Background: Company A has developed a software product. Revenue is about $8K per month; margin is about 75% (after royalties). Debt owed to angel and family/friends investors is about $550K. The company has effectively no cash reserve and all gross profit goes to pay operating costs and then the original founder gets what's left as income. The software product is part of the business that Company A does; there is also a consulting business.
The founder of Company A would like to get myself and a couple other entrepreneurs to help him grow the software product. To compensate new people working on the software business, the proposal is that we create a new company (NewCo) and share ownership in NewCo based on contribution to NewCo.
NewCo would buy ($1) IP and assume the debts, obligations, and revenue related to the software product from the old company. Because profit is not currently (revenue has been flat for about 6 months) sufficient to carry the debt, can we value the new company at or near $0 dollars?
The reason we want a low initial valuation is we want to grant the members of the new team all the equity that they would earn working for the NewCo for 2 years (assuming they did not take cash compensation during this period), when NewCo is created and the new team members do not want create an unfavorable tax situation for themselves by agreeing to receive this equity.
Question: Do knowledgeable folks out there think we have reasonable grounds to set the valuation of NewCo at or near nothing, so that when people get their redeemable equity they incur no tax liability? Please let me know why and what valuation method you use to reach your answer. TY!
- In the event that people who get this initial equity get paid in cash for their work or do not perform, NewCo would redeem the appropriate number of shares.
- The original founder will keep his personal guarantee on the debts that transfer over; new owners in NewCo will not be liable for this debt personally.