Whether engaging in cryptocurrencies or digital assets (“crypto”), starting a crypto company, or just investing, how good are your books and records? Are you ready for an audit? Do you have the right tax and legal advisors to help you with compliance or deal with federal, state, and foreign tax controversy matters? As a founder or a business stakeholder, you are looking for practical solutions to add business value and offer best practices, including core competencies to manage today’s issues and tomorrow’s challenges.
Maintaining a clean set of books and records, completing the year-end financial audit and complying with taxing authorities depend on the steps you take today. Whichever actions you or your team take, follow these tips and always ask this important question: “Are we ready?”
Tip #1: Seek Expert Advice in the Crypto Industry
Engaging in crypto can be exciting and rewarding, but crypto transactions can impose audit, accounting, tax and regulatory or compliance concerns. To avoid issues, engage experienced crypto professionals, such as lawyers, accountants, tax advisors, auditors, valuation specialists and other advisors to support you along the way.
Some professionals say they know crypto, but do they? It is important to do your homework and consult professionals with proven crypto experience and knowledge. The crypto industry is complex and is constantly evolving, from regulations to crypto products and technology. Surround yourself with the right experts to avoid costly mistakes. Work collaboratively with your service providers to ensure success.
Tip #2: Choose the Right Business Entity and Legal Structure
Choosing the right business entity and legal structure is critical to starting and running a successful business. The business legal structure determines the levels of taxation, tax rates, regulatory and compliance burden (management and paperwork requirements), fundraising, access to traditional capital markets, compensation, distributions, and even future transactions such as a liquidity event or business combination. The legal entity choice and structure may also impact worker/employee mobility, talent acquisition and employee retention. It is important to have the right legal and tax advisors to help your growing business and to understand available options across multiple jurisdictions (U.S. federal, state and foreign).
Tips #3: Ensure Your DNA Includes Clean Books and Records
Maintaining thorough documentation and clean books and records will please your auditors, tax and other advisors, speed up turnaround time and decrease the effort your service providers will need to incur. Internally, perpetual readiness helps you track and report your crypto financial results. Externally, this preparation keeps you ready for lenders and investors who review your books before providing capital, as well as prospective buyers if you look to sell the business.
It is important to understand the roles of your auditors, tax and other advisors. They are not there to clean up your books and records – that task belongs to the accountants or fund administrators you engage. The onus is on you to maintain clean books and records. Staying ready is easy if your company’s leaders make this process part of its DNA. Keeping your company’s books and records clean is a strategy that is high on return and low on investment. Invest in the right people with the right skills and right experience.
Tip #4: Protect Your Intellectual Property
The choice of entity and legal structure can have a significant impact on your company’s ability to deploy assets across jurisdictions and build, sustain, grow and commercialize your intellectual property (IP). Whether you are planning to have an open-source protocol or utilize a more traditional business model, IP concerns should be the top issue for any business with emerging technology. The most relevant concerns broadly surround four common types of IP: copyrights, trademarks, patents and trade secrets.
Copyrights protect the exclusive ability of creators of original tangible works to use and duplicate the original work. Trademarks are any words, designs, slogans or symbols that represent a brand, product or company. Patents are exclusive rights granted for an invention, which is a product or a process that provides a new way of doing something or offers a new technical solution to a problem. Trade secrets are a company’s IP that is not public, has economic value, and carries information, such as a formula, recipe or process used to gain a competitive advantage.
Founders often overlook IP resulting in trapped profits building up in high-tax jurisdictions. Poor management of IP across borders (or affiliated entities) may increase transfer pricing risks and increase tax liabilities and can also become subject to costly and time-consuming government challenges and tax controversy.
Tips #5: Reconcile, Reconcile and Reconcile
When you engage in crypto, proper tracking and reporting of crypto transactions are mandatory. Your reconciliation should be performed in quantities and dollar values of crypto activities, including staking, lending and DeFi. Reconciliation is typically done at regular intervals, such as monthly or quarterly, as part of the close process. A reconciliation of crypto activities includes a roll-forward schedule/analysis by: (i) quantity and types of crypto assets; (ii) cost basis; and (iii) fair value basis.
