purple_gear_header_logo.png
IP News

Blog Editors

Recent Posts

Analyzing Tech Regulation: Shapiro's Critique and Policy Recommendations

UPCOMING EVENT: Automated Decision-Making Technology and Artificial Intelligence

Free Speech and Trademark Law Clash in Vidal v. Elster

Using Technical Solutions to Address Issues in Privacy Law: A Talk by Professor Zubair Shafiq

An Introduction to Venture Capital

Archive

2013

Debt or Equity: Convertible Bonds, Nine Factors, and the Difficulty of Investing in Startups

Posted By Dominick Severance, Apr 27, 2013

Introduction

THE INHERENT DIFFICULTY OF INVESTING IN STARTUPS: RISK, CONTROL, AND LIQUIDITY

Investing in start-ups can be a very complicated process for a multitude of reasons. Startups, for instance, don’t always have a proven plan for commercially monetizing their product or service; this increases the risk of investing in the company dramatically. Even Facebook, which has over one billion users, struggles to prove that it can remain both relevant and profitable in the long run.[1] The unproven nature of a startup’s business plan creates an inherent and substantial risk; investors must consider whether their investment will ever have a sufficient ROI to justify the risk they take putting their money into the startup as opposed to another venture.

A second downside to investing in startups is that startups require the investor to balance the interests of the founders with the interests of the investors. Founders are often inexperienced as executives yet feel strong ties to their “baby” and don’t want to see someone else run “their” business.[2] Founders also have tremendous influence in the company through their position as board members and shareholders.[3] To protect their investment, investors may have to negotiate, for example, for a seat on the board, the adoption of procedures such as unanimous board voting, and the hiring of experienced executives to run the company. As demonstrated, the issue of control requires tremendous micro-management for investors to ensure that the company is, and remains, oriented towards growth and is not at the whim of founders inexperienced in the market.

A third difficulty with investing in startups is that startups have a tremendous valuation problem. As seen already, investing in startups carries a lot of risks; calculating those risks into a valuation that can form the basis of an investment is very difficult. Moreover, startups do not have the benefit of established exchanges where investors can freely trade the stock and establish a valuation that way. Finally, in forming a valuation, investors have to spend considerable time, money, and energy doing due diligence to ensure there is proper documentation, proper accounting, and no hidden liabilities. Added together, valuing startups is a very costly, difficult, and time-consuming process.

A fourth and final downside to investing in startups is the incredible illiquidity of startup stock. There are two main reasons for this illiquidity. First, there is the aforementioned risk and valuation problems, which make trading stock very difficult. Second, limited markets exist to facilitate trading in startup stock. Although sites like secondmarket.com have established a somewhat viable exchange for startup stock, not every startup can participate in those sites. Moreover, the federal government limits both who can invest and how many can invest in startups before the startup is required to make certain expensive disclosures.[4] Thus, even when a secondary trading market exists for a startup, the number of investors who can trade in the stock is inherently limited due to federal securities regulations.

In sum, investing in startups carries quite a few downsides. On the risk side, startups may have few disclosures, an unproven business plan, inexperienced executives and founders, and control issues. Furthermore, there is no easy way to value a startup. This risk when coupled with the difficulty in valuing the company can result in the stock being incredibly illiquid. This issue of liquidity is further exacerbated by the limited markets and limited number of qualified investors who can purchase the stock. Although these issues seem insurmountable, investors and startups have used convertible bonds as an effective way to get around a majority of these issues.

Part 1 – Defining the Convertible Bond

A CONVERTIBLE BOND IS A FINANCIAL INSTRUMENT THAT HAS BOTH EQUITY AND DEBT CHARACTERISTICS; THE BOND IS LIKE DEBT IN THAT IT HAS A FIXED PRINCIPLE, FIXED INTEREST RATE PAYABLE AT FIXED INTERVALS, AND A FIXED MATURITY; THE BOND IS LIKE EQUITY IN THAT THE HOLDER CAN CONVERT THE DEBT TO STOCK

To get around some of the issues surrounding investing in startups, investors and startups embraced a financial instrument called the convertible bond. A convertible bond, also called convertible note, is a hybrid instrument that combines the potential economic return of equity with the security of a bond.[5] The bond has a fixed principle, a fixed interest rate payable at fixed intervals, and a fixed maturity.[6] The bond also has a call option that allows the holder to convert the debt, usually at any time during the loan period, for a fixed number of the issuer’s shares.[7] This ability to convert the bond from debt to equity is what gives the convertible bond its name and the reason why it is considered a hybrid financial instrument.

