4 Common compliance mistakes that might hurt your chances of winning funding
Successfully winning venture capital (VC) funding depends on a variety of factors, including your level of tax compliance. In today’s economy, a large portion of venture capital firms that won’t fund your business if you’re having significant tax compliance issues on a regular basis.
In this blog, we’ll cover some of the most common compliance mistakes a business might make and how these mistakes might factor into your application for VC funding.
1. Not charging correct tax
Applying the correct tax rate whenever you complete a transaction can be difficult. Companies commonly charge tax incorrectly if they’re unfamiliar with the regulations regarding tax in the industry and country they’re operating in.
For example, trading in the U.S. can cause significant difficulties for businesses because of the sheer number of tax jurisdictions that exist. There are over 13,000 sales and use tax jurisdictions in the U.S. — many overlap significantly and have different tax rates. In a single U.S. transaction, a company might have to calculate and apply tax rates from state, county, and city regulations.
Although it’s indirectly related, charging the incorrect tax can affect your venture capital prospects. One of the key factors VC firms look for in a startup is an existing customer base that’s satisfied by the service the startup provides. If you’re charging taxes incorrectly, you can damage the customer experience from sudden price shifts. Additionally, charging incorrect tax can lead to significant legal and financial penalties, which can discourage investors.
2. Understanding liability
Many startups struggle with the concept of tax liability, particularly if they’ve recently expanded their business. Operating in a new country (or even a new city) might mean applying a new set of tax rates, implementing a new method of registering for tax, or remitting tax to a new authority.
U.S. nexus laws are a great example of how complex liability can be. If you have a physical presence in a state, or if you sell more than a certain value of goods there, you’ll establish nexus and have to remit sales tax to the relevant authority. Although it might sound simple, the specific nexus rules for each state can become very complicated for businesses new to the U.S.
Tax liability can be more straightforward in the EU, but only slightly. At one time, a company that traded throughout the EU had to register in every single country they sold goods to. Now, using the Import One-Stop Shop (IOSS) they only need to register in a single member country to trade everywhere
Venture capital funding and understanding liability can be closely connected, because venture capital may be given to support a startup’s expansion. If tax liability mistakes jeopardise that expansion, there will also be a negative impact on the agreement made with the VC firm.
3. Collecting tax but not remitting
Even businesses with a firm understanding of their tax liabilities might not know where the money should go after it has been charged to customers. The process of paying collected taxes is known as remittance, and it’s commonly overlooked by startups.
As with the other issues listed, this problem is most common in the U.S., where sales tax laws differ between states and change frequently over time. In some states, companies can absorb sales tax, meaning that they can choose to pay the tax from their own cash reserves instead of passing the cost onto consumers. In other states, like Ohio, there are highly specific rules on how and when taxes can be paid.
The best way to avoid making the mistake of remitting taxes incorrectly is to rely on automation or outsourcing. The Avalara returns and reporting solutions can help companies fulfil their tax obligations without forcing the company to learn the details of every complicated remittance law in each region.
Having an automated solution in place to deal with this sort of problem can show your leadership team’s diligence and business acumen, so it’s also a great way to impress VC investors.
4. Confusion over digital tax laws
DIgital companies commonly make mistakes when it comes to the taxation of their goods, as digital tax law is inconsistent across different territories and changes often.
For example, digital tax law varies considerably between different U.S. states, and EU rules on digital services VAT differ depending on if the buyer is a business or a consumer. A business that primarily sells digital goods (e.g. a software company) must thoroughly research how their goods and services will be taxed in a region before they start trading into that region.
Liability is a particularly tricky issue. Digital businesses rarely need to deal with liability as it relates to having a physical presence in a particular territory (since they can conduct the majority of their business online), but that doesn’t mean they’re immune to tax liability issues. Startups that send salespeople to other territories or to attend conventions might unknowingly create significant tax liabilities for themselves.
Modern venture capital firms tend to invest most often in technology and software businesses. As such, they are likely to be more aware of compliance mistakes that specifically affect software startups. If you operate a software startup that’s seeking VC funding, tax compliance should be a prominent part of your business plan, so you can avoid losing out due to non-compliance.
Work with Avalara to improve your chances of winning VC funding
Winning venture capital funding can help you grow your business, but it’s essential that you put your business in the best position to win funding first. Auditing your tax compliance processes should be a central part of these preparations, so you can identify and fix any compliance mistakes.
If you need assistance with tax compliance, Avalara can offer both in-depth guidance and advanced automation to support your compliance processes. Click here to get in touch with our experts today.
If you’d like more information on improving your chances of winning VC funding through tax compliance, click here to download our free VC funding guide.
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