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  • How Do Startup Technology Businesses Start Their Tax Planning?

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    Many valuable companies today began as startups, such as tech businesses founded by influential entrepreneurs like Mark Zuckerberg, Steve Jobs, and Elon Musk(1).

     

    The estimated market value of unicorns (private startups that haven’t gone public) is about $929 billion in North America as of April 2021(2). Meanwhile, Asia-Pacific unicorns had a cumulative market value of $952 billion.

     

    Credit:wutwhanfoto

     

    With these investment amounts, one could imagine how much tax planning these companies went through. Enterprising individuals eager to open their own startups but need expert advice on tax planning should visit this page for a free consultation.

     

    What should startup business owners consider when preparing their tax plans? What should you think about when selecting a business entity? Should you also consider planning for research and development (R&D) costs?

     

    Readers, especially startup owners, will learn what aspects of their businesses they need to consider, such as the business entity, startup costs, and R&D costs, when making tax plans.

    Essential Considerations for Startups When Preparing Their Tax Plans

    Startup tech businesses have a lot to think about, such as what products or services they should sell, office or factory location, target market, and the needed capital to set up the business. Not the least of these concerns is tax planning.

     

    Entrepreneurs should consider several factors when doing tax plans, such as the business entity, funding requirements, and research and development costs.

     

    Selecting a Business Entity

     

    Different business entities have their strengths and disadvantages, so think about what business type you want to establish before proceeding with funding.

     

    For example, startups that plan to go public through an initial public offering (IPO) in the future may consider setting up as a C corporation or C-corp. Institutional investors prefer C-corps as these entities have a more straightforward legal definition than limited liability companies (LLCs).

     

    One disadvantage of C-corps is that they are subject to double taxation, meaning the company gets taxed on profits, and shareholders get taxed on dividends.

     

    Business owners who want to avoid double taxation and aren’t in a hurry to go public can set up an LLC instead.

     

    Reviewing Funding and Startup Costs

     

    Before any funding rounds begin, analysts perform a valuation of the startup company. Market size, track record, and risk can affect the valuation. These factors can determine why the company seeks new capital and influence the types of investors likely to invest.

     

    Depending on the business goals, industry, and how interested potential investors are, startups can engage in several funding rounds, such as:

     

    • Seed funding: This funding round provides the first official money that a startup raises. Depending on this round’s outcome, the company may or may not need to go beyond seed funding.
    • Series A funding: During this round, startups attempt to raise approximately $2 million to $15 million. In 2021, median Series A funding was $10 million(3).
    • Series B funding: In this round, companies attempt further funding of around $30 million to $60 million.
    • Series C funding: This round focuses on scaling the company to grow as successfully and quickly as possible.

     

    Taking Account of Research and Development Costs

     

    Companies manufacturing their own goods and services must spend on research and development (R&D) expenses, including costs for intellectual property the business generates.

     

    On average, top software companies invest between 10% and 15% of their revenue in R&D.

     

    Businesses can choose to deduct the costs of R&D from their taxable income for the year those expenses occur. Note that by 2022, the Tax Cuts and Jobs Act (TCJA) will require businesses to gradually pay off R&D costs over five years rather than deducting these costs immediately each year(4).

    Exit Plan

     

    Startups aiming to go public in the future should have a well-thought-out exit plan to make the transition from private to public smoother. Exiting means the company moves from a private startup into a public company.

     

    Some startups seek funding as fast and as much as possible to go public immediately. Others will take their time to grow and accumulate wealth before entering the public through IPO.

     

    Because the business entity also determines the types of taxes the business must pay, owners should consider developing an exit plan before they seek funding.

     

    Entrepreneurs interested in setting up their startups and needing assistance with tax planning should consult a tax advisor or specialist.

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