Making sure crypto founders do not flounder 

By Jaspal Pachu (Partner), and Cathy Wirz [Consultant] at CMS

The founders can be forgiven for neglecting their capital when the company is being run from a spare bedroom and when turning a profit, let alone the idea of ​​selling the company, is still a pipe dream.

When forming a company, many forget to include details about the owner. Sometimes the original founder might have been forgotten or an employee who was instrumental at launching the company may not be able to receive capital upon incorporation.

A few years later, the potential exits and investment rounds are well underway and it becomes very important to know who owns what.

Tax considerations

Founders and key employees are often the company’s directors (executive director or NED) and are generally treated for tax purposes as employees of the company (even if not actually employees).

Any shares they acquire or purchase are considered “employment related security” (ERS). Their acquisition or disposal could be subject to income tax, as well as employers and employees. Income tax, for example, may be payable under certain circumstances.

• For less than the market value, shares are transferred to or between other founders and employees.
• Exclusion or deregulation occurs when shares are restricted (eg have bad or good provisions to give up), and the founders/employees fail in making a selection and/or paying the ‘unrestricted market value’ upon acquisition.
• Indirect value is gained from shares owned by employees or founders. If the founding shareholder decides to give up his shares to increase the value of the shares of the employees and founders, he may do so by agreeing to forfeit his shares.

This rule applies to past and future employment as well as to shares made available to a person due to another person’s employment. Some share transfers between family members may be exempted from this rule, as they are not considered employment-related transfers.

As the company’s value increases, so does the potential tax problem. It is important to correct stock ownership as soon and as possible when it is low.

Evaluation is essential. Moving around stocks that are undervalued has very little tax impact. Companies House filings are usually all that is required.

The problem lies in proving and proving the share’s value at transfer. It can be difficult for potential buyers of multimillion-pound businesses to accept that shares once weighed pennies. Therefore, there is no historical tax.

Effective alternatives

Rebalancing the founder’s stake can be a great opportunity to increase the company’s options for employees.

The company can transfer excess founder shares into an “repository”, such as an employee benefit fund, without diluting investors. Employees can then be motivated through options and other stock awards.

Equity-based bonuses can be more tax-friendly than cash bonuses if they are properly structured.

EMI options

If the company qualifies for Enterprise Management Incentives, UK employees may be eligible. This is a great way to not only correct the organization’s problems but also to encourage the workforce and other founders.

EMI options give HMRC the assurance that the tax value for the underlying shares will be accepted by HMRC in these circumstances. This is a valuable valuation tool. EMI options also reduce employees’ taxes liability if they decide to sell option shares. This can be reduced from 20% to 10%