VCs: Did Your Portfolio Companies Potentially Commit Tax Fraud?

By Vanessa Kruze

The IRS just froze the Employee Retention Credit after paying out $230 billion in credits to startups and small businesses.

Why? Because of the staggering amount of potential fraud the program has experienced.

My firm is one of the leading providers of tax advice to VC-backed startups. Our clients have been inundated with marketing from companies claiming to be able to get them $26,000 per employee in “free government money” from this program.

It’s rampant. I, the leader of a CPA firm and tax expert, receive at least three cold calls and emails a day from ERC mills who, more often than not, have zero accreditation.

While founders are being bombarded with ERC sales calls, the catch is that most VC-backed startups are not eligible to get a tax credit. We are frequently asked about these credits, observe each startup’s eligibility, and advise them.

Venture capitalists should be concerned about working with founders who take government funds improperly. Not only could this possibly cause serious legal issues and fines, but if the Paycheck Protection Program is any guide, the names of companies that take these funds are going to be disclosed publicly.

VCs, do not align yourself with a portfolio company that takes any government credit they are reasonably ineligible for. We have found that this is a mindset, and indicative of other, deeper behaviors.

If you feel that your founders have taken credits leniently, the IRS is indicating that there will be a grace period. The IRS will be issuing guidance soon on how companies can return the money and get forgiven.

Be proactive

Of course, it’s not just existing investments that investors need to worry about. Incorporate questions on the ERC into your due diligence checklists to ensure you aren’t about to invest in a company that will get into tax trouble, or that will have to use some of your investment funds to pay back the IRS.

It’s also a good idea to make it mandatory for prospective investments to disclose any government funds they have received, including PPP loans, R&D tax credits and ERC.

Given how widespread and aggressive the marketing was for the ERC program — by pretty sketchy providers — we think the news is going to get worse before it gets better.

And it seems like many VC-backed startups are going to get caught up in this scandal.

The danger isn’t over. We continue to see more companies market various tax credits to startups, some of which claim to be automated or to use AI. The complexities involved in government programs like ERC, R&D credits and PPP loans require significant expertise, and the IRS doesn’t care who a company used if a return or filing is wrong. Trusting an automated or offshore service for such critical financial matters can add more risk to your portfolio.

For the ERC debacle, we hope that with proactive action and diligent oversight, it’s possible to correct the course without severe fines. As VCs, it’s imperative to initiate these corrective measures and instill a culture of compliance and ethical governance in your portfolio companies.

Failure to do so could result in not just financial loss, but also reputational damage.

Vanessa Kruze, CPA, is founder and CEO of Kruze Consulting. Her firm, founded in 2012 and based in San Francisco, works with more than 800 startups and assists with accounting, taxes, finance and human resources. Kruze is one of the top startup accounting and finance writers on Quora, and also contributes to Accounting Today and other accounting and finance publications.  Prior to founding Kruze Consulting, she worked at Deloitte Tax and as the controller of a  $20 million startup with more than 120 full-time equivalent employees.

Illustration: Dom Guzman