INSUBCONTINENT EXCLUSIVE:
Late last week, Congress moved one step closer to passing theAmerican Innovation Act of 2018, a bill that would make accounting and tax
changes thatwouldlikely increase thevaluationofstartupsin anacquisition.The House Ways and Meanscommitteeapproved a bill containing text
that would improve the treatment of Net Operating Losses (NOLs) for startups.While many startup founders would probably rather watch paint
dry (or build their companies) than dive into complex tax code changes,theprovisions in the bill could greatly improve the ability of
startups to invest in growth activity, and could drive meaningfully positive impacts to valuations, acquisition prices, capital markets
participation and venture returns.First, though, what are NOLs Each year, if a company loses money, it can claim the losses as a deduction
tax code has allowed companies to cumulatively track and carry forward NOLs to offset taxable income in future years, reducing the amount of
cash required to pay taxes
These NOLs are essentially a cash-like asset, and they can be exchanged in the event that a company is acquired.However, a long-standing IRS
provision, Section 382, which was originally implemented to prevent companies with large tax appetites from acquiring those with large
operating losses exclusively to reduce taxes, limits the use of NOL carry-forwards in instances of ownership change.Currently, in cases of
an ownership change, specified as a more than 50 percent change in the ownership of shareholders who own at least 5 percent of a company
stock, the amount oftaxable incomeforthe &post-change&company that can be offset by existing NOLs cannot exceed thevalueof the&pre-change&
company, multiplied by the long-term tax exempt rate set by the IRS.(Yes, this is why you hire a tax attorney.)The net-net is that this
provision has been particularly challenging for startups, which often trigger this limiting condition, given they frequently operate in the
red through growth stages and often see frequent, sizable changes in their ownership structure due to fundraising, public offerings and
acquisitions.The House bill would alleviate this complication by protecting these tax offsets and creating an exception to the section 382
provision for startups, allowing the application of NOLs and RD tax credits realized in the first three years of operations regardless of
ownership change limitations.These changes have a number of benefits for startups.It would provide increased flexibility around early-stage
financing activities and remove potential issues that could arise with capital markets activity
Additionally, with startups more easily maintaining tax offsets to reduce their cash taxes, startups would have larger cash balances to
invest in growth efforts.The protection of the NOL from ownership change limitations could also have serious impacts to company valuations
and the attractiveness of startups as acquisition candidates
With acquirers better able to utilize existing tax offsets, startups should benefit from higher purchase prices from the inclusion of NOL
balances in valuations, helping founder and VC returns.The bill passed through committee through a voice vote with no objections and is now
expected to be voted on by the rest of the House later this month before advancing to the Senate
The bill has 23 co-sponsors, all Republican.