Prior to the bondholder converting the bond to equity, the bond is considered debt – or to put it another way, “[U]ntil conversion, debt genes are treated as dominant and equity genes are treated as recessive.”[8] Because the bond is legally considered debt, the issuer gets to deduct any interest paid on the bond.[9] Furthermore, the US Treasury has issued regulations that when the bondholder converts the bond “pursuant to [the] holder's option under the terms of the instrument to convert the instrument into equity of the issuer,” the IRS will recognize the conversion as a non-taxable event.[10] This means that the bondholder will not have to pay taxes on the conversion, only when he subsequently sells his interest in the stocks. Note, however, that the IRS has stated that conversion into non-issuer stock is a taxable event.[11]

Part 2 – The Benefits and Downsides of Convertible Bonds for both the Issuer and the Bondholder

CONVERTIBLE BONDS HAVE PROVEN TO BE AN EFFECTIVE WAY FOR A STARTUPS TO RECEIVE CASH QUICKLY, CHEAPLY, AND EASILY WITHOUT GIVING UP IMMEDIATE CONTROL OR DILUTING SHARES; THEY ALSO PROVIDE THE ISSUER WITH VALUABLE TAX DEDUCTIONS

Convertible bonds provide quite a few benefits to issuers. The first benefit is generally lower interest rates compared to bonds without conversion rights. The second benefit is the tax deduction that the issuer can take on interest paid or accrued. The third benefit is the delay on the dilution of shares and control of the company until the bondholder actually exercises the conversion right. Additionally, since the bondholder can request that the valuation for the conversion right be delayed until the next round of financing, convertible bonds become a fast, simple, and cheap way to put money into the startup; “A startup could close a convertible note round in a day or two by merely issuing a 2-3 page promissory note, which could cost as little as $1,500-$2,000 in legal fees.”[12] Taken together, all of these benefits give the issuer a powerful incentive to use convertible bonds whenever possible.

One of the first benefits that startups receive is lower than market interest rates. The lower interest rates are justified based on the inclusion of the right of conversion; bonds without this right but the same terms should have higher interest rates. [13] These lower rates allow the startup to keep more money in the company during the payback period. [14] Moreover, the holder often allows the interest to accrue thereby allowing the startup to forgo payment until a later, more cash positive period, if at all.[15] In some cases, the bondholder includes the accrued interest with the debt converted and thereby allows the issuer to forgo cash payment entirely.

Regarding the second additional benefit, an issuer may deduct the interest owed under the bond up until the holder converts the debt to equity.[16] The issuer can even deduct accrued interest even if the bondholder converts that interest into issuer stock along with the rest of the debt.[17] In the case, Marathon Oil Co. v. Comr., 838 F. 2d 1114 (10th Cir. 1987), the US Tenth Circuit Court of Appeals held that the only requirement for the deduction of the accrued interest was that the  “convertible bond's indenture [be] properly documented to reflect that accrued but unpaid interest that arises between the date of a scheduled interest payment and the date of conversion is deemed to be paid in stock upon the conversion.”

Thus, in situations where the bondholder allows the startup to accrue the interest, the IRS is, in effect, subsidizing the convertible bond. The startup gets the tax benefit of deducting the accrued interest it did not pay prior to conversion. This means the startup gets the time value of money as many of the convertible bonds have maturities that are sometimes decades long. This tremendous tax benefit illustrates why the hybrid nature of convertible bonds is a key benefit to startups - the startup gets all of the tax benefits of the bond being debt while also getting the benefit of being able to pay the debt with equity instead of cash.

