How to cheat legally on your tax return.

When do you cross the line between honesty and dishonesty in tax planning? 

Is it ethical to allocate income between periods to take advantage of tax breaks?  Can expenses be put off until the next period to increase income, or accelerated into this period by prepayment to decrease net income?  Where do you draw the line, assuming no intent to defraud?

Revisiting corporate vs. personal tax rules

First, corporations are usually on an accrual accounting basis, meaning that income and expenses are accounted for as earned, not when the cash is received.  (You, on the other hand, account for your individual income on a cash-accounting basis, counting the cash not the date of your earning or accrued expense.  The difference:  If you earn pay due December 31st and it is paid January second, you pay income tax on those earnings in the following year.  But the corporation that pays you accrues the expense and takes the deduction in the year in which the income was earned or expense actually incurred.)

Where do we draw the line here?

[Email readers, continue here…]   It is perfectly legal to hold delivery of goods until after the start of the next period and take the income next year rather than this.  It is a bit murky if you accelerate payment for incomplete services or even for products not yet received into this year to take the deduction from income early.  In either an IRS audit or an accounting review or audit, the accelerated costs and payments will show as an accrual – a balance sheet item – that does not change income, just cash and an asset.

In other words, for the usual accrual-based business, there are fewer ways to affect the outcome than for a cash-accounting individual.  There are lots of caveats here and certainly if the issue is critical to you, an accountant (rarely a bookkeeper) should guide you to the action that is both legal and strategic.

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Do you really need an accountant?

First, let’s be sure we define our terms.

Accountants are trained, certified and usually quite experienced in financial analysis, both creating and reviewing data.  Bookkeepers are often trained on the job although sometimes more formally and handle the physical work of accounting for the transactions.  To expect a bookkeeper to provide analytical planning is to ask for something they often cannot provide, except in a cursory way.

We need to repeat this distinction on occasion, because there is a considerable difference between the cost of a bookkeeper and an accountant.

Why bother with this?

[Email readers, continue here…]    Many early-stage founders and CEOs believe they can delegate design and creation of metrics, flash reports, analytical reports and more from their bookkeepers.  And at some early stages, a bookkeeper can prepare such information.  It does not take long for a growing business and a knowledgeable CEO to quickly outgrow the lack of depth and sophistication such reporting usually offers, looking instead for deeper analytical tools.

On the other hand,

Many early-stage CEOs are not trained and ready for such tools even if available.  The lesson here is twofold.  There is a benefit to using a good accountant to help devise critical reports for a corporation; and CEO’s must quickly become financially savvy in the analysis of financial statements and metrics that measure the health of a business.  To fail to have this skill is to reduce the corporation’s capability to discover problems early and take advantage of growth opportunities.

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Can your lawyer destroy a good business deal?

Let’s talk about lawyers…

Over the years in business and as a member of over forty boards, I have received good advice from corporate attorneys and on occasion bad advice as well.  There is a line that should be drawn in a relationship between corporate attorney and CEO or board.  Attorneys are paid to protect the corporation, not to give business advice.  Some are experienced enough to provide great business advice.

But the law degree they earned does not assure that, even though most CEO’s respect the advice they receive from their attorney highly enough not to doubt the conclusions or the experience behind the conclusions offered.  And since attorneys are paid to protect, often they will give a litany of warnings about what could go wrong when accepting a contract clause that they have been trained to challenge.

Business advice vs. legal advice

There comes a time when a CEO must decide to reject what may seem like important good advice from the attorney and chance acceptance of terms within a contract that may cause risk, but controllable risk or risk that is so remote as to be worth the acceptance of the business represented by the contract at hand.

Another story about this…

[Email readers, continue here.]   I was chairman of a company that had been offered an investment by a Fortune 500 company offering to make a strategic investment in our business, which would be capable of driving new demand to the large company through a series of new web services creating a greater need for the large company’s products.

The business terms had been agreed between the business development officer of the investing company and our board, as both companies turned the details over to their respective attorneys for documentation.  The attorney for the investor was a member of a large, respected law firm in Silicon Valley, and certainly was full of himself as sole legal protector of the rights of his very significant investor.

As drafts of the otherwise standard investment agreements passed from him to our attorney and our management, we immediately spotted a significant number of terms we not only had not agreed to but were contrary to the spirit of the investment.  The attorney held fast defending every challenge, stating that “these terms are standard for our client and cannot be changed.”  We appealed to the business development executive, who deferred to the attorney restating that the terms were unchangeable as far as the big company was concerned.  After conferring between our attorney and board, we walked away from what would have been a fine strategic partnership, killed by an attorney who probably understood the client requirements but was unwilling to offer flexible solutions to problem areas.

