Why Angels Are Eager to Invest Right Now

By Susan SchreterBusiness on Main

New tax breaks for investors will make it easier for you to raise money for your business. Find out how.

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While Congress often passes laws that make it more costly and administratively demanding for startups and small businesses to thrive in America, at last small-business owners and their investors are getting a break.

There’s a little-known provision of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 that provides certain investors with a considerable incentive to purchase qualifying stock in small businesses.

The law provides an unprecedented 0 percent tax rate on capital gains up to $10 million or 10 times the investment amount. The law also removes most gains from alternative minimum tax (AMT) obligations (the AMT is one way the IRS collects extra taxes from many business owners, the upper middle class and high-income-earning Americans).

With this tax break, many more angel investors may pull extra funds out of low-interest-paying certificates of deposit or the stock market for the opportunity to invest in innovative privately held businesses. That’s a good thing for business owners who need startup or expansion capital — and it’s a good thing for America in terms of sustainable job creation and wage growth.

Here are some of the fine points of the legislation:

- Timing. The investment must be made before December 31, 2011, and purchased directly from the corporation. I would not assume that this tax break will be renewed in 2012, so business owners should start fundraising now to allow investors plenty of time to complete due diligence.

- Business organization. The investment must be in a standard C corporation, not an S corporation. Is this a problem? Possibly for businesses that care more about their annual federal income tax obligations than raising growth capital for their companies.

However, most S corporation business founders eventually learn that investors prefer to invest in C corporations to sidestep IRS restrictions on investment activity. S corporations can only issue one class of stock and can’t have more than 100 shareholders. S corporation shareholders must be U.S. residents, estates or certain trusts and partnerships — not other corporations or foreign investors. Can S corporations become C corporations quickly and without a lot of administrative hassle? Yes, but it’s best to do so with the help of an accounting professional.

- Small matters. Corporations can’t have more than $50 million in assets to qualify for the tax break.

- Investment time frame. In general, the stock must be held by the individual or partnership investor for at least five years, which matches the amount of time most business owners need to develop, test and commercialize new products and services. Someone was thinking in Washington!

- Investment purpose. At least 80 percent of the corporation’s assets must be used to conduct research or operate the business. My only criticism of the new legislation is the limitations on industries that might qualify for the tax break. In general, restaurant, hospitality, real estate, finance and many service businesses may not be able to offer this tax-saving reward to their new investors.

Before assuming that your business won’t qualify, do some added research. A service business in certain types of Internet, advanced health care or education enrichment services might qualify.

States such as Ohio, Rhode Island, Virginia, Maryland, Kansas, Wisconsin, Oklahoma, North Dakota, New Mexico and New Jersey also recognize the job-creating benefits of stimulating small-business investment. These states are more generous to investors, but the definition of a qualifying small business can vary considerably. In New York, for example, qualifying companies must demonstrate they are advancing “emerging technologies,” whereas in Minnesota, qualifying companies must operate in certain counties.

As an advocate for entrepreneurship and the greater small-business community, I encourage business owners to reach out frequently to their state and national representatives. You can often get their research staffs to provide specific information about incentives for small-business investors. And if your state rep doesn’t offer any help or voting support for better tax deals for small-business owners, ask, “Why not?”

What do you think?

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