Another benefit is that convertible bonds facilitate the investment process by allowing the parties to disassociate the investment funds from the question of control at least temporarily. By delaying the issuance of stock until the bondholder exercises the conversion right, the issuer receives funds without having to immediately dilute shares of the company. This, in turn, allows current shareholders to retain their current levels of control. Note, however, that the bondholder could still negotiate for control rights; as will be demonstrated later in this paper, however, a court may find that those negotiated rights make the bond an equity investment instead of debt.

Even though the current shareholders keep control, the downside is that it is only temporary. The bondholder still retains the right of conversion. Moreover, the convertible bond may contain the right of the bondholder to exercise the conversion right at its choosing. This means that, at any time, the bondholder could convert the bond to equity thereby diluting the shares, future distributions of profits, and current shareholder control. The delay, therefore, actually creates a level of uncertainty for the company as the shareholders do not know for certain when their shares may be diluted.

Another downside is that the issuer may actually want the bondholder to have more control in the company; the bondholder may be more experienced in the market and be able to provide valuable advice and network connections for the startup. In a recent interview, Naval Ravikant, founder of the website AngelList, a match.com for investors and startups, spoke about the downside of “unbundling” money from control:

Venture capital used to be the bundling of advice, control and money. And now people have come along, like Y Combinator and TechStars and AngelPad and so on, to say ‘we’re the advice’; and then people have come in, like Yuri Milner at Start Fund, and say ‘we’re money – we just want to give you money’ and the control provision has gone away.  So you’re starting to see the whole ecosystem become unbundled.[18]

As Naval pointed out, this “unbundling” has the downside of forcing the startup to get solid people in all three areas. In the end, though, convertible bonds extend many more benefits to issuers than downsides; compared to straight equity investments, convertible bonds allow money to flow into a startup quickly and cheaply and give the issuer valuable tax deductions for interest paid or accrued.

CONVERTIBLE BONDS HAVE PROVEN TO BE AN EFFECTIVE WAY FOR A POTENTIAL INVESTORS TO REDUCE RISK, INCREASE LIQUIDITY, AND DELAY VALUATION WHILE ALLOWING THEM TO PUT MONEY INTO A STARTUP

Convertible bonds provide quite a few benefits for bondholders. The first benefit is a reduction in risk in putting money into the startup due to the contractual requirements that the money be paid back. The second benefit is that the guaranteed payout also increases liquidity as it allows the bondholder to easily cash the bond or convert the debt into equity. And, finally, the third benefit is that convertible bonds allow the bondholder to delay valuation in certain circumstances.

The fact that convertible bonds carry debt characteristics means that a convertible bond is inherently less risky than a straight equity investment in the startup for three reasons. First, with a convertible bond the bondholder is guaranteed interest payments at set rates and for a set period of time. Second, the bondholder also has a payout provision should the bondholder want to get out. And third, as noted in the first part of this paper, a startup may have an unproven business plan, inexperienced CEO, or undisclosed liabilities; by giving the option to convert, convertible bonds allow a potential investor to take the time to determine whether the company is a worthwhile equity investment.

Another benefit for bondholders is that convertible bonds are very liquid for two reasons. First, as just noted, convertible bonds have a stop gap provision wherein if the bondholder wanted to get out of, it could require the bond paid in full with cash. With this provision, the bondholder is safe from any severe downturns in the company’s stock. Second, if the bondholder wanted to sell the convertible bond, the fact that the bond contains the conversion right and the stop gap make it more attractive to buyers.

One of the biggest benefits for bondholders, though, is the ability for them to delay the issue of valuation while still being able to put money into the startup. As noted, a convertible bond works by tying the debt to a certain number of stocks, usually based on the value of the stock at the creation of the bond. If the startup does not have a current or reliable valuation, then the parties can spend the time, money, and energy developing a valuation or delay the issue of valuation by tying the valuation to the startup’s next series round of funding.[19] If the valuation is delayed, the bondholder receives a discount on the valuation price of each share to represent the initial risk it took putting money into the startup.[20]

