Startup Toolbox

Jay Parkhill February 5th, 2009

Payroll is the biggest expense for most businesses, especially young companies.  When times get lean management looks for ways to stretch cash out as far as possible.  The dilemma is that most companies would like to reduce their payroll expenses without reducing headcount, since with fewer people to do the work it may take even longer to get through a tight spot and get business flowing again.  Here are some of the biggest traps to avoid.

Note- employment law is completely different from state to state in the US, so this post is even more California-centric than most I write.  The *right* answer for a given situation is also entirely fact-specific, so don’t rely on this as advice for your company.  Use this information to be forearmed, then go talk to your lawyer about strategies that will work for you.

1) Salary reduction.  Everyone takes a haircut in their salaries.  The question is how far salaries can be reduced.  In many cases, it can go all the way down to minimum wage.  The gotcha here is that there is a “special” minimum wage for computer professionals.  I wish I knew how this law came to be, but the gist of it is that administrative employees can go down to minimum wage ($8.00 in California; $9.79 in San Francisco) but computer professionals need to be paid at least $79,050 per year (~$36/hour).  Figuring out who is a computer professional goes beyond the scope of this blog and is a job for your friendly neighborhood employment lawyer.

2)  Stock in Lieu of Cash.  This is a popular one and a major gotcha.  Don’t do it.  The IRS sees stock and cash as equal compensation, so if Startup, Inc. pays Employee $50,000 worth of stock instead of $50,000 cash, Employee will still have $50,000 worth of income to report- and no cash to pay the taxes on it.  Ouch.

California doesn’t like this strategy either.  Under California law Employee will continue to have a claim for payment of the $50,000 until it is paid in cash.  The claim can not be legally waived by payment of any other type of compensation, esp. company stock.

The even worse news is that employee wage claims are one area where directors and officers of a company can be held personally liable.  There are cases where courts have declined to hold officers liable, but don’t count on it.  The rule of thumb here is to act as if any wage-related actions are backed by the directors’ and officers’ personal bank accounts.

3)  “Deferred” Salary.  It is much easier to tell employees that you need to reduce their salaries temporarily and will catch them up once ___ event happens (e.g. a funding event, major customer deal, etc.) than to cut salaries permanently.  Don’t do this either.  In legal terms “deferred” means they are entitled to the full salary amount and can file claims for payment if it never comes through.  If you need to reduce salaries do it permanently and tell people that *if* certain positive events happen the company will do its best to offer bonuses that recognize the sacrifices employees have made. No side-of-the-mouth promises to catch up, either.  The bonus has to be truly discretionary to avoid the deferred/unpaid trap.

4)  Switching to Independent Contractor Status.  This is another common practice that can work in some cases, but gets overused.  A company can reduce payroll expense dramatically by laying people off and then re-hiring them as independent contractors.  The problem is that the IRS and California authorities have the final say as to who is a W-2 employee and who is a genuine contractor.  An audit by either entity can result in huge penalties for companies that mis-classify personnel.  There is so much gray area here as well that you can be certain either entity will find violations once they start looking.  Again, talk to an employment lawyer for more information on how to properly classify people.

Tough times require creative measures.  If my experiences during the last downturn are any guide a lot of companies will take on uncomfortable amounts of risk in the employment area so they can keep stay afloat.  I hope this helps to point out some spots where the risk outweighs the benefits.

And once again, this is not legal advice for your company. These are complex issues and you need to talk to a lawyer in order to figure out the best way to navigate your company’s own particular minefield.  Be careful out there!

• Comments

Jay Parkhill January 13th, 2009

This situation comes up for me all the time and it is really hard to manage in a way that makes everyone happy.

The scenario is that founders A and B start a company and split the initial shares.  Time passes, business happens.  The company may or may not take on investors or issue equity to employees, but the business grows one way or another to the point that even by the most conservative valuation methodology- free cash on the balance sheet- the company can no longer justify the super-duper-low stock price the founders paid.

