4 Considerations That Impact a Startup’s Valuation

While every startup aims to achieve the highest possible valuation, the process involves more than just market potential and investor interest. Tax considerations often play a critical, yet overlooked, role in shaping a company’s worth. Specifically, the following tax-related factors can influence a startup’s valuation:

• Entity type
• Capital raising
• Equity awards
• Due diligence

Understanding these elements early can help founders maximize returns and avoid costly surprises.

1. Choose the Right Entity Type for Better Startup Valuation

The entity type can impact the startup’s valuation in two different ways:

First, if the company is set up as a C-Corp, the stock is granted at a time when the tax asset value is less than $50 million, and it meets a few other criteria, the business stock could be considered a qualified small business stock (QSBS). This designation qualifies the holder of the stock for a gain exclusion at the time of the sale in the amount $10,000,000 or 10x basis, whichever is greater.

Investors may be willing to pay more at the time of investment if they’re aware the future tax gain can be excluded from income.

Second, the type of sale also has an impact, whether it be a sale of assets or a sale of equity. It’s important to understand the buyer and why they would want to have the transaction be treated as one rather than the other.

Intentionally selecting the proper entity structure and type of sale helps founders negotiate the best deals.

2. Protect Startup Tax Advantages When Raising Capital

While raising capital will increase a company’s cash funds, it can also make their tax attributes limited due to I.R.C. Section 382. A 382 limitation is when ownership changes by greater than 50% of the value of the stock in a three-year period, based on the valuation of a company.

To avoid losing valuable tax benefits under this rule, startups should maintain a detailed cap table. This helps ensure tax attributes like net operating losses remain usable and prevents unpleasant surprises when the company becomes profitable.

Another way raising capital can impact a company is by increasing net worth taxes. This is important to consider as the company could be paying taxes even if it is still in a tax loss position.

3. Design Equity Awards to Attract Talent and Optimize Startup Tax Outcomes

The type of equity awards a startup offers can affect the interest of potential investors. An I.R.C. Section 83(b) election can be made by an employee who is granted restricted stock. This election allows the holder of the stock to be taxed at ordinary rates at the date of the grant based on the fair market value on that date rather than at the vesting date.

While this does have its advantages, there is a risk that the value of the stock will decrease when the vesting date comes. The benefit of this election is to save on taxes by paying less tax at ordinary income rates, and more at capital gains rates upon future sale of the stock.

4. Mitigate Tax Risks Through Proper Startup Due Diligence

Due diligence is another factor that will impact the company’s valuation. During a due diligence check, if tax issues are found, the diligence team must compute the potential exposure, which can be held in escrow or reduce the purchase price all together.

It’s important to be due diligence ready before the company is ready to sell. It would be best if the company found everything swept under the rug and remediated any issues prior to a potential buyer uncovering the skeletons in the closet.

Learn More on How Tax Can Impact Startup Valuation

Overall, there are many factors that can impact the valuation of a startup. It’s important to be aware of all of them to keep buyers’ interest and make the highest return on investment.

To learn more about this topic, check out the related webinar: How Tax Can Impact Startup Valuations.

Tax & Compliance Benefits of Outsourcing Services for Your Startup

In addition to understanding entity structure, capital raising, equity awards, and due diligence, startups should consider how outsourcing tax and compliance functions can safeguard valuation.

Outsourcing to experienced professionals helps with accurate filings, proactive tax planning, and compliance with complex regulations. In turn, outsourcing reduces the risk of costly errors that could surface during due diligence or valuation negotiations.

Access to specialized expertise allows founders to focus on growth while maintaining confidence that their tax attributes and compliance obligations are optimized.

In short, outsourcing these critical functions not only mitigates risk but also strengthens investor trust, positioning the startup for a higher valuation and smoother exit.