Account reconciliation is a fundamental accounting process that ensures the actual money spent or earned matches the money leaving or entering an account at the end of any fiscal year. Reconciling accounts is a particularly important activity for businesses and individuals because it is an opportunity to check for unusual activity and to promptly detect errors.
Tip #6: Solidify Your Founder Agreement
Founder agreements are overlooked by many start-ups. A founder’s agreement is a legal contract between a founder and the company covering a variety of important business and operational areas, such as founder involvement, contribution, co-founders’ roles and responsibilities, equity ownership, founder departures and more. The agreement is a legally binding contract that holds each founder’s interests at stake and should be created at the launch of the company to get everything out on the table.
Tips #7: Invest in the Right Tools
Many crypto companies wonder which accounting tool or software applications can take care of their crypto transactions and maintain their books and records. Before you invest money into tools or software applications – whether off-the-shelf accounting software, an advanced solution customized to your needs or a basic spreadsheet program – make sure to do your homework and ask the relevant questions. Although you should take advantage of the full functionality of the tools or software application, they may not address complex or unique crypto transactions like staking, lending or DeFi. All tools or software applications will require some form of human interaction.
Tip #8: Understand International Tax Planning and Transfer Pricing
Most crypto start-ups have international tax issues. These issues can range in complexity and can impact the company’s ability to claim certain deductions and foreign tax credits, determine eligibility for tax treaty relief and withholding obligations, impact the company’s ability to finance U.S. and foreign operations, or impact the taxation of distributions.
Most jurisdictions now have significant transfer pricing compliance obligations. Transfer pricing accounting occurs when goods or services are exchanged between divisions of the same company. A transfer price is based on market prices in charging another division, subsidiary or holding company for services rendered. To demonstrate that a company’s related party transactions have been conducted at arm’s length, contemporaneous documentation is required to support current transfer pricing policies. This documentation is “contemporaneous” because it must be prepared by a certain date and is typically done simultaneously with annual tax returns.
Tip #9: Define Compensation and Incentives
Compensation is a key consideration for founders and key employees when a business is in the start-up stage. Most new crypto companies struggle with fundraising and founders often turn to tokens to compensate themselves, workers (both independent contractors and employees), and third-party vendors in the early stages of an enterprise as tokens generally do not result in equity dilution.
When tokens are structured properly, external stakeholders are also aligned with the goal of the project as well as with internal stakeholders’ compensation needs (i.e., those of the founders, workers and vendors). These incentives can create and facilitate the right participation environment within the ecosystem and drive token demand with community-building and marketing, while also reducing adversarial behavior and deterring bad actors.
Crypto companies are also leveraging token award plans as a tool for executive compensation, including restricted token units and options. Token-based awards can be automated via “smart contracts,” which may decrease administrative costs and directly incentivize employees to develop the company’s product portfolio.
Tips #10: Invest in Human Capital
Crypto transactions can be complex and, at times, difficult to manage. Having the right people with the right skills and experience in place will help your team identify problems and develop solutions to streamline operations and reporting. Be sure to invest in continuous learning so your team is always on top of the latest changes and developments. Your tools or software applications and your professional advisors will not be a substitute for the human contributions within your company.
As a founder or a business stakeholder, the onus is on you to maintain clean books and records and stay abreast of changing regulations. Staying ready is easy if your company’s leaders make this process part of its DNA. Keeping your company’s books and records clean is a strategy that is high on return and low on investment.
About Our Blockchain and Digital Assets Group
Whether your business is a startup cryptocurrency or blockchain company preparing for a strategic event, or a mature cryptocurrency or blockchain company expanding into new markets, BPM provides the technical advice you need to thrive and navigate through the rapidly changing regulatory landscape. Our professionals have extensive knowledge and experience in dealing with tax, accounting, and auditing matters, as well as regulatory and compliance issues, including revenue recognition, IT compliance, enterprise risk management and classification of digital assets. Our integrated approach allows us to simplify complex business processes as a “one-stop” shop for all your financial needs and more. For more information, contact Mark Li, Assurance Partner, or Dmitri Alexeev, Tax Partner, leaders of our Blockchain and Digital Assets Industry Group, today.