Unscripted with @jrichlive: Ed Zimmerman of Lowenstein Sandler LLP Explains Startup Legal Counsel and QSBS

TL;DR

Startups should engage strong legal counsel early and assess Qualified Small Business Stock eligibility because mistakes involving equity, intellectual property, taxes, or the cap table can reduce what founders keep. Ed Zimmerman of Lowenstein Sandler LLP explains that eligible shareholders who hold qualifying startup shares for five years may exclude the greater of $10 million or 10 times their cost basis from taxable gain. Read on for the requirements and potential pitfalls.

Transcript

ed how are you i'm great how are you i'm doing great good afternoon you look great did you you got hair and makeup done for the show thank you i was gonna get hair for the show but the plugs aren't in yet i've got a grow light though so because weed is now legal in new jersey or almost legalized interesting thing yeah so i'm hoping it'll work for a... Read More

Key Insights

• 🫥 Founders should prioritize hiring a great attorney early in their startup journey to avoid legal complications down the line.
• 🉐 QSBs offer significant tax advantages for shareholders, allowing them to shield gains from taxation.
• 🖤 Lack of awareness about QSBs is still prevalent, but efforts have been made to increase understanding and utilization of these tax benefits.
• 🧑‍🏭 Startups should consider factors such as industry exclusions, active business status, and asset thresholds to determine their eligibility for QSB treatment.
• 🏂 Companies must be prepared for the IPO or M&A process, considering governance requirements, financial predictability, and additional board diversity to ensure a smooth transition to the public market.

Questions & Answers

Q: Why should startups hire strong legal counsel early?

Early legal counsel can help startups properly handle their cap table, equity promises, intellectual property, and tax position. Mistakes in these areas can impede a financing round or outcome and leave founders keeping much less of a successful result.

Q: How should founders work with startup lawyers?

Founders should give counsel enough information and rely on their judgment for appropriate decisions. Ed Zimmerman warns that treating lawyers only as vendors or technicians can produce poor results even when the counsel itself is good.

Q: What is Qualified Small Business Stock (QSBS)?

Qualified Small Business Stock is a category created under Section 1202 of the tax code to support business creation and long-term gain. It can allow shareholders in certain qualifying startups to exclude some gain from tax.

Q: What is the potential QSBS tax exclusion?

An eligible shareholder may shield or exclude from tax the greater of $10 million or 10 times the shareholder’s cost basis. Zimmerman emphasizes that this benefit applies per stockholder, not once for the entire company.

Q: How long must someone hold qualifying startup shares for QSBS treatment?

The shares must be held for five years. The transcript also states that there must be no disqualifying redemptions.

Q: What kinds of companies may qualify for QSBS?

Zimmerman says the shares must be in a startup that is a qualifying type of company. He gives a garden-variety software company or SaaS business as examples.

Q: What startup mistakes can create problems during fundraising or an exit?

Startups may improperly document promised equity, mishandle intellectual property, damage their tax position, or make errors in the cap table. Zimmerman says these problems can become an impediment to a financing round or an outcome.

Q: Who is Ed Zimmerman of Lowenstein Sandler LLP?

Ed Zimmerman says he had worked at Lowenstein Sandler for almost 30 years and co-founded its tech group with Anthony Pergola in 1998. He also taught venture capital and angel investing at Columbia for 16 or 17 years, invested in about 140 companies, and served as an LP in dozens of venture funds.

Summary & Key Takeaways

• Hiring a great attorney early on in the formation of a startup is essential to avoid legal complications in the future, such as cap table and tax issues.

• QSBs, created under section 1202 of the tax code, allow shareholders of eligible startup companies to exclude or shield from tax on gain up to $10 million or 10 times their cost basis.

• Lack of awareness about QSBs is still prevalent, but it has increased over the years as people file their tax returns. However, founders should focus on it early to establish eligibility.