Startups Say Senate Tax Plan Would Be Catastrophic for Their Industry

(Bloomberg) -- Startups and venture capitalists rarely get worked up over laws before they pass, but the tax plan currently winding its way through Congress is causing an uproar in Silicon Valley.

The Senate version of the bill requires employees pay tax on stock options at the time they vest, rather than when they are exercised. That means staff would be liable for tax long before reaping any financial benefit from owning and selling stock. These options are a big part of compensation at startups, giving staff a long shot at serious wealth in the unlikely event their startup succeeds.

"This would be a catastrophic blow to early stage companies," said Michael Boswell, co-founder of health startup Cue. "This is like paying taxes on the winning of the lottery without knowing whether you're going to win."

The current approach works like this: Companies give options to staff but the awards usually take a year or more to kick in, or vest. This is just an option to buy shares. If everything goes well, the value of the firms’ stock rises and staff exercise the option to purchase shares at the lower price assigned when they first joined the startup. Ordinarily, it’s at this stage -- when employees purchase the shares –  that a tax is levied on the gain in share price. Holders of the private shares, if they are able to find a buyer, sometimes sell a portion to help pay the tax bill.   

The Senate plan would force employees to pay tax when their options vest, before they purchase shares. This could put staff in a tricky financial situation because they would have to pay up without being able to sell stock. Startups often fail, so options regularly end up worthless. 

The wording is likely to change as policymakers continue revising the bill this week, and members of the House of Representatives are working on a version that startups like. Still, Boswell and others in the startup world, including PayPal co-founder and venture investor Keith Rabois, are worried. BitTorrent creator Bram Cohen, former Facebook Inc. Chief Technology Officer Bret Taylor, and venture investor Fred Wilson also criticized the bill.

Wilson urged startup employees to contact their senators to tell them to remove the provision before it becomes law. If it remains, "it would be the end of equity compensation in startups as we know it," he wrote on his blog.

Engine, a research and advocacy group supporting tech startups, collected more than 500 signatures for a letter it sent to Senator Orrin Hatch opposing the changes to the tax code.

Representatives from the National Venture Capital Association, an industry group, said they are also talking with lawmakers to try to persuade them to drop the provision. An NVCA spokesman said Senator Rob Portman has an amendment to strip out the language and the NVCA is "hopeful" it will get adopted during the next version of the bill.

To contact the author of this story: Lizette Chapman in San Francisco at lchapman19@bloomberg.net.

To contact the editor responsible for this story: Mark Milian at mmilian@bloomberg.net.

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