Drawing the line…

That attorney had made what we considered business decisions on behalf of his client.  By the way, we immediately found a willing replacement that had an attorney not quite so full of himself and quickly concluded a similar deal to the acceptance of all.  And to this day, I caution my CEO’s not to deal with that Fortune 500 firm because of the experience we had with its attorney.  You never know how much far reaching an action can be, given the speed and extent of communication between CEO’s today.

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What if you see juicy competitor information?

Has this happened to you?     

Many of us belong to industry associations and find ourselves at conferences and trade shows with time to spend with competitors.  Some of these are old friends, some even former associates.  It is natural to want to associate with these people for many reasons, certainly socially. Most CEOs want to obtain information about their competitors in the most subtle and non-obvious ways.  And of course, most are willing to trade information to get information.

A fair example

In my former industry, I became an informal centralized source for knowledge about the revenues of each of the many competitors, with a special skill for asking just the right questions to obtain the information.  How many employees does the firm have today? Are you profitable yet?  Can you guess what percentage your revenue comes from recurring sources such as maintenance revenues?

In return for the answers to these several questions, I was usually able to guess a company’s gross revenues within a few percent and would state my guess to the CEO.  His reaction would guide me to increase or decrease my estimate appropriately.  He’d be a bit amazed with the quick fancy math work, and I would have yet another piece of the puzzle helping me to gauge the total size of the industry in annual revenues and the growth and size of competitors.

[Email readers, continue here…]  All of this was immensely helpful in strategic planning and marketing, even though to this day I do not think those CEOs were aware of the value of the information so easily given.  And none of this is especially considered a trade secret, violating the unspoken covenant between competitor CEOs that there is a limit to such exchanges.

The other kind of example

On the other hand, often a salesperson or marketing manager would show up at my office door with a complete package of a competitor’s materials, including price lists, a proposal with discount percentages clearly shown and a list of feature functionality meant to reinforce the proposal.  The source of this information was typically the purchasing decision-maker for a friendly customer or candidate customer.  The question is one of ethics, since the competitor certainly did not volunteer any of the information, which would have been the competitor employee’s violation of confidentiality and cause for being fired.

How should you respond?

What does a CEO do with this wonderful, rich information dropped at his door at no cost or obligation? Few would destroy it and ask all to forget that it was ever in their hands. Most would absorb the information and then admonish those who had seen it to not repeat to anyone that it was in their hands.  If you’ve been in business for long enough, you’ve seen your share of this gray market information.  My advice is to be very careful, think of the golden rule, never use this information publicly, and certainly never reproduce it, let alone disseminate it internally.

And a warning…

As to sharing information to get information, CEOs and executives are bound by a duty to their corporations not to share trade secrets with anyone who has not signed a confidentiality agreement, including consultants to the company.  For CEOs on the corporate board, it is a large part of the “duty of care”, a legal requirement of board members to protect the assets of the corporation first and foremost, one of those assets being the trade secrets of the corporation.

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Wow! Are your relationships important!

Forming business relationships at the highest level

As you follow these insights from ignition to liquidity event, you’ll detect a continuing theme, emphasizing the need for deep and wide relationships that the CEO and senior staff can call upon for advice and guidance.  This is the time to elevate those insights to the level of highest value for the corporation, one that cannot be listed on a balance sheet nor included in an appraisal of corporate worth.

And yet, such relationships properly used and never overused, can quickly and precisely help you cut through delays in government agencies, speed the process of product planning and ultimate release, aid in positioning in the market and help you avoid a myriad of mistakes that could prove costly in time and money.

Analyzing your commitments of time to business

Often, I am asked by young CEOs how much time should be devoted to various types of tasks by a good senior manager in a small, growing enterprise.  Of course, the response depends upon lots of variables, including whether the company is in a fund-raising mode (in which case the CEO may be spending up to 80% of their time on this alone).

[Email readers, continue here…]   I am chairman of the Technology Division of the ABL Organization, a roundtable organization with multiple CEO roundtables of about twelve members each, meeting monthly.  Each CEO is asked to make a deep presentation once a year in which he or she starts with personal and business goals for the coming year followed by concerns as to how to reach these goals. Much of the rest of the presentation is devoted to explaining to the group the causes for the concerns and offering information for the group to use in the feedback session to help that CEO seek solutions and to provide resources to them for that purpose.

