This week, Ivan Gaviria walks us through the 5 mistakes startups make with their people… A mistake a day.

Ivan is a partner at Gunderson Dettmer’s Silicon Valley office, practicing in the Corporate and Securities Group. He has extensive experience working with startup and emerging growth companies through their entire lifecycle as well as representing venture capital, private equity and other investors.

MISTAKE #4 OF 5:
Failing to File Those 83(b) Elections

Without getting too deep in the weeds, an 83(b) election refers to a tax code section that allows the taxpayer to make an election on when to pay taxes in connection with the acquisition of certain kinds of stock.

Founders in a typical startup will acquire their stock subject to vesting – if they leave the company, the unvested portion of the stock can be repurchased by the Company at cost, or at the lesser of cost or the then current fair market value of the stock. That repurchase right is the key element for 83(b) purposes.

A founder who makes the 83(b) election is electing to measure the tax consequences of the purchase at the time of the purchase. Failing to make the election means that the tax consequences are measured at every vesting date during the entire vesting period.

Since the tax is on the spread between the fair market value of the stock and the price paid, so long as fair market value is paid at the outset, there will be no spread at the time of the election and no tax on that acquisition (there will of course be tax on the gain when the stock is eventually sold).

The big “gotcha” in failing to make the election is that the fair value is reassessed at each vesting period and it can change dramatically during the typical 4 year vesting period.

When you imagine that a typical startup where founders’ stock that is purchased for fractions of a penny can conceivably go through several rounds of financing and even an exit or IPO during the standard 4 year vesting period, the tax consequences of that ever increasing spread between fair market value and the original purchase price can get really ugly.

83(b) elections have the added issue that the election must be made within thirty days of acquiring the stock or it is missed. There are no second chances or ways around the deadline.

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MISTAKE #1 OF 5 (posted on Monday): Not understanding obligations to prior employers.

MISTAKE #2 OF 5 (posted on Tuesday): Failing to be informed about employee rights with respect to wages

MISTAKE #3 OF 5 (posted on Wednesday): Employees versus Independent Contractors

ABOUT GUNDERSON DETTMER:
Gunderson Dettmer is a leading law firm for entrepreneurs, emerging growth companies and the venture capital firms that support them. With 125 lawyers in four offices – Silicon Valley, Boston, New York, and San Diego – we represent companies in every stage of development from incorporation through entry into public markets and beyond. We provide counsel on general corporate and securities law, mergers and acquisitions, venture capital services, intellectual property, strategic alliances, and tax matters. We combine our experience, industry relationships and expertise to provide practical, business-oriented advice tailored to the needs of the emerging growth company marketplace.

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