Startup companies typically weather several years of losses in the hopes that, someday, they will have the luxury of worrying about being profitable and paying income taxes. Net operating losses (NOLs) incurred during a startup’s development period can be “carried forward” to offset future taxable income. However, a company’s ability to use NOLs can be severely restricted by IRC 382 limitations. IRC 382 often blindsides startup businesses but Teknos can help companies maximize their use of NOL carryforwards.
You would think you would know if you had an ownership change. Think again. As a result of the extremely complex rules surrounding ownership changes under IRC 382, startup companies typically experience multiple ownership changes through their preferred stock financings and stock-based compensation (SBC) grants. This is because, according to the IRS, changes in ownership are determined on the basis of value of company securities transacted. So if a company issues Series A stock accounting for 25% of its fully-diluted capitalization, and the per share value of Series A is 5x greater than the per share value of common stock, that company just experienced an ownership change.[1] That is bad news for the Company, because ownership changes trigger IRC 382’s NOL restrictions.
In general, the rules for determining whether or not a company has experienced an ownership change are extremely complex. They’re also extremely important in calculating your tax bill. The professionals at Teknos maintain deep expertise with both the IRC 382 regulations and the valuation issues underlying them.
How can we help?
Teknos can help companies determine if they have experienced an ownership change, as defined by IRC 382. In addition, we can help companies plan capital raises in order to avoid triggering unintended ownership changes or maximize the NOL limitation in the event a change is unavoidable.
The IRS has approved the use of several methodologies in determining whether or not the target company experienced an ownership change. Teknos’s experts are well-versed in all allowable methodologies and can select the method that will result in the most favorable tax consequences. We can also help clients save money by forecasting the impact of net unrealized built-in gains (NUBIGs) and losses (NUBILs).
When do I need to get a 382 study?
In addition to being required for tax planning, 382 studies may be necessary for tax and financial disclosures. ASC-740 requires companies to disclose any tax attributes that it believes will not be utilized and substantiate the value of their NOL deferred tax asset. The amount of the NOL limitation is not known until and unless a 382 study is done.
In the event of an acquisition, the buyer’s due-diligence team may request a 382 study to validate the quality of the target corporation’s NOLs. A study may also be necessary for a company considering an initial public offering (IPO) of its stock.
Valuation is critical for IRC 382 as changes in ownership are determined on the basis of value, not simply the number of shares. In addition, the limitation itself is a function of the corporation’s value just prior to the ownership change. Teknos is uniquely situated to provide superior 382 services through its deep expertise in both the IRC 382 regulations and valuation.
[1] This example assumes the Series A investor is a new investor in the company.