Person C them comes into the picture.  C is an extremely high-powered executive who can bring tremendous value.  A and B want to treat C as effectively a co-founder and give her a share of equity equal to theirs.  The challenge is that since the company now has real value, C’s share of it can be expensive.

A, B and C come to me and say “please do your legal magic and make this all work out right”.  Sadly, there is no magic here, just a bunch of unhappy compromises.  There are three main intertwined issues: how much the stock costs, when to pay for it and what the tax consequences will be.  Here’s my shot at acknowledging them and pointing out the options in 500 words or less.

What the Stock Costs
This is simple on its face.  Per share value = company valuation / number of shares.  The valuation number is the toughest variable to work out, and the methodology we use depends in part on IRS rules.

When to Pay For the Stock
Wherever possible, we want to buy the stock early.  Owning stock outright starts the capital gains clock ticking and that can make a big difference when the company is sold (the SEC’s Rule 144 holding period starts at the same time).  Owning a stock option does not count toward the capital gains period until the option is exercised.

What are the Tax Issues to Dodge?
The two big ones are capital gains rules, which require the stock to be held for one year before it is sold, and Section 409A, which imposes a penalty on stock or options issued as “deferred compensation” (i.e. basically any equity issued now and paid for later) if the stock or options are issued at a price deemed below fair market value (more on 409A here).

And here are the preferred ways to handle this situation, with their attendant drawbacks.

Buy the Stock
This is the cleanest option.  Buying the stock outright avoids 409A issues completely and starts the capital gains clock.  In my experience, though, most people do the math and decide that a year or two of sweat equity is one level of risk, but cash is something else entirely.  Most people opt not to take this option, especially when the price is in the 5, 6 or 7 figure range.

Stock Options
This used to be everyone’s favorite way to handle this situation, and it may still be the best.  If the company has real value, co-founder C could have a huge bill to get her stock.  Options let her defer payment of the price until she knows the company is going to be worth something (esp. the night before the company is sold).

409A throws up one roadblock here.  To avoid the 20% penalties, the company will need a valuation of its stock.  This is often manageable, though no one likes paying ~$10,000 for the valuation.

The bigger drawback is that she will probably lose her shot at capital gains treatment.  She would need to exercise a year before the company is sold to get into capital gains land, and if the exercise price is high that may not be feasible.

Historically, more of my clients have elected this option than any other.  No one likes paying taxes, but at least this option limits the risks (assuming the 409A issue is handled well).

Promissory Note
Back in the dot-com days this was popular.  Executive buys the stock and gives the company a promissory note for the purchase price, intending that the company would either forgive repayment or Executive would repay it from sale of the stock in a merger or IPO.  When the companies hit the wall, however, bankruptcy trustees seized on these notes as collectible debt and a number of very unhappy conversations followed (”you mean I got almost no salary, my stock is worthless *and* I need to pay you $200,000?!?”).

A promissory note would work for C’s purposes, but it carries a lot of risk.  It is a promise to pay the company and if things don’t go as expected C can find herself not merely uncompensated for her time spent with the company, but actually owing money to it.  Once in a while a situation arises where this arrangement can make sense, but it is rare.

Is That It?
That’s what A, B and C always ask me when we talk through the possibilities.  Unfortunately the answer is yes.  We use the most favorable valuation we can justify to bring the price down (assuming we have any flexibility there), but in the end the whole purchase price must be paid.  C can pay up front or she can pay later, but there is no way to do what clients really want- which is to sneak C in at the original founder price.

The lesson?  There are two, I think.  (1) get in as early as possible; and (2) get your stock documented right when you arrive before the deal gets any worse.

Related articles by Zemanta

• 409A: the worst single tax provision of the Bush era
• When to Issue Stock Options

• Comments

Jay Parkhill January 9th, 2009

I have recently lamented the lack of clarity around user name ownership on Twitter and other social networks.  My friend Erik Heels has a proposal to do something about it- namely to create a uniform username dispute resolution policy promoted by the major social networking sites.

