- How to conduct a Tech IPO/ICO
The SEC defines an Initial Public Offering (IPO) as when a company first sells its shares to the public.  Technology (Tech) companies distribute IPOs to raise the funding necessary for growth. Tech companies have raised approximately $4.3 billion in funding via IPOs by the third quarter of 2018.
The process of starting an IPO is a long exhaustive process which involves several layers of intense diligence by investment banks and lengthy filings with the SEC. The SEC requires certain corporate information to become open to the public. During the initial phase of going public, the company and its financials must be prepared to withstand public scrutiny. Extensive due diligence is performed (by an investment banker) to prepare the company books to go public, underwrite the potential IPO, and determine the potential IPO’s value.
The Securities Act of 1933 requires companies to register securities sold on the U.S. market with the SEC.  These companies must file a registration statement (From S-1) with the SEC prior to going public. A Preliminary Prospectus is filed as the first draft of the registration statement which includes the pertinent information found in the due diligence process. Once the preliminary prospectus becomes effective, the company will then file a final prospectus to include the IPO’s price range and amount of stock issued.
When conducting an IPO, a tech company must consider that sensitive information might be made public. The value of Intellectual Property is part of the analysis used to determine the price of the company’s IPO. This information may consist of trade secret information and/or expiration dates of patents. By releasing this information, the company is now open to varies IP related issues which can put a strain on the IPO. Tech companies with considerable IP investments must take the necessary steps to prevent IP issues from arising, pre and post IPO.
Tech companies may also place Initial Coin Offerings (ICO) on the market to raise capital. Similar to IPOs, the ICO process involves registering with the SEC. However, ICO generally does not fall under the SEC’s jurisdiction over securities. Therefore, filing a registration statement with the SEC is not required. Companies issuing ICO’s file a Regulation D exception which will allow them to trade their ICO without registering as a security.
The first steps to issue an ICO is to create a product and a token. The token/coin will be used to purchase interests in the product. The token and product are then described in detail on a “White Paper” which is published to inform the market of the ICO.
- How to resolve Tax basis concerns with multiple levels of investors for Tech M&A
Tech companies rely greatly on investors to fund their companies’ activities. Generally, there are three levels of investors in a company, the 1) Founders, 2) Employees, and 3) outside investors. When engaged in an M&A transaction an investor will pay taxes on the sale according to their basis in the company stock. The proposed transaction may require shareholder’s approval to complete the transaction. To maximize returns and prevent shareholder disapproval, their individual basis should be established at the onset of investment.
It is common that founders and key employees to own restricted stock in the tech company in exchange for stock. Restricted stock is equity stock which interest does not fully vest until certain conditions are met. When the shareholder’s interest vest, the value of the stock is taxed as ordinary income. When an M&A transaction is complete the stock will be taxed at capital gains rate. Their basis will be valued at the FMV of the time their interest vest.
Under Sections 83 of the Internal Revenue Code, Section 83(b) election allows founders and employees to determine whether to have their basis be valued at the time of issue or the time interest vest. The election must be made within 30 days of the initial issue of stock. By the use of section 83(b) election, a founder or employee shareholder, whose approval is necessary for an M&A taxation, may determine a tax basis at the date of issue which will provide him or her with the greatest tax benefit at the time of sale.
The IRS gives the following example for guidance.
“Company A is a privately held corporation and no stock in Company A is traded on an established securities market. On April 1, 2012, in connection with the performance of services, Company A transfers to E, its employee, 25,000 shares of substantially non-vested stock in Company A. In exchange for the stock, E pays Company A $25,000, representing the fair market value of the shares at the time of the transfer. The restricted stock agreement provides that if E ceases to provide services to Company A as an employee prior to April 1, 2014, Company A will repurchase the stock from E for the lesser of the then current fair market value or the original purchase price of $25,000. E’s ownership of the 25,000 shares of stock will not be treated as substantially vested until April 1, 2014 and will only be treated as substantially vested if E continues to provide services to Company A as an employee until April 1, 2014. On April 1, 2012, E makes a valid election under § 83(b) with respect to the 25,000 shares of Company A stock. Because the excess of the fair market value of the property ($25,000) over the amount E paid for the property ($25,000) is $0, E includes $0 in gross income for 2012 as a result of the stock transfer and related § 83(b) election. The 25,000 shares of stock become substantially vested on April 1, 2014 when the fair market value of the shares is $40,000. No compensation is includible in E’s gross income when the shares become substantially vested on April 1, 2014. In 2015, E sells the stock for $60,000. As a result of the sale, E realizes $35,000 ($60,000 sale price – $25,000 basis) of gain, which is a capital gain.”
- Important tax considerations for a Tech M&A
The Tax Cuts and Jobs Act saw the most changes to U.S Tax policy in recent history. Tax matters are a driving force of mergers and acquisitions (M&A) when determining the value of the transaction. In order for Technology (Tech) companies engaged in M&A to assess the impact of the TCJA, they must take into consideration the changes in the rules for 1) Net Operating Losses (NOLs), 2) Research and Experiment tax deduction, 3) fringe benefits, 4) the Global Intangible Low Tax Income (GILTI), and 5) the new limitations interest deductions.
