Startup Compliance Failures: Why Firms Like Carta and Pulley Struggle with State Regulations

In 2022, Carta’s business license was revoked in Illinois due to unpaid franchise taxes, a tax applicable to national corporations doing business within the state, as reported by TechCrunch. Following suit, Washington state terminated the business license of cap table software company Pulley in 2024, according to official state filings.
A representative from Carta, Amanda Taggart, informed TechCrunch that the company narrowly missed the deadline for submitting its annual report and remitting the associated tax. She further stated that the matter has been rectified, and they are currently awaiting Illinois’ confirmation of their reinstatement to good standing. Meanwhile, Yin Wu, the founder and CEO of Pulley, confirmed that the outstanding returns have been filed and efforts to reinstate their license are underway.
Startups like Carta and Pulley are not isolated cases of mismanagement regarding state business regulations. While both companies complied with registration requirements, many startups fail to initiate this process promptly.
When a startup engages employees, conducts acquisitions, or attracts customers in a state, they are typically required to register in that state and maintain good standing, including the payment of state taxes and ongoing fees. Andrea Schulz, a legal expert from Grant Thornton, emphasized the risks of non-compliance, which can lead to fines and other penalties.
Experts contend that the complexity of different states’ fees, tax structures, and business registration processes presents significant challenges for startups. Moreover, compliance is often not a priority for early-stage entrepreneurs who are focused on other critical areas of their business.
As Schulz noted, “In some scenarios, every dollar goes towards enhancing the customer experience. The oversight doesn’t stem from excessive burdens or a lack of knowledge; rather, it’s from strategic focus.”
Issues related to state compliance might not surface until a startup seeks acquisition, contemplates going public, or undergoes an audit. Ginger Mutoza, a paralegal and corporate legal operations manager at 8×8, shared her own experience, highlighting complications encountered post-acquisition that arose during due diligence.
She described the complexities: “They opted for a simpler path, neglecting to report mergers or employee stock options, which led us to reconstruct historical records for tax claims, emphasizing the costly nature of rectifying such errors.”
The Challenge
The primary issue with state-level compliance for startups is the inconsistent and opaque nature of state requirements. Each state mandates its own unique reporting formats and information, complicating good standing maintenance.
Robert Holdheim, COO of compliance platform Traact, expressed frustrations, stating, “We haven’t encountered a client who had their state compliance accurately in order, even when they believed it to be so.”
Illinois is particularly notorious for its strict reporting requirements. For instance, it still demands paper filings and check payments.
Additionally, the thresholds for when a startup must register differ significantly across states. Notably, some states require registration when a business is deemed to be conducting a “substantial amount” of activity, while others tie it primarily to employee presence, according to Bruno Drummond, founder of Drummond Advisors. For businesses claiming to offer remote work flexibility, this could mean needing to file as a foreign business entity whenever an employee relocates to a different state.
Consequences
For most startups, the financial repercussions of mismanaging state rules tend to be minimal. Typically, companies can settle back taxes and penalties, regaining good standing.
However, repercussions could escalate. If a startup grapples with excessive fines, it may deter potential acquirers unwilling to shoulder the cleanup responsibilities, Schulz cautioned.
Being classified as a non-registered entity can also jeopardize a startup’s legal protections within that state. Holdheim highlighted that under Section 9.051 of the Texas Business Organizations Code, businesses not in good standing forfeit their ability to defend themselves legally in Texas courts. This burden extends to initiating legal actions, such as safeguarding intellectual property rights.
Moreover, startups could neglect compliance in additional areas like sales tax, or overlook the requirement for monthly reporting to the U.S. Bureau of Economic Analysis for firms exceeding $50 million in revenue or investment. International hires further complicate matters.
The takeaway is clear: integrating state regulatory considerations into a startup’s business strategy is crucial, whether through compliance software investments or legal consultancy services. Companies like Traact, Mosey, DFIN, and Vanta provide critical services to help startups remain current with state compliance.