero tax on gain? Are you sure?
- 16. What if equity is sold/cancelled at a loss? Redeemable Equity: Tax Preferences Under the small business stock (SBS) regime: Investors can treat up to $100k of losses / year as ordinary losses. This provides dual benefits of avoiding $3k / year cap and offsetting higher-taxed wage income. SBS regime has separate requirements and the company must be smaller, but many early-stage US corporations still qualify.
- 17. Redeemable Equity: Tax Preferences
- 18. Liquidity Terms – Investor Perspective Jarred Maxwell Co-founder / Partner Austin Foodshed Investors Jarred leads AFI’s venture relations, guiding them through the fundraising process, providing business analysis and assisting as they prepare to present to potential investors. Jarred has been the Local Leader for Slow Money Austin since 2011. He is dedicated to healthy food, local economic vitality, support of small-scale businesses, re-invigoration of small towns and small family farms and ranches. Jarred is an active angel investor in more than a dozen local socially responsible companies and helped found the Sustainable Texas Investment Club in 2010 to provide a mechanism for non-accredited investors to put some of their investment dollars into local food companies. In 2010 Jarred founded The Happy Land Company, which specializes in the acquisition, restoration and preservation of rural land, including large property acquisition and assemblage, range land restoration, and land trust filing. Prior to this, Jarred was a land broker and partner with the Luedecke Group of Austin for six years. He started his career as an engineer at Dell. Jarred is a lifelong Texan and a rancher, managing over 400 acres of family ranch outside Lampasas in northern Burnet County. He has a BS from UT, and lives in Central Austin with his wife Sommer and their young son.
- 19. TX dba: Campbell Tans Henry & Mikulencak Bruce Campbell | Chief Happiness Officer bruce@bluedotlaw.com Brian Mikulencak | Tax Alchemist brian@bluedotlaw.com +1 303.402.9284 www.BlueDotLaw.com dba Campbell Tans Henry & Mikulencak (in Texas)
Editor's Notes
- #3: Brief intro. on impact terms; audience can browse sample impact terms on the website.
- #5: The website covers many structuring innovations in the impact space, including types of legal entities available to impact focused businesses and legal avenues to better preserve mission. However, we’ll primarily be addressing two categories of terms frequently encountered in financing social impact businesses: terms meant to define and align investor and founder expectations with respect to impact and “structured exit” terms, which are designed to provide investor liquidity in recognition that the parties don’t anticipate an IPO or a strategic acquisition. Additionally, we’ll touch on some preferential tax regimes that the parties may be able to utilize when structuring for liquidity.
- #6: Brief intro. on impact terms; audience can browse sample impact terms on the website.
- #9: Describe similarities in the economics of flexible debt and redeemable equity, and how both fall toward the center in the equity-debt spectrum. Note that for certain purposes the distinction between equity and debt is important (e.g., usury laws).
- #12: Describe website interface, sample legal language for term sheets, and commentary based on legal analysis and interviews with impact investors.
- #15: [Summarize chart]
- #18: [Summarize chart]
- #19: [CONSIDER REPLACING THIS EXAMPLE WITH ACTUAL TERM SHEET FROM ROLE PLAYING PARTICIPANT; IF SO, SHOULD WE ENGAGE THE PARTICIPANTS NOW, OR WAIT UNTIL THE ENTIRE BDA PRESENTATION IS OVER?]