The format also calls for the CEO to examine their calendar over time and report classes of activities by percentage of total time spent, so that the group may add comments about use of that person’s valuable time to the critique.  It is from over a thousand of these CEO presentations over the years that I attempt to make the following generalities.

How much time do you devote to each type of activity?

A good CEO spends at least 30% of their time dealing with customers, including meeting directly with customers and being involved in closing the largest deals, maintaining valuable relationships, and “sniffing” the attitudes of customers toward the company as well as exploring customer needs that might be satisfied by new product development.  15% typically is spent on direct management issues such as supervision of next level subordinates.  15% might be spent networking with those in the CEO’s relationship circle, including the roundtable organizations.  10% is typically spent networking with board members and advisors, usually with frequent phone calls, and preparing for board meetings.  10% is typical in exploring strategic concepts, reading about new developments in the industry and just spending quiet time contemplating opportunities.  That last 10% is most important and often overlooked. It represents strategic thinking.  “What if?”  “How about…” “When should we…” “How could we…” You get the idea.

There are many other classes a typical CEO will list for that remaining 20%, some concentrating upon time spent in meetings of all kinds, lumped together as if all meetings are of some equal value. The group cohort reviewing this time spent often pays close attention when this happens, since it is a sign that the CEO considers meetings of all kinds a drain upon available time, and few meetings of special importance.

How many hours do you spend on business each week?

Whatever the spread of percentages to make 100% of a senior manager’s time, the roundtable presentation requires the CEO to estimate the average number of hours spent each week at or on work.  Most respond with between 60 and 80 hours a week, emphasizing what you already know, that CEOs are not often 40-hour workers.  But then again, in this new world of always-on communications, who is?

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What are the costs of taking investor money?

Let’s talk about the reality of taking money from professional investors.  It is not the first time we’ve covered this general subject nor the last. But this time, we concentrate upon governance changes.

After friends and family…

Once a company founder has tapped the funds available from his or her resources and from friends and family, if the company needs more cash for growth, the most obvious next step is to look for money from angel investors and venture capitalists, typically in the $300,000 TO $3,000,000 range.

And the restrictions upon your freedom to operate…

This money comes with restrictions a founder may not expect, including restrictions upon the sale of founder stock, clauses that require the investor be allowed to sell an equal proportion of stock upon any other person’s sale of stock, anti-dilution provisions that protect the investor from a subsequent offer of stock at a lower price, and much more.

A seat on your board? 

[Email readers, continue here…]    Almost always, professional investors, including angel groups and venture capitalists, also require at least one seat on the corporate board.  The investor organization is granted the seat if the investment remains, and the documents often name the first representative assigned by the investor group to the position.

Why these restrictions?

In later insights, we will explore the legal and ethical responsibilities of board members.  But the intent of these “forced” placements of a representative on the board is obviously to watch over the company’s use of invested funds and to help grow the company in value.  The combination of restrictive covenants in the investor documents and the new dynamic of board members with an agenda make for a change in the culture of the corporation, certainly one for the CEO.

However, outside professional investor board members can be a very good asset to the corporation with the skills, experience and broad relationships many bring to the boardroom table.

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Do you need an advisory board?

Have you ever thought of creating an advisory board?

As you can guess, that would be an informal group with no legal responsibilities, but one able to be called upon to act as business, industry and scientific advisors to the company or CEO.

Why?

Usually, you would want to create an advisory board to fill in the critical areas of need not evidenced in the board of directors or within the company itself.  University professors, industry gurus, lawyers familiar with patent law and former executives of competitor companies are typical recruits you might consider. Sometimes, celebrities will agree to sit on an advisory board as a gift to the CEO, providing a bit of glamour for the company at small expense.

How about the size of the group?

There is no limit to the number of individuals for such a board, but there is a practical limit to the amount of cash and / or stock to be allocated to these outside advisors.  The rule of thumb for an advisory board member is to expect a half to a full day each year on site, typically in a strategic planning meeting with numerous members of the staff, as well as some reasonable number of phone calls from senior members of management during the year.

How about using the names for marketing, fundraising?

Included in the “package” is the expectation that the advisor’s name will be freely used in the company’s marketing, a bio listed on the website, and occasional calls will come as references to the advisor from potential investors and others looking for deeper insight into the secret sauce of the company or state of the industry than can be provided by many on the inside.