Some bondholders require that there be no cap on the discount. In that scenario, the bondholder will have the choice of taking the valuation of the series round or taking a valuation based on the when the bond was created.[21] In the latter situation, both the investor and startup have to go back and determine what the value of the company was at the time of the bond’s creation.[22] Although creating the valuation has its costs, by having this option the bondholder gets the opportunity to secure as much of the growth benefit in the stock as possible.[23] The point here is that no matter what option the bondholder takes, the convertible bonds gives the investor obvious flexibility in how to approach valuation, an incredible benefit when compared to a straight equity investment.[24]

Part 3 – The US Government’s Attempts to Crack Down on the Abuse of the Dual Nature of Convertible Bonds

ALTHOUGH THE HYBRID NATURE OF CONVERTIBLE NOTES CREATES THE POTENTIAL FOR ABUSE, NO BRIGHT LINE LAW EXISTS FOR TO DETERMINE THE NATURE OF A CONVERTIBLE NOTE

As stated in the previous section, startups receive tremendous tax benefits in the form of deductions for the interest paid or accrued on a convertible bond. The principle underlying why the government gives these deductions is that Congress has categorized interest as a business expense.[25] However, the IRS has put certain general limitations on these deductions, namely, that a business “can deduct interest on a debt only if [it] meets all the following requirements: 1) [it is] legally liable for that debt; 2) [the business] and the lender intend that the debt be repaid; and 3) [the business] and the lender have a true debtor-creditor relationship.”[26]

Rev. Rul. 83-98, 1983-2 C.B. 40 (1983) is an example of a case where the IRS found a convertible bond as equity instead of debt. In Rev. Rul. 83-98, the issuer had issued adjustable rate convertible notes (ARCNs) to the bondholder for $1,000 with a 20-year maturity at an extremely below-market interest rate. Upon maturity, the bondholder had the right to receive either $600 in cash or 50 shares of the issuer’s common stock.[27] The bond stated that, “the ARCN’s will be subordinated to all present and future … creditors” [28] and, “in the event of bankruptcy, the holder of an ARCN [was to] be treated as a creditor for in the amount of $600.”[29]

In reviewing the applicable law, the IRS found that no bright line existed to determine whether the bond was debt or equity. Instead, the IRS cited John Kelley Co. v. Commissioner, 326 U.S. 521 (1946), which held that, “Whether an instrument represents indebtedness or an equity investment for federal income tax purposes depends on the facts and circumstances of each case. No particular fact is conclusive in making such a determination.”[30] The IRS then cited Fin Hay Realty Co. v. United States, 398 F.2d 694 (3d Cir. 1968) in finding that the intent of the parties and structure of the instrument are two important factors in determining whether a bond is debt or equity.[31]

In issuing its ruling in Rev. Rul. 83-98, the IRS found that, “The ARCNs in this case are structured so that under most likely eventualities they will be converted into … common stock.”[32] The IRS held that, “as long as the 50 shares of [the issuer’s] stock are trading at more than $600 in the aggregate … it would be economically disadvantageous for the holder of an ARCN to … redeem it for $600.”[33] The bondholder further benefited by converting the bond because when “upon the conversion of an ARCN, [the bondholder] will recognize no gain or loss.”[34] In other words, because the conversion is a non-taxable event, the bondholder would not have to pay taxes at the time of the conversion.

For the issuer, the IRS noted that, “it will be to [the issuer’s] advantage to force conversion because by doing so it would avoid having to pay out cash.”[35] The IRS then mentioned that the unreasonably low interest rate meant that the bondholder was intentionally forgoing larger interest payments because it clearly intended to convert the stock anyways. That is also why the bondholder allowed the debt to be subordinated to other creditors; it never planned on keeping the debt long enough for that to be an issue.