One of his main points is that trying to differentiate user name conflict from domain name conflict is wrong.  Companies have brands and use those brand names as domain names and user names.  E.g. yahoo.com is also twitter.com/yahoo.

User name policies have a Wild West feeling right now.  Businesses are just figuring out how to work with lightweight social networks.  It won’t take too long for them to get tired of fighting the same user name battles over and over.  Erik has a great proposal.  Heavyweight advertisers everywhere take note: start leaning on the social networks to get their acts together and set some clear rules for the game.

• Comments

Jay Parkhill January 6th, 2009

Enterprise software companies sooner or later accumulate a lot of paper governing customer contracts.  Maybe half the time customers accept a company’s standard sales or license agreement without substantive comment, but the other half gets negotiated- sometimes a little, sometimes heavily and sometimes the customer insists that its own paperwork govern.

Managing all these terms is complex and painstaking work.  I know a few large companies that take a draconian approach to the task- they only circulate agreements in pdf form (to prevent changes) and any revised terms go in an amendment instead of the original document.  The theory is that the presence of an amendment flags the fact that there are non-standard terms.

In practice this makes a giant mess.  It should be possible to draft amendments that are very specific and clear about which terms have been changed and how, but it never seems to work that way.  I think the companies that get to the stage of doing this get overly caught up in process, the lawyers making the changes are not connected to the deal being done and the terms end up more confusing than they should be.

You need to be a really big company to take that approach in any case, so what works better for the average company?  As with many other things, the answer is to make sure that the information doesn’t live only in the heads of certain people.  Write it down.  Put someone in charge of collecting signed contracts and tell that person to make up a spreadsheet (for starters, at least) that notes any variations from standard.

As the lawyer I wish I could tell the sales teams they won’t get paid until they tell the contract managers about any wrinkles, but I know I’d get overruled.  Still, collect the info right when the deal closes before everyone forgets about it, then work on keeping it up to date.  It’s an ugly “uh-oh” when you realize you have inadvertently been in breach of a contract’s terms because you didn’t know it was non-standard.

• Comments

Jay Parkhill January 1st, 2009

I just watched this video of Lawrence Lessig’s talk in 2007 at the TED Conference (thanks LA). It gives a brief history of copyright and recorded media, going back to John Philip Sousa’s vehement opposition to the very first audio recordings for fear that they would cause people to stop playing music and singing on the porch at night, and eventually lose their vocal cords entirely  (!).

The thing that really grabbed me was a fight between ASCAP and upstart copyright clearinghouse BMI in 1939.  ASCAP have the “top shelf” artists and recordings locked up, but was so afraid of radio that it kept raising royalty rates beyond what any broadcasters were willing to pay.  BMI had second-tier content, but its pricing was better so it got its music on the radio and forced ASCAP in 1941 to cave in to the new radio-driven marketplace realities.

Contrast this with the RIAA today.  They have been fighting online distribution of music for 10 years now (the Napster case was decided in 2001) and the battle shows no sign of ending soon.

The issues are different and more complex these days for sure (where *exactly* is the line between fair-use mashups and flat-out copying songs without paying for them?),  but still- it’s gone on far enough.

One of Lessig’s best points is that the battle has created two extreme polar mindsets: the “sue ‘em all” studios on one side and the “all music should be free” zealots on the other.  Let’s just agree now that digital music is going to cost less than it did on CD, most people will still pay something for it and a few will persistently refuse.  Then we can all focus on finding new and interesting ways to increase the ratio of buyers to non-buyers instead of harassing bands’ biggest fans.