And now the expected cost…

[Email readers, continue here…]    For this, an advisory board member for a small to medium sized company should expect to receive options equal to ¼% of the fully diluted stock of the company, vesting over two years, and subsequent grants if there has been additional stock issued to dilute the advisor, bringing the advisor back to this percentage if an advisor is renewed after subsequent two-year intervals.  Alternatively, some companies pay an advisor a fee of $1,000 to $2500 per “on premises” meeting day and optionally much smaller stock grants, if any.

What if an advisor acts as a consultant with more time?

Additional commitments of time by an advisory board member should be compensated as would any consultant, at half and full day rates agreed upon in advance between the CEO and the advisor. There is no rule as to uniformity of pay, as some advisors may be willing to serve at no cost while others are industry consultants used to receiving fair payment for services rendered.

Create a formal advisor agreement listing expectations.

Advisors fill blind spots in the corporate knowledge base and guide you in areas where you feel you have a personal weakness.  There is usually a formal agreement between the company and the advisor, carefully calling out the time expectation, the forms and amounts of payment, and the indemnifications from liability granted by the company to the advisor in return for confidentiality and non-disclosure of company trade secrets by the advisor.

How about “chairman” of the advisory board?

A particularly strong advisor, especially if well known, may be named chairman of the advisory board, which is often just an honorary title, since the CEO is usually tasked with the planning of the full day meeting of advisors annually, and setting the agenda to match the needs of the corporate board and senior management.

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Do you even need a business coach?

Everyone, even seasoned CEO’s can use a good coach who knows how to bring out the best in a person, is knowledgeable about the business process, and who has an extended list of relationships to call upon to fill needs that become obvious in the coaching process.             

Business coaches come in all sizes and shapes.  

Entrepreneurs will have a relative willing to devote time, a school friend with business experience, professionals who charge for the service, investors with a reason to promote your success and more.

Find a coach who has “been there and done that.”

But by far the best coaches are those that have lived through the process you’re going through and built successful enterprises in your same industry.  Especially if they have sold their companies and live comfortably upon the proceeds, these people are often the most willing to help and the most patient through the process.

Where can you find the best coaches?

[Email readers, continue here…]   One great source for coaches is among fellow members of a CEO roundtable organization, Young Presidents Organization or similar association where you are comfortable with the coach candidate and know something about his or her style.  Another is through industry associations or civic groups such as Rotary or Lions Club or even SCORE, sponsored by the US Small Business Association (SBA).

Some larger communities have organizations of corporate directors, composed of a combination of service providers and professional corporate directors. I’ve personally been involved with the ABL Organization for over thirty years and share problems and solutions with a monthly roundtable of smart CEOs from companies of all sizes.

Board members or lead investors as coaches

If you take smart money from a good angel or venture organization, the lead investor usually becomes your board member and has a vested interest in your success.  If you are lucky enough to create competition among investors for your company, you can select the investor or group with an individual who has experience in your niche and identifies with your vision.

How do you pay a coach?  

If the coach is also a significantly large investor such as a VC fund, the board member-coach will offer a limited amount of time outside of board work at no extra cost, all for the good of the investment.  Professional advisors and consultants are typically paid by the half day or full day, charging anywhere from $600 per half day at the low end up to $4,000 or more at the high end for a full day of work.  Some charge by the hour, making themself available much as an attorney, keeping track of hours spent on phone calls and emails with you. And some will willingly work for stock options, an amount to be negotiated based upon time spent and stage of corporate development.

Years ago, I co-wrote my first book, profiling just such a person, trading his time and experience in exchange for equity – and managing to become wealthy in the process by picking and aiding great young companies that grew large and were ultimately sold at a tremendous profit.  We had no term for such work in those days and created the phrase “resource capitalist” to describe the person and process.  He brought resources to the table from personal experience to a great contact base and was able to help speed the time to market while introducing the company to great potential buyers at the right time in the process.  His average percentage of a company was 5% in return for spending a day a week as I recall.

…and “working for food.”

Jokingly, I used to tell people that I worked for food, with so many free lunches being offered from all sides. But alas, there is no free lunch.  And over the years I have vastly curtailed the practice. However, there surely are experienced executives out there who’ll work for a meal. It is worth asking.

A warning about those willing to take advantage:

There must be many more creative ways to pay a coach, especially for early-stage businesses.  The one warning: avoid those looking to become partners, asking for larger portions of equity than, say, 5% when they contribute no cash to the enterprise.  There may be times when such a person can truly be a founding partner in a young business and devote enough time and resources to warrant more, but this is taking on a partner in every sense of the word and should be done carefully and only after spending time with a number of the person’s references and becoming comfortable with the person, ready for the long run.

 

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