In the end, IRS found that the issuer and bondholder had simply structured the bond to receive the tax benefits of having the bond categorized as a debt even though it was, in reality, an equity investment.[36] The IRS held that, “Because of the very high probability that all of the ARCN's issued will be converted into stock, the ARCN's do not in reality represent a promise to pay a sum certain.” Since the structure of the ARCN led to the inference that neither the issuer nor bondholder considered the bond debt, the IRS concluded that, “The ARCN's constitute an equity interest in [the issuer] and will be treated as stock for Federal income tax purposes.” Because the bond was equity, the IRS held that, “the periodic distributions with respect to the ARCN's, although denominated as interest, are distributions … and are not deductible by [the issuer].”[37]

Thus, Rev. Rul. 83-98, 1983-2 C.B. 40 (1983) demonstrates that even though the potential for abuse exists there is no bright line rule for determining the nature of a convertible note. Instead, multiple factors must be reviewed to determine when a convertible note is debt or equity. The next section will detail the specific factors that Congress and the IRS have labeled as important, but not conclusive, in determining the nature of a convertible bond in each particular case.

ALTHOUGH NO BRIGHT LINE EXISTS, CONGRESS AND THE IRS HAVE DEVELOPED A NON-EXHAUSTIVE LIST OF FACTORS TO CONSIDER WHEN DETERMINING THE NATURE OF A CONVERTIBLE BOND SO AS TO PREVENT ABUSES OF THE INSTRUMENT BY THE ISSUER AND THE BONDHOLDER

As noted in the previous section, whether a convertible bond is debt or equity depends on the facts and circumstances of each case; it was for this reason that Congress and the IRS refrained from developing a bright line rule. To provide guidance, however, as to what “facts and circumstances” are more important than others in determining the nature of a convertible bond, Congress passed 26 U.S.C. § 385; the law contained a non-exhaustive list of five factors to be reviewed in determining the nature of a convertible bond for federal income tax purposes. Expanding on Congress’ list, in Notice 94-47, 1994-1 C.B. 357, the IRS listed three additional factors. Together, the eight factors serve as a baseline for the IRS and the courts to use in reviewing the particular facts and circumstances of each case.

Regarding 26 U.S.C. § 385, Congress entitled the bill, “Treatment of certain interests in corporations as stock or indebtedness,” and broke the bill down into three parts. In the first part, Congress listed five factors to be used in determining the nature of convertible bond.[38] The five factors are as follows:

  1. Whether there is a written unconditional promise to pay on demand or on a specified date a sum certain in money in return for an adequate consideration in money or money's worth, and to pay a fixed rate of interest,
  2. Whether there is subordination to or preference over any indebtedness of the corporation,
  3. The ratio of debt to equity of the corporation,
  4. Whether there is convertibility into the stock of the corporation, and
  5. The relationship between holdings of stock in the corporation and holdings of the interest in question.[39]

In the second part, § 385 gave the Secretary of the Treasury the right to prescribe regulations “as may be necessary or appropriate to determine whether an interest in a corporation is to be treated for purposes of this title as stock or indebtedness.”[40] Finally, in the third part, § 385 stated that the issuer’s characterization of the bond as debt or equity is not binding on the Treasury Secretary but will be binding on the bondholder; the bondholder can get out of the issuer’s characterization, however, if the holder discloses on its return that it will be treating the bond in a different manner.[41]

In 1994, the IRS issued Notice 94-47, 1994-1 C.B. 357, entitled, “DEBT/EQUITY ISSUES IN RECENT FINANCING TRANSACTIONS.” The purpose of 94-47, the IRS stated, was to provide notice that, “the Service will scrutinize certain instruments to determine whether their purported status as debt for federal income tax purposes is appropriate.”[42] The IRS then stated that, “Of particular interest to the Service are instruments that contain a variety of equity features, including an unreasonably long maturity or an ability to repay the instrument's principal with the issuer's stock.”[43] Thus, although not explicitly stated, Notice 94-47 applies to convertible bonds since they are instruments that purport to be debt and carry a variety of equity features including the right to pay the underlying debt with issuer stock.

