Why you should keep on angel investing before the tax incentive kicks in

[Update: an edited version of this post is available on StartupSmart]

I am a Sydney based early stage tech investor. I have made 20 investments in the last 2 years. The new tax incentives may provide tax benefits for me — but it may not start until July 2016.

There is this talk of an “investor drought” among my peers. We are worried that the lack of clarity and the timing of its implementation may cause the angel funding pool to dry up. As a result, startups will die because they can’t close a funding round.

I want to share a few stories of “Angel Investor Bill” so that everyone can “keep calm and angel invest”.

Keep Calm and Angel Invest

Disclaimer: I am not a lawyer, nor an accountant. I don’t have an AFSL licence.

Story #1: tax offset

Draft: A 20 per cent non-refundable tax offset on investment capped at $200,000 per investor, per year.

Plain English: If you invest $200,000 (after July 2016), you can claim $40,000 against your income tax.

Angel Bill #1

Bill’s friends passed on the deal because there is no tax benefit, and they made $0.

They waited and invested in another startup after July to claim the 20% offset, that startup declared bankruptcy six months later.

Story #2: CGT exemption

Draft: A 10 year capital gains tax exemption for investments held for three years.

Plain English: The CGT exemption only works for investments held between 3 to 10 years.

Angel Bill #2

Bill’s friends waited and invested in December 2016 at twice the price. They sold into the secondary market almost 10 years later, at a $2 billion valuation. The main reason was to avoid capital gains tax.

The founders of the company then figured out the Chinese market and made 5 times their average revenue next quarter. The public market went crazy at their IPO.

Bill sold at the IPO at $10 billion market cap. He held his shares for 11 years so Bill can’t claim the CGT exemption.

Bill still made more money than his friends, even with the $40,000 tax offset, the CGT exemption and “time value of money” taken into account.

Story #3: the eligibility test

Draft: Have expenditure and income of less than $1 million and $200,000 in the previous income year respectively.

Plain English: (Government) thinks startups should spend less than $1 million and make less than $200,000 a year. If you spend or make more, you are not qualified as a startup.

Angel Bill #3

Bill’s friends passed on the deal because the company is not eligible for tax offset, and they made $0.

Bill made enough money to buy beers for his mates for the rest of their lives, so everyone is happy.

My question

If you see a great company led by great founders showing great traction with a great plan to grow, do you really want the team to eat ramen for the next 5 months, burn out and eventually give up?

Alibaba returned more than 3,000 times to their investors at the IPO. If the same investment opportunity is in front of you right now, would you say “NO” due to lack of tax benefit?

My proposal

Don’t restrict the investment time frame because we can’t force liquidation events. Angel investments are not liquid. By imposing a 10 year time frame on the tax benefit, we may cause unnecessary tension for the company around the 10 year mark. Great companies take time to build.

Don’t restrict the investment terms, let it be a priced equity round, a convertible note, with ordinary or preference shares, because we don’t want to distort the market.

Don’t restrict the investment vehicle, because the money can come from a person, a family trust or a self managed super fund. Otherwise, lawyers and accountants make money, not startups.

Conclusion

A wise man once said, “tax benefit is a sweetener, never the reason”. Angel Investor Bill’s strategy is NOT optimal, but don’t optimise your strategy around tax benefits. You may miss a unicorn, and invest in a bullshit because the filters and restrictions set by the officials may not be optimal either.

Footnote

  • Special thanks to Beth Massey and Dean Little from the Sydney Startups Facebook group for reading a draft of this post.
  • For angel investors. Please add me on LinkedIn so that we can invest together.
  • For startups. Email me your pitch deck. May the focus be with you, until July.
  • Also, intro Mary to me.
Family Office Mary