How We Overturned the Retroactive Tax on Startup Founders

10/7/13Follow @BrianOverstreet

The call came at 1:15 pm this past Friday, as I was driving home from a client meeting. “Mr. Overstreet?” questioned the voice on the other end of the line. “I’m calling from Governor Brown’s office. We wanted you to be the first to know that the Governor signed your bill into law.”

And just like that, it was over.

A saga that began on January 15, 2013, with the publication of my Xconomy blog post came to a stunning conclusion with the ratification of legislation to rescind a 5-year retroactive tax on start-up founders and investors.

In 1993, California created the Qualified Small Business Stock (QSBS) incentive. The QSBS program encouraged founders and early-stage investors to start, grow, and keep businesses in California by offering a 50 percent personal tax exclusion on capital gains if the company was ultimately acquired. Nineteen years later, in August 2012, a California appellate court ruled one of the California-centric provisions unconstitutional. The Franchise Tax Board responded in December 2012 not only by cancelling the entire program but also revoking it retroactively back to 2008. Suddenly, without warning, 2,500 California start-up founders—me included—were personally on the hook for over $120 million in 5-years of retroactive taxes, interest, and penalties.

But this story encompasses more than political process and legislative procedure. It’s about a group of strangers with no political experience who banded together and secured a victory in a state capitol infamous for its icy relations with private enterprise. Defying long odds, we formed an organization, created a team, raised capital, and created and successfully marketed a solution to a very big problem.

In short, we succeeded by doing what we do best: being entrepreneurial.

Within hours of my original Xconomy post, three affected entrepreneurs contacted me. We four arranged a conference call and immediately decided to collaborate. On the spot, we formally organized a group to fight the retroactive tax. Within 48-hours we had a name—California Business Defense—as well as a brand, a website, and a mechanism to grow membership and collect funds. The coalition grew to 40 people, all founders of California start-ups that were penalized by the retroactive tax.

As experienced entrepreneurs, we knew our first priority was to assemble the right team. We brought in Eric Miethke of the Sacramento-based law firm Nielsen Merksamer as our field general. Working with our coalition, he crafted and executed a multi-tiered attack on the retroactive tax. At the same time, Senator Ted Lieu (D-Torrance) reached out in support. Incensed by this violation of the basic rule of law, Sen. Lieu fired off a letter to the FTB demanding that they reconsider their decision to retroactively tax law-abiding business founders. The FTB response amounted to, “If you want change, do it yourself.” Sen. Lieu did just that. With early support from Assemblyman Jeff Gorrell (R-Venutra), Sen. Lieu authored SB209, a bill to overturn the retroactive tax. We launched the campaign for SB209 in April, endorsed by influential business coalitions like Bay Area Council, Connect, Tech America, Cal Chamber, Silicon Valley Leadership Group, and many more.

With bill in hand, we set out to sell SB209 to the California legislature. As with every sales process—whether introducing a new product, raising capital from investors, or good old fashioned cold calling—selling SB209 was a grind.

In countless trips to Sacramento, we met with over 50 legislators and other government officials. In each meeting, we identified the problem, presented our solution, elicited feedback, and overcame objections. With each new objection raised, we tweaked our pitch for the next meeting. Many days it was unclear if we were making progress at all. No legislator discounted the injustice of a retroactive tax. But the implications of its reversal were complex and far reaching. Then ever so slowly, the arduous grind started to pay off. Support swelled, insiders learned of our plight, and pivotal leaders like Assemblymembers Bocanegra and Gatto came out in support. The leadership in both the Assembly and the Senate ultimately followed suit.

Still, there were certain objections that we simply couldn’t overcome. When we hit those, we changed course. One Senate committee added a series of hostile amendments to SB209. Weighing the unfavorable amendments against the prospect that the bill might die in committee, we accepted the changes and ran with them. And in the final days of the legislative calendar, we pulled off the biggest pivot of all. With technical snafus and political pressure weighing down SB209, we worked with legislators to gut an unrelated bill, AB1412, insert our desired language, and push that through both the Senate and Assembly. After five months of delicately nursing SB209, we didn’t hesitate to replace it with another bill that would better position us for success.

The final legislative vote tallied 112-1 in favor of AB1412. With strong support from the State Controller, all five members of the Board of Equalization, and the two outside members of the Franchise Tax Board, Governor Brown signed AB1412 into law.

For a bunch of political greenhorns operating in an environment where political partisanship is at an all-time high, we did all right.

But it should never have been this hard.

