Your client is a startup medical device manufacturer. It intends to raise $20M – $30M in order to design, test, obtain FDA approval and bring to market 2-3 medical devices in different areas/uses, including spinal implants, aortic stents and corneal/retina applications. It is likely that a competitor would seek to acquire one or two of the company’s products if they are successful.
1. The three founders, Joe, Tracey and Whitney, have asked you to outline the pros and cons of forming as an LLC, S corporation or C Corporation. Please briefly address the tax and corporate benefits and drawbacks of each type of legal entity at all stages of the business lifecycle, including formation, fundraising, use of losses, and flexibility on sale. 45 minutes.
2. Tracey and Whitney are skilled doctors and engineers. They each own a patent with a value of $1M and a tax basis of $0. Joe is a wealthy investor and he would like to invest $2M cash in startup capital.
a. Please describe the consequences to each of Joe, Tracey and Whitney, if Tracey and Whitney each contribute their patents in exchange for 25% of the common stock of the company and Joe contributes $2M for 50% o the common stock of the company. 15 minutes.
b. Several months later, Holly, another successful engineer, approaches the company and offers to contribute her patent worth $1M with a basis of $0 in exchange for 20% of the company. What would be the consequences to her and the company of such a contribution? 15 minutes.
c. After several years in 2023, the company wants to make a distributions to its shareholders (Joe, Tracey and Whitney – Holly ended up not contributing her patent). The company intends to distribute $3M at a time when the company has historic earnings and profits of $1M and current earnings and profits of $1M. Describe the tax consequences to Joe, Tracey and Whitney. 15 minutes.
d. Same facts as in 2.c, except instead the company decides to repurchase 50% of the shares owned by Joe for $1M (so that his ownership drops from 50% to 25%). What are the tax consequences to Joe. 15 minutes.
e. Same facts as in 2.c, except instead the company decides to repurchase 100% of the shares owned by Joe for $2M (so that his ownership drops from 50% to 0%). What are the tax consequences to Joe. How would the tax consequences change if Joe and Tracey were husband and wife? 15 minutes.
f. After 6 years (and at a time when the company has $0 in historic earnings and profits), the board realizes that 2 of its product lines are close to being commercialized and likely to be sold to an acquirer for $10M each, but the third product is going to need significant more investment and time to develop. Please describe the tax consequences to the company and Joe, Tracey and Whitney if the company sold two of the product lines in an asset sale for a total of $20M (assume $0 basis) and distributed the proceeds to Joe, Tracey and Whitney. 15 minutes.
g. Same facts as in 2.f, except instead the company decides to adopt a plan of liquidation prior to the sale of the two business lines for $20M. After the sale, the company liquidates and distributes to the shareholders the cash from the sale along with the third business line (worth $5M with a basis of $0). What are the tax consequences to the company and shareholders.15 minutes.
h. Same facts as in 2.f, except instead the company decides to contribute the two commercialized product lines into a wholly owned subsidiary and spinoff the subsidiary to the shareholders on a pro-rata basis. There have been no negotiations or discussions with any acquirers. What are the tax consequences to the company, the controlled corporation that is distributed and the shareholders. 30 minutes.
i. Same facts as in 2f, except instead an acquirer offers to acquire 100% of the stock of the company in exchange for $5M in cash and $25M in common stock of the acquirer, which is publicly traded on NASDAQ. How would you recommend the sale be structured so that the shareholders of the company are not immediately taxed on the receipt of the $25M in stock? 20 minutes.