Taxes

Should you worry about taxation?

This chapter doesn't cover corporate income tax, VAT, or other trade taxes your business may face. However, if you expect to reach breakeven and generate profits quickly, it's crucial to understand the local tax system's rates, payment schedules, and intricacies. You should also have a solid grasp of the local social system and your obligations as an employer.

Instead, this chapter focuses on the tax implications when investors require corporate restructuring in a different jurisdiction as part of a funding round. Under the local tax system, shareholders may face taxation when exchanging their original shares for new ones in the restructured company. The funding raise typically boosts your shares' (virtual) value significantly, potentially leading to a substantial tax liability. If the new jurisdiction is another EU country, this process is usually straightforward. However, if it's the US, things get considerably more complex.

Regardless of where you plan to incorporate, I would always advise setting up a legal entity as a buffer between you, the founder, and your venture. This separate company will own your shares instead of you personally, shielding you from potential tax liabilities if ownership changes. It's a precautionary measure worth considering, as you can't predict how your company will evolve, especially when its success hinges on external financing.

In the summer of 2017, flyiin successfully secured institutional investors—a US-based hedge fund and family office. Although it took two years to reach this milestone, it was worth the wait. The deal was perfect, with terms favoring the founders. Our investors strongly believed in our concept of a consumer-facing Air Travel Marketplace and were committed for the long haul.

As the US-based investors requested incorporation in Delaware and preferred immediate ownership equity over convertible loans, we consulted one of Germany's top corporate law firms. Initially, they saw no issue with the company flip to Delaware, so we signed the term sheet and began executing the plan. However, tax lawyers saw things differently. Despite spending months—and racking up significant legal fees (paid from my own pocket)—seeking a way to execute the deal, we hit a major roadblock that prevented us from closing. This setback would push the company to the brink of collapse over the next 18 months.

Since I owned shares in flyiin personally, rather than through a company, converting our German limited company to a US-based entity would have exposed me to a potential tax bill exceeding €800,000. While I'm no stranger to risk-taking, this was a bridge too far (to put it mildly). The root of the problem lay in Germany's tax system, which—unlike those of more startup-friendly countries—hadn't yet adapted to the unique realities of new tech companies.

Key Takeaway #11

To protect yourself from unexpected tax situations, it is important to set up a legal entity to own your shares in your venture. Depending on your location, this may cost a few hundred euros per year to maintain. However, it will save you headaches and ultimately be key to a successful funding raise.