A five-year retroactive tax on law-abiding start-up founders never should have happened. Once enacted, it never should have required a dedicated team working full time for nearly nine months to overturn it. Some will interpret these events as further evidence that our government is irrevocably broken. But I hope you will consider our outcome. We proved that success and progress can happen when we engage with our lawmakers.

Still, our triumph over the retroactive tax is just a very small first step. Sacramento is fighting its way out of a budget disaster. The federal government is shut down. A debt ceiling crisis is looming, and partisan leaders won’t even talk to one another.

This isn’t the way our government is supposed to work. And I believe that we can fix it.

As entrepreneurs we’ve accumulated unique, transferable skills from starting and running successful businesses. Let’s do more than just denigrate our government in clever 140-character missives. Let’s actually work to influence policy and re-craft the institutions and mindset of our government from within.

We’re all hard-wired to seek out and solve big problems. I can think of no bigger problem—and no bigger opportunity—than re-fashioning our government to reflect the spirit of the companies we’ve built. Given our successes in private enterprise, is it so hard to envision similar success in the public sector? Are we so cynical that we can’t even imagine a more efficient, impactful, responsive, representative, and ‘customer-centric’ Sacramento or Washington?

Maybe it’s a fool’s errand. We’re all busy people with myriad responsibilities, and this is a heavy lift. But it is clearly time for a new generation of leaders to emerge and bring a more common sense, forward-thinking, and results-oriented approach to our governing bodies.

As entrepreneurs, we are positioned to make a difference. Don’t we have a burden of responsibility to try?

Brian Overstreet is the co-founder and president of AdverseEvents and the former CEO of Sagient Research Systems. Follow @BrianOverstreet

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  • Ben Lenail

    This is above all a story of grassroots democracy, one that renews hope in the political process. A tiny group of entrepreneurs, focused on their startup companies and not politically connected, showed an iron-will determination to right a wrong. Facing overwhelming inertia, hostility or indifference at first, they hunkered down to get this punitive retroactive tax repealed. Little by little, they succeeded, and now, of course, everyone is on board, realizing the lunacy of the punitive tax in the first place!

  • Jim Fowler

    Huge kudos to Brian and Eric, as well as the whole California Business Defense team. I’m disgusted we had to fight this fight in the first place, but very happy with the outcome.

    Don’t forget that there is still no QSB incentive moving forward. The incentive is now gone. Hopefully the State of California will fix this wrong as well.

  • C.J.

    Brian,

    Although such a tax would have had no impact on me personally, I recall feeling a strong sense of injustice when reading your original blog on the matter back in January – congratulations on your victory.

    I, for one, do not believe working hard to bring about positive change within our government to be a fool’s errand. It would not be easy, but it can be done – this story serves as a proof-of-concept. As you have mentioned, it would take an incredible amount of commitment and perseverance from people with attitudes mirroring yours and the other 39 members of your team… people who I aspire to be like… It can be done.

    • Brian Overstreet

      Thanks C.J. I appreciate your note.

  • jlemkin

    Thank you.

  • foxylady49

    I am happy to hear that this has turned out on such a positive note. Our government is broken and we need people like this team to get in there and help to fix things. Not everything is broken, but enough is that the rest is trying to uphold the the broken pieces and is wearing very thin. Go for it and make a difference.

  • cthulhu

    It’s California, they’ll throw another one at you next week. Take your startups where the government is less predatory! You could even hire me when I get out.

  • righteousreverenddynamite

    “But it should never have been this hard” nails it. Look at our state legislators; how many of them have any economic or business sense (or more directly have more anti-business leanings and pro-socialist/Marxist tastes). They hold a supermajority right now to pass any whim of a tax on us without any political backlash. The opposition party is impotent. Is our state’s once “Golden” business community going to protest every week at the Capitol steps and incessantly call ask our “legislators” why business is atrophying and many are rushing to Nevada and Texas? It is way past time to embarrass these idiot politicians of their arrogant impotence. Buy scathing commercials to air on radio/television EVERY day. Tell your neighbors and employees that if they keep voting for Candidate X (who solemnly pledges, if elected, to make sure the redundant public library [that nobody will use] has appropriate wetlands for the Delta Smelt and offers free abortions for trans-gender artisanal cheesemakers), they will not have a freakin’ job and will no longer have “income” to allow their lil’ Jaden/ Madison to attend the Academy for Amazing Children!!(!) Enforce the message that you cannot attract new business if the government taxes it way above the national average and then spend it on stupid stuff. I am not a businessman but as a physician, I admire the huge risks they take and the benefits (jobs) that they directly and indirectly produce. Every one of my businessman/woman patients report high stress and many have depression due to their daily battles. I have continual sleepless nights with thoughts going through my head of whether I should do X or Y with patient(s) Z that no doubt plague these admirable and striving folks when they try to sleep dealing with one of the worst business environments in state history. Illegitimi non carborundum!!