Related articles by Zemanta

• RIAA finds its soul, will stop suing individuals downloading music
• Metallica stops punishing fans on YouTube [Copyfight]
• Outdated Copyright Laws Need a Do Over
• DiMA, NARM Fight Royalties on Audio Clips
• End the Copyright War

• Comments

Jay Parkhill December 31st, 2008

There is a sweet spot for companies (and individuals) between the profit motive and the idea of making the world a better place.  Milton Friedman notwithstanding, most corporate managers hope to do more than line shareholders’ pockets.

Glenn Kelman, CEO of online real estate company Redfin, has a post about the “mercenaries” vs. the “idealists” in business.  He makes two insightful, tightly intertwined points:

1)  Many top-performing companies get that way- in part- by pursuing an idealistic goal.  His best example was of Alcoa chasing a specific, hard-nosed figure.  It wasn’t cash-related, though.  It was reducing the number of employee work-related injuries, which improved morale and reduced labor costs, one of Alcoa’s biggest expenses.

2)  We frequently work the other way too- caring deeply about something and then figuring out how to make money from it.

Glenn’s point is that the green-eyeshade types will miss the boat by focusing only on the numbers.  It takes ideals- focused ideals- to build a really successful business.

Jumping threads only slightly, one of my goals for 2009 is to focus on my family’s equivalent of Bhutan’s Gross National Happiness index:

GNH, like the Genuine Progress Indicator, refers to the concept of a quantitative measurement of well-being and happiness. The two measures are both motivated by the notion that subjective measures like well-being are more relevant and important than more objective measures like consumption.

Here’s to a year of economic and personal well-being in 2009.

• Comments

Jay Parkhill December 28th, 2008

Steve Poland’s open letter to Evan Williams last week hit Techmeme and apparently got widely read.  Another Twitter user name “dispute” sparked, caught fire and went out all in one Saturday- yesterday- on what is probably one of the slowest weekends of the year.

The Dispute
A school teacher named Colin adopted the user name @room214, which also happens to be the name of a social media agency.

I think the episode started with this tweet from the agency, using the name @room_214: 

Colin responded that he likes the name and uses it in other places as well, so no.  From what I can tell the agency did not file a complaint with Twitter itself, though it sounds like someone might have sent Colin a nastygram threatening to do so.

The Speedy Resolution
The episode ended about 12 hours later when the co-founder of the agency posted a note saying that the note came from an overeager employee, and that the agency itself had no desire to push Colin off the name.

The name itself is totally banal- @room214.  There is no practical way for anyone to know that it is also the name of a business, and there is nothing famous or proprietary about it.  Twitter’s terms of service have two sections that might allow them to change a user name (”You must not abuse, harass, threaten, impersonate or intimidate other Twitter users”; and “We reserve the right to reclaim usernames on behalf of businesses or individuals that hold legal claim or trademark on those usernames”) and Colin violated neither as far as I can tell, so by my reading the agency would be out of luck.

The Conclusion
This episode ended up a whole lot of nothing.  It does show that people get attached to their names and are starting to wonder how much to rely on them.  Steve’s suggestion is to create paid Twitter premium accounts that “protect” user names like telephone numbers or domain names.

Twitter is the biggest network that uses unique user names to identify users (I think) rather than email addresses or Facebook-style numerical identifiers, but the issue goes beyond just Twitter.  I probably have accounts as @park3 on 20 different services.  I would not pay money for that name on most of them, but I might pay a very small amount on 3-5 or so- probably not more than $10/year or so since I don’t make money from any of them (and i’m cheap!).  Would I use fewer services if I knew I had to pay to be guaranteed my preferred name?  Would I search harder to find a really “unique” name?  Probably not on both counts.  Do I just need to start a user name-reservation-and-arbitration business?   Hmm.

• Comments

Jay Parkhill December 22nd, 2008

My friend Steve Poland blogged a few days ago about the experience of losing his @celtics Twitter account.  The story got picked up on Techmeme and made the rounds on the Internet, which was a wondeful thing.  It sounds as though the Boston Celtics decided they wanted to try out Twitter, saw that @celtics was taken and successfully petitioned Twitter to yank it from Steve.