Deferred tax benefits such as NOLs add value to the transaction because it allows the acquiring company to benefit from the target’s prior losses. Prior to the TCJL NOLs were allowed to be carried back provision where the taxpayer could apply its NOLS to previous years. The TCJL eliminates the ability to carry back NOLs. Tech company with volatile cash and operating capital may use NOLs as an incentive to facilitate the sale. The new restrictions on NOLs may decrease the purchase price.
Tech companies are heavily invested in research and experimentation (RE) activities by nature. Expenses incurred from these activities are deductible. Under the TCJA these expenses will eventually no longer be allowed to be deducted immediately and will only be allowed to be capitalized and amortized between 5 and 15 years. This will have a great impact on the tax position of Tech companies with significant capital invested in RE actives.
The TCJA disallows the deduction of fringe benefits or perks given to employees. These activities considered to be entertainment, amusement or recreation, and transportation benefits. In the current employee friendly climate, Tech companies are at the front of the line in terms of providing work friendly environments and employee amenities. Tech companies now must weigh the option ceasing to provide these benefits or incur the tax cost of the activities.
The Global Intangible Low Tax Income (GILTI) is an entirely new provision. This provision requires shareholders of Controlled Foreign Corporations to include GILTI into their gross income. The provision allows for 80% foreign tax credits and an incremental GILTI tax levy on corporations whose taxes are below a certain threshold. U.S. Tech companies routinely establish foreign own subsidiaries in counties with no taxes on income. As such they are subject to GILTI tax provision which can frustrate the tax implications of a transaction.
Section 163(J) places a cap on deduction of interest expenses to interest income plus 30% if adjusted taxable income. The limitation is without regard to allowable deductions for depreciation amortization and depletion. The TCJA revises and expands section163(j) to apply to all businesses including partnerships. These new limitations decrease the amount of cash flow a Tech company has to include in the valuation of the transaction. 
- What intellectual property considerations must be made in Tech M&A?
Intellectual property is the lifeblood of the Tech industry. Intellectual property includes patents, trademarks, and copyrights. The major benefit of M&A to tech companies is that it allows immediate access to new technologies without having to build from scratch. More specifically, Tech companies engage in M&A activities to gain ownership of the intellectual property associated with the target company. Therefore, the value of the target company is directly affected by the value of it’s IP.
When conducting IP due diligence, it is important to consider how to protect the IP value in order to get the greatest value of the deal. To protect the value of their IP tech companies, consider 1) the credibility of their IP and 2) branding of their IP.
No one will complete a transaction with a company they cannot trust. It is important to have a full understanding of the IP held by the target in order to remain credible. There is no place for embellishments in IP heavy transaction. Claims of “patented” status when the IP is only “patent pending,” may make the deal more enticing to buyers on the front end of the deal. However, the deal will be placed in jeopardy when the potential buyer learns of the true patent pending status. The buyer may either view the target company as untrusty worthy for making false claims or as unprofessional for failing to uncover the patent status during the due diligence process.
It is important to focus on the branding of IP to drive up perceived market value. With the rise of silicone value, public awareness has also risen for tech companies. Making brand awareness is an important practice because it can restrain or increase the value of IP. For a positive example of brand awareness driving up value, we can look to Facebook’s attempted acquisition of SnapChat in 2013, for $3 billion. Snapchat had no revenue at this point and the value was based on its positive social media perception as well as its technologies. Conversely, Facebook itself felt the negative effect of public opinion on value when their stock value dropped 7% during a high publicized data privacy scandal in 2018. 
- What considerations are made when insuring a tech M&A
The growth of the tech industry is driven by expansion of the mobile platform. However, the rise of the mobile platform places the tech industry at a distant disadvantage in the fight against cybercrime. In 2017, cybercrime was a leading risk to businesses worldwide. Cybercrime cost U.S companies $21M with damages expected to reach $6 trillion by 2021.
The nature of technology places the tech industry as a perpetual target for cybercrimes. Data breaches and the extent of damage they cause have a huge impact on a company’s bottom line. Cyber Security insurance provides a buffer which will protect the company from the cost of cyber-attacks. Insurers consider a company’s security score when determining to underwrite an M&A deal.
To determine a company’s security score, insures will analyze the companies 1) construction of security program and crisis management, 2) Occupancy of data management and access management, 3) Protection of their operations and responses, and 4) exposure to security breaches. Adequate cyber security measures can decrease a company’s risk exposure. Therefore, the acquisition of cyber insurance mitigates the risk associated with cybercrimes in the tech industry and help protect the deal value.
 Rev. Proc 2012-29, https://www.irs.gov/pub/irs-drop/rp-12-29.pdf
 Unless otherwise indicated, all IRC section refence are to the Internal Revenue Code.