Tax Aspects of Raising Capital for Start-Ups and Scale-Ups

Start-ups and scale-ups often face the challenge of supporting their innovative business ideas with sufficient capital. The choice of the right financing method not only affects liquidity and market success but also has significant tax implications. This article highlights key tax aspects of raising capital and provides founders with a guide to avoiding pitfalls.

Types of Financing and Their Tax Implications

Equity Financing

• Investments through venture capital or business angels usually require the issuance of new company shares via a formal capital increase.
• A key tax advantage is that these funds allow for the full deduction of operating expenses without restrictions.
• Unclear capital structures or gift tax issues pose risks, especially in cases of disproportionate share transfers. The valuation of the company (pre-money and post-money valuation) is particularly crucial.

Debt Financing

• Debt financing through bank or shareholder loans offers tax benefits such as the deductibility of interest. However, start-ups often face losses in the early stages, making this benefit less relevant.
• Shareholder loans are typically highly flexible, allowing for interest-free arrangements and customizable payment terms.
• It is very important to conclude all shareholder loans in writing and in advance.
• Be mindful of liquidity implications: Interest payments on third-party loans can place a significant strain on cash flows.
• High debt ratios can lead to tax disadvantages due to regulations such as trade tax add-backs and interest limitation rules.
• For start-ups, it is important to agree on effective subordination clauses to avoid insolvency-related over-indebtedness.

Grants and Loans

Raising capital through grants or personal contributions is particularly relevant for resource-constrained start-ups:

• Public Subsidies: Many programs are tax-free, but complex tax rules can arise if grants are tied to specific purposes.
• Founder Contributions: The contribution of intangible assets, such as patents, can result in unintended tax consequences at the personal level of the founders.

Crowdfunding as an Alternative Financing Method

Types of Crowdfunding

• Classic Crowdfunding: Non-financial rewards.
• Crowdinvesting: Equity participation.
• Crowdlending: Debt participation.
• Donation-Based Crowdfunding: Usually straightforward from a tax perspective.

Tax Implications

• With crowdinvesting, capital gains and losses are subject to taxation.
• Crowdlending allows for the deductibility of interest, while investors must declare interest income for tax purposes.

Regulatory Requirements

• Companies engaging in crowdfunding are often subject to prospectus requirements. Clear separation between crowdfunding projects and regular business operations is essential to avoid tax and legal conflicts.

Corporate Structure and Tax Planning

Choice of Legal Form

The choice of legal form significantly affects tax treatment:

• Corporations provide limited liability.
• Partnerships allow for direct taxation of profits at the shareholder level. However, this is not always beneficial.
• Hybrid forms, such as the German GmbH & Co. KG, can combine both of the above, but come with higher administrative costs.

Structural Planning

A clear asset and corporate structure minimizes tax risks. For instance, it may be advisable to hold real estate or intangible assets in separate entities to reduce tax burdens in future transactions.

Tax Risks When Attracting Investors

Loss Carryforwards

• Loss carryforwards are crucial for young companies.
• For corporations, these carryforwards may be forfeited in the event of share transfers (§ 8c KStG).
• Early planning of the ownership structure is therefore essential.

Real Estate Transfer Tax

• Shareholder changes or restructurings can trigger real estate transfer tax if properties are involved.
• Separate property companies can help avoiding this burden.

Internationalization and Location Selection

Location selection significantly impacts your tax burden:

• Holding structures abroad offer advantages, but require careful examination of controlled foreign company rules (§ 7 AStG) and double taxation agreements.
• Relocation of functions can lead to high tax burdens when intangible assets are transferred abroad.

Conclusion

Comprehensive tax planning is indispensable successful capital raising of start- and scale-ups. Founders should seek expert advice early to avoid tax pitfalls and create optimal structures.

At INSIGHT TAX, we specialize in advising startups on complex transactions including the tax qualification of crowdfundings. Contact us to ensure that your funding strategy is aligned with your strategic tax goals.