  • JR48

    You know how you fix it? You cut spending, pay off existing bills and go forth being fiscally responsible as a state. This bill is a victory but a small one in a state that has absolutely no excuse for being fiscally insolvent. Yet it is? That would because it’s legislature never stops coming up with new and novel ways to separate the individual from their money for whatever ‘good idea’ that they have. No thought as to how one would actually pay for those good ideas..they’re like children in a toy store and Mommy is supposed to whip out the credit card. And then does. And then the utilities get turned off and they all sit in the dark, wondering what happened…

    I left the state nine years ago. About five years after I left I discovered that the state had put two tax liens on me for unpaid taxes for a non-existent job during the time that I was already gone. The brain surgeons in the legislature, desperate for money, has started taxing people with professional licenses (of any kind), without any evidence that the person is working in that state. You heard me right. No evidence that the person with the license has a job there, just the fact that the license exists has them ‘estimating’ what tax that they might make if they were working there, billing them, and if the person doesn’t respond by mail, they go through the legal processes to put a lien on them.

    I was living 2000 miles away and discovered this when we attempted to refinance our current home. Of course i didn’t receive the original state’s mailings…the USPS only forwards mail for a single year. Took hours on the phone for over almost a year to fix.

    Imagine the amount of money that the state shelled out estimating my mythical tax for my mythical job, sending out mailings, and going through all of the legal steps to put a lien on me, more than once, when all that they had to do was run a simple credit check on me and discover that I now lived half a country away?

    THAT is the mindset that is wrong with California. Retroactive taxes on businesses…imaginary taxes on imaginary jobs…Desperately seeking out new revenue instead of cutting spending and living within their means. Always looking for ways to separate more and more money from the individual, instead of asking whether or not they can afford to do something because of their previous good ideas that they haven’t paid for, let alone pondering the question ‘is the state responsible for every societal woe’? The answer to the latter is that it can’t be because it’s not possible.

  • Fellow Traveler

    Leave California.

  • Mailman

    Amazing entrepreneurial work and hustler spirit, HT Brian

  • cynicwithtaste

    “But it should never have been this hard. A five-year retroactive tax on law-abiding start-up founders never should have happened.”

    That captures the key problem – that this fight had to happen in the first place. Then again, California is a state that passed Prop 30 in November 2012, which retroactively raised income tax rates back to January 2012. A proposition that had the full backing of Governor Brown and the state Democratic establishment, by the way.

    That said, great job Brian fighting the good fight and prevailing.

  • cynicwithtaste

    “We’re all hard-wired to seek out and solve big problems. I can think of no bigger problem—and no bigger opportunity—than re-fashioning our government to reflect the spirit of the companies we’ve built. Given our successes in private enterprise, is it so hard to envision similar success in the public sector?”

    Brian, I think that is a bridge too far and that anyone taking on the task of improving government operations needs to be realistic.

    Can government operate more efficiently? Yes. Is it realistic to expect government to reflect the spirit and efficiency of well-operated private enterprises? No.

    The very nature of government is that it is, for the most part, a monopoly provider of services. Even with well-intentioned people, the nature of governmental institutions is that they tend towards inertia, growth, and self-preservation, with limited incentive to rock the boat. That’s not to say that things can’t be improved: periodic sunset reviews of organizations and regulations are useful. Scaling back civil service and union protections of public employees so that underperformers can actually be fired is also useful. It’s important, though, to temper expectations and recognize that government institutions are fundamentally different than private companies in many ways and that “running government like a business” isn’t ever going to happen.

  • Linda Ole’

    California statistics from sba.gov:
    Small businesses significantly impact California’s economy. They represent 99.2 percent of all employers and employ 50.4 percent of the private-sector labor force. Small businesses are crucial to the fiscal condition of
    the state and numbered 3.5 million in 2010.

    It was surprising to see how underrepresented “we” are at the capitol.

    Brian O – you up for the challenge?

    http://www.sba.gov/sites/default/files/ca12.pdf

  • Rob Leathern

    Congratulations Brian – this is truly a massive achievement and definitely something to use as an example of being able to get things done even in a difficult environment.