I feel bad for Steve not so much for the fact that the name was taken from him as for the way it was done.  He posted the notification email from Twitter and it was blunt, unsympathetic and offered no recourse to someone who believed he had been wronged.  There are good ways and bad ways to convey a message and if ever there was one likely to inspire a rant this was it.

The consensus from around the Internet agrees here, and says that while everyone understands intellectually that Twitter owns user names (unlike phone numbers or domain names) there should be a fair review process.  Steve has a great example in @STP, his personal Twitter account and also the name of a brand of motor oil.  Steve never Twitters about motor oil that I am aware of, so by Twitter’s own rules there is no “impersonation” happening and Twitter should not be permitted to take the name away.

But what if it does anyway?  And what if Steve also has “STP” accounts on 17 other social media sites (or every one listed at Username Check)?  As the social media business figures out how to charge people for services I wonder if someone needs to step up as a global user name mediator so that individuals and companies don’t end up fighting the same battle in multiple forums simultaneously, where they might well win some and lose some.

Twitter seems to have jumped way up in the public consciousness recently.  I imagine they are dealing with a lot of these issues right now.  I bet they wish they could hand them off to someone else as well.

–

And as long as I am on the subject of Twitter growing pains,  I am fervently looking forward to the day I don’t have to give my Twitter password to every site that wants to plug into my account.  Erik Heels recommends changing Twitter passwords regularly, probably for this very reason.  I am going to have to write down all the places that have my Twitter credentials so that I can start doing that.

• Comments

Jay Parkhill December 18th, 2008

I don’t know for a fact that the fight between Anheuser-Busch and Budejovicky Budvar NP over the marks “Budweiser” and “Bud” is officially the oldest continually active trademark dispute in the world (Erik?), but it must be close.

The Budvar brewery was founded in 1895.  The beer was named for the Germanized version of the city in which it was founded, Budweis (České Budějovice in Czech).  Distribution was extremely limited until the second half of the twentieth century.  Anheuser-Busch was founded in the 1850s and introduced the Budweiser brand in 1876.

For decades the two brands existed in parallel, using very similar names and script for their logos, but not directly competing on a large scale.  That changed when Anheuser started selling Budweiser in Europe in earnest and the two companies have been playing a real-world version of the game Risk ever since, locking up trademark rights country by country.  Budvar obtained first rights in Czechoslovakia, France and Austria and Anheuser had primary rights in the US.

Anheuser won in Australia, New Zealand and 23 or 27 EU member states, among others.  Budvar won in Japan, but seems to be losing the war.  This week, though, a European Union court denied Anheuser’s move to register the Budweiser mark across the EU.

It may not be much more than a symbolic victory for Budvar.  One has to think that the cost of litigation is a much bigger issue for tiny Budvar than for giant Anheuser, now owned by mega-giant InBev.  The multi-jurisdiction chess match is fascinating to watch, though.

[Full disclosure: I once carried a six pack of Czech Budweiser home from Prague]

• Comments

Jay Parkhill December 17th, 2008

A friend of mine turned me on to a company called One.  They sell bottled water and donate all the profits to a foundation that build playground-water pumps in southern Africa.

What on Earth, one might ask, is a playground-water pump?  It is an extremely clever device that harnesses a nearly

Image courtesy www.playpumps.org

inexhaustible supply of energy to pump clean water from deep wells by turning the pump “engine” into a playground-style merry-go-round for kids.

This is very clever.  If my kids are any measure, this pump will have enough energy to run for hours on end, and at the same time the kids’ natural energy can be channeled to good effect bringing clean water to people who need it.

When my kids get hyperactive I threaten to install a giant hamster wheel in the house and putting them on it for an hour or so, but I’ve never followed through.  PlayPumps has done just that- in a much smarter way.  Kudos to them.

Related articles by Zemanta

• Josh Dozoretz: Play Pumps

• Comments