“V” is for venture capital. Venture capital is a way for small businesses to get needed funding. Venture capital comes in many different ways, but generally a deep pocket invests a bunch of money in a growing company that needs cash to keep expanding. If that sounds like the setup of Shark Tank, well it is. Shark Tank is basically venture capitalists trying to strike a deal with promising companies.
Venture capital is really a financing mechanism but it can have some important tax ramifications. When venture capitalists contribute their money, they normally receive shares of the company in exchange. That purchase is not a taxable transaction, but down the road if they sell, it will be a capital gain or loss. Holding the shares of the company will normally entitle the venture capitalist to a share of the distributions of the business. In partnerships and S corps the distributions are a reduction of basis but not taxable. For C corps, distributions are normally dividends which are taxable when received.
Venture capital can be set up a number of ways, but understanding the tax impact is obviously very important for both the venture capitalist and the business that is seeking the investment. When you get into more complicated royalties or payback models, it’s good for both sides to have a clear understanding of the taxes so you don’t run into problems in the future.
Taxes A to Z – still randomly meandering through tax topics, but at least for 26 posts in an alphabetical order.