Nate Network $($Nate$)$ developed an idea for a new social media

venture. He would like to form a start$-$up company, raise $$150,000$ of

additional capital and hire an experienced person to manage the business.

He has located Venturer, who is willing to invest $$150,000$ cash and

Manager, who has agreed to serve as chief operating officer if the terms are

right.

The parties have decided to join forces and form Newco Network, Inc.

$($Newco$)$ as a $$C$$ corporation. Nate will transfer tangible assets and

intellectual property with an aggregate basis of $$50,000$ and an agreed fair

market value of $$200,000($do not be concerned with the character of the

individual assets for this problem$)$; Venturer will contribute $$150,000$ cash;

and Manager will enter into a five$-$year employment contract. Nate would

like effective control of the business; Venturer is interested in a guaranteed

preferred return on his investment but also wants to share in the growth of

the company; and Manager wants to be fairly compensated $($she believes her

services are worth approximately $$80,000$ per year$)$ and receive stock in the

company, but she cannot afford to make a substantial cash investment. All

the parties wish to avoid adverse tax consequences.

Consider the following alternative proposals and evaluate whether they

me$$t the tax and non$-$tax objectives of the parties:

$($a$)$ In exchange for their respective contributions, Nate will

receive $200$ shares and Venturer will receive $150$ shares of

Newco stock. Manager will agree to a salary of $$40,000$ per

year for five years and will receive $150$ shares of Newco

common stock upon the incorporation. $($Assume that the value

of the stock is $$1,000$ per share.$)$

$($b$)$ Same as $($a$),$ above, except Manager will receive compensation

of $$80,000$ per year and will pay $$150,000$ for her Newco stock.

Any difference if Manager, unable to raise the cash, gave

Newco her unsecured $$150,000$ promissory note, at market

rate interest, payable in five equal installments, in exchange

for her $150$ shares?

$($c$)$ Same as $($a$),$ above, except Manager will pay $$1,000$ for her $150$

shares and the incorporation documents specify that she is

receiving those shares in exchange for her cash contribution

rather than for future services.

$($d$)$ Same as $($c$),$ above, except Manager will pay $$20,000$ cash

rather than $$1,000.$

$($e$)$ Same as $($d$),$ above, except Manager will receive only $20$ shares

of stock without restrictions; the other $130$ shares may not be

sold by Manager for five years and will revert back to the

corporation if Manager should cease to be an employee of the

company during the five$-$year period. See I.R$.$C$.83.$ Would

you advise Manager to make a $83($b$)$ election in this

situation? What other information would you need?

$($f$)$ In general, is there another approach to structuring the

formation of Newco that would harmonize the goals of the

founders? Consider the use of a capital structure with two

classes of stock.