Brad Feld just sent out his first Finance Fridays post called “Getting Started -Allocating Equity and Founder’s Investment”.

This post is not about financial statement literacy, but is meant to begin setting the stage for the hypothetical company that will be the subject of the Finance Fridays series.  In particular, this first post deals with allocating initial equity between 2 founders.  I posted a comment to the post as follows:

“Brad, the split could have been 50/50 regardless of Jane’s $$ contribution, right?  My point is that while Jane and Dick negotiated the split is was basically arbitrary.

Also, someone recently argued with me that in your scenario Dick would actually have taxable income on the value of his shares based on the value “attributed” to the shares derived from Jane’s investment and implied valuation.  I argued “no” and that Jane’s cash investment would just increase the tax basis of her shares.   Do you agree?”

My comment was based on a situation that I was just encountered in which one founder was putting in real cash and the other 2 founders were putting in IP and sweat.   An advisor took the position that if Founder “A” put in $60K and got 33% of the company, then the other Founders “B” and “C” (who also got 33% of the company) would have taxable income of $60K each.  I argued against this position instead saying that Founder A would simply have $60K added to his tax basis in his shares (so that when Founder A sold the shares later his gain would be $60K less).  And that Founder B and C would be unaffected…….and that this situation happens all the time!

Hopefully I will get some responses to the comment and let you know.  Chime in.

Secondary markets are fascinating.  And potentially a royal pain in the ass for the private company involved.  Simply stated, secondary markets are highly unregulated exchanges on which shares of private companies are traded.  Importantly, the given private company must consent to the trades so there is a self imposed regulatory function.  You have likely read about secondary market trading in Facebook, Twitter and Zynga.  Numerous companies are actually involved, but those are the 3 that get most of the press.

The most noted secondary markets are SecondMarket and SharesPost.  The innovation behind the creation of these sites and the services they provide is awesome.  The legal issues surrounding the exchanges are not fully fleshed out and many questions about liability (among other things) exist.  For example, even though Facebook, as a private company, does not publicly disclose its financial results, could the active secondary market trading in Facebook stock impose liability on Facebook or a Facebook stock seller for non-disclosed material information about Facebook?  Likely.

A short article today in the NYTimes is worth reading.

I hope that all of your companies get big enough and popular enough for you to have to worry about secondary market issues!