Mitigating startup investors' risk with federal and state tax benefits.

• Author: Bakale, Anthony

In today's investment climate, startups must not only convince investors that their business model is viable, they must compete against other, often unrelated, startups for capital. A startup can significantly improve its attractiveness to potential investors by fully leveraging Federal, state and local tax benefits and incentives, thereby mitigating the risk associated with the investment. A well-tax-leveraged startup can limit an investor's net economic risk to less than 40% of the amount invested, while a poorly tax-leveraged startup can put nearly 87% of the amount invested at risk. Assuming similar success potential, the startup with the lower failure risk has the advantage.

Overview

There are numerous tax benefits and incentives administered through the Federal, state and local tax systems designed to encourage investments in startups by sharing the risk with investors. An example of a combination of a Federal and state program that would significantly reduce an investor's risk is Ohio's Technology Investment Tax Credit (TITC) program combined with a Federal deduction under Sec. 1244. It is important to keep in mind that there are countless combinations of programs that can yield similar (or superior) results.

Example: X is a married taxpayer filing a joint return, with a Federal tax rate of 38% and an Ohio tax rate of 8%. He wishes to invest $100,000 and has no other capital gains. With TITC and Without TITC Sec. 1244 and Sec. 1244 Cash invested $(100,000) $(100,000) Ohio TITC 25,000 0 Federal tax benefit 38,000 10,925(*) Ohio tax benefit 8,000 2,300 Federal tax effect of reduction in itemized state tax deduction (9,500) 0 Net economic risk to potential investor (38,500) (86,775) (*) Present value of $3,000 annual capital gain limit at 10% rate of return. Ohio's TITC Program

Since 1996, the Ohio TITC program has been an integral part of Ohio's economic development strategy, providing businesses and individuals an additional incentive to invest in small, research and development, and technology-oriented firms, subject to specific requirements. The Ohio TITC program provides a tax credit for 25% of the...