Before listing the eight factors, the IRS was careful to iterate, however, that ultimately, “The characterization of an instrument for federal income tax purposes depends on the terms of the instrument and all surrounding facts and circumstances.”[44] Furthermore, the IRS noted that, “No particular factor is conclusive in making the determination of whether an instrument constitutes debt or equity. The weight given to any factor depends upon all the facts and circumstances and the overall effect of an instrument's debt and equity features must be taken into account.”[45]

The eight factors the IRS considered important in any review of whether a convertible bond was debt or equity for federal income tax purposes are as follows:

(1)  Whether there is an unconditional promise on the part of the issuer to pay a sum certain on demand or at a fixed maturity date that is in the reasonably foreseeable future

 (2)  Whether holders of the instruments possess the right to enforce the payment of principal and interest;

(3)  Whether the rights of the holders of the instruments are subordinate to the rights of general creditors;

(4)  Whether the instruments give the holders the right to participate in the management of the issuer;

(5)  Whether the issuer is thinly capitalised;

(6)  Whether there is identity between the holders of the instruments and stockholders of the issuer;

(7)  The label placed on the instruments by the parties;

(8)  Whether the instruments are intended to be treated as debt or equity for non-tax purposes.

Noticeably, this list is an incorporation and expansion of the five § 385 factors: The first § 385 factor relates to (1); the second § 385 factor relates to (3); the third § 385 factor relates to (5); and the fifth § 385 factor relates to (6). Interestingly, the fourth § 385 factor does not seem to be included in the IRS’s eight factors; regardless, the IRS held in Rev. Rul. 83-98, 1983-2 C.B. 40 (1983) that convertibility is an important factor to consider and is integrally related to whether a convertible bond is debt or equity.[46] Thus, whether there is a right of conversion can be considered the 9th factor.

From these nine factors it is possible to see three main themes that dictate whether a court would find a convertible bond as debt or equity: the intent of the parties; whether there is a unity of identities between the issuer and the bondholder; and the level of risk assumed by the bondholder. The first theme, the intent of the parties, relates to factors (7) and (8) of Notice 94-47 and is the weakest of the three in indicating whether a convertible bond is debt or equity; the US Court of Appeals for the Fifth Circuit has held, for instance, that a mere showing that the parties’ had a particular subjective intent or had placed a particular label on the bond is insufficient since both are just self-serving declarations. Instead, the Fifth Circuit determined that the stated intent of the parties must be compared to their objective, concrete actions in entering and treating the bond.[47]

The second theme is whether there is a shared identity between the issuer and the bondholder. This theme relates to factors (4) and (6) of Notice 94-47. Bondholders are generally very passive when it comes to having control in the companies they invest as they are protected on many levels by the contractual agreement. Moreover, the payout on bonds is generally separate from the success and failings of the issuer. Equity investors, on the other hand, usually want control in the companies they invest as the success of their investment is heavily dependent on the success of the company overall. Thus, if the bondholder takes a leadership or shareholder position within the company, then the relationship between the issuer and the bondholder seems to be more in line with an equity investment than a debtor-creditor relationship. [48]

The third theme is probably the most important and concerns the amount of risk assumed by the bondholder. This theme incorporates factors (1) through (6) of Notice 94-47. If a bond doesn’t have a reasonable maturity date, for instance, then the bondholder runs the risk that the startup may not be in existence by the time the bond matures fully.[49] Moreover, a bondholder assumes tremendous risk if: the bond does not contain a certain degree of creditor rights; the bond is subordinated to other creditors; and the issuer is thinly capitalized. As noted earlier, equity investments carry tremendous risk whereas debt is much less risky due to contractual safeguards. If the bond lacks these safeguards and the assumption of risk is high, the bond is more similar to an equity investment than a debt.

Part 4 – Best Practices in Structuring a Convertible Bond

PARTIES CONSIDERING ENTERING INTO A CONVERTIBLE BOND SHOULD CONSIDER THE NINE FACTORS OUTLINED IN 26 U.S.C. § 385 AND NOTICE 94-47 AND STRUCTURE THE BOND ACCORDINGLY SO AS TO ENSURE THE IRS OR A COURT DETERMINES THE BOND IS DEBT BASED UPON THE FACTS AND CIRCUMSTANCES OF THE CASE 

Taken together, to reduce the chance a judge or the IRS would find the bond as an equity investment issuers and bondholders should do three things. First, they should structure the bond so as to reduce the risk assumed by the bondholder and ensure there are some contractual safeguards for the bondholder. Second, they should not structure the bond in a way that gives the bondholder a significant level of control in the company. Third, and finally, there should be a statement on the bond that the parties intend the bond to be debt and the parties should structure the bond in as debt-like a way as possible; the parties, therefore, should ensure the bond has a reasonable interest rate, payout, and maturity date for instance.

