Forming an entity in the U.S. – beware of the tax cost

Should I form a US entity to attract US investors?

I am often asked this question by entrepreneurs who are conducting business outside of the US but believe that they may be able to raise money from US investors.  In my opinion, a business that would not otherwise be subject to US taxation should form an entity in the US for financing purposes only as a last resort.   In certain scenarios, a US entity could increase the net taxable rate on income – including income from the sale of the business — by over 50%.  In addition, once a US entity takes ownership of assets, it is very difficult to unwind the US entity or transfer those assets without incurring potentially substantial US taxes.

If I were a founder conducting business outside of the US, here’s how I would approach raising money from US investors:

• Focus on the investment proposition for investors, not the legal structure.
• Prioritize interactions with US investors that have experience investing outside of the US.
• If US investors demand a US parent entity, then:
  1. ensure you and those investors understand the tax and other regulatory implications associated with running a multi-national company out of the US; and
  2. condition implementation of the US parent entity structure on closing the financing.

Large multi-nationals are looking to engage in inversion transactions to move the parent company outside of the US.   There are many behaviors of large corporate conglomerates that shouldn’t be emulated.  But this trend should at least provoke some thought for founders and investors of the micro versions of these corporate groups  — especially those that don’t have any employees or other business activities in the US.

Note:  This content is provided solely for general informational purposes.  It does not constitute legal advice regarding any specific facts and circumstances, and its dissemination does not create an attorney-client relationship.   If you are interested in learning more or want to discuss a particular situation, you should contact one of us or another attorney or tax adviser.