Conclusion

Startup stock carries tremendous risk, is very illiquid, and very difficult to value. To get around these limitations and to get certain tax benefits, issuers and investors turned to the hybrid financial instrument the convertible bond. The debt aspect of the bond allowed issuers to deduct interest and ensured that when bondholders converted the debt to equity the conversion event was non-taxable. The equity aspect of the bond meant that the bondholder could “invest” with much less risk while still enjoying the appreciation of the stock upon conversion.

To prevent abuse of the instrument, however, Congress and the IRS together have detailed nine factors to be used in reviewing whether a convertible bond is debt or equity for federal income tax purposes. To ensure that a convertible note is seen as equity or debt, investors should bear these nine factors in mind when creating a convertible bond agreement and structure the document accordingly. Although the factors are non-exhaustive and courts and the IRS will weigh each factor differently, the nine factors serve as a good foundation to ensure the courts and IRS would find the convertible bond as debt.



[1] http://www.examiner.com/article/facebook-s-earnings-are-up-here-s-why-investors-are-still-scared

[2] http://reidhoffman.org/if-why-and-how-founders-should-hire-a-professional-ceo/

[3] http://allthingsd.com/20130321/negotiating-private-equity-how-women-startup-founders-can-ensure-their-fair-share/

[4] JUMPSTART OUR BUSINESS STARTUPS ACT, PL 112-106, April 5, 2012, 126 Stat 306.

[5] U.S. Income Portfolios: Income, Deductions, Credits and Computation of Tax – Section E: Interest or Dividend?, Bloomberg BNA Tax and Accounting Center.

[6] Id.

[7] Id.

[8] Bittker &  Eustice, Federal Income Taxation of Corporations and Shareholders ¶ 4.40 (7th ed. 2000).

[9] 26 U.S.C.A. § 163 (West).

[10] 26 C.F.R. § 1.1001–3.

[11] Rev. Rul. 69-135, 1969-1 C.B. 198.

[12] http://techcrunch.com/2012/04/07/convertible-note-seed-financings/

[13] U.S. Income Portfolios: Income, Deductions, Credits and Computation of Tax – Section E: Interest or Dividend?, Bloomberg BNA Tax and Accounting Center.

[14] Id.

[15] Id.

[16] 26 U.S.C.A. § 163 (West).

[17] U.S. Income Portfolios: Income, Deductions, Credits and Computation of Tax – Section E: Interest or Dividend?, Bloomberg BNA Tax and Accounting Center.

[18] http://techcrunch.com/2012/04/07/convertible-note-seed-financings/

[19] http://martin.kleppmann.com/2010/05/05/valuation-caps-on-convertible-notes-explained-with-graphs.html

[20] Id.

[21] Id.

[22] Id.

[23] Id.

[24] Id.

[25] U.S. Income Portfolios: Income, Deductions, Credits and Computation of Tax – Section E: Interest or Dividend?, Bloomberg BNA Tax and Accounting Center.

[26] http://www.irs.gov/publications/p535/ch04.html#en_US_2012_publink1000243104

[27] Rev. Rul. 83-98, 1983-2 C.B. 40 (1983).

[28] Id.

[29] Id.

[30] Id.

[31] Id.

[32] Id.

[33] Id.

[34] Id.

[35] Id.

[36] Id.

[37] Id.

[38] 26 U.S.C.A. § 385 (West).

[39] Id.

[40] Id.

[41] Id.

[42] Notice 94-47, 1994-1 C.B. 357.

[43] Id.

[44] Id.

[45] Id.

[46] Id.

[47] Tyler v. Tomlinson, 414 F.2d 844, 850 (5th Cir. 1969).

[48] Estate of Mixon v. United States, 464 F.2d 394, 406 (5th Cir. 1972).

[49] In re Lane, 742 F.2d 1311 (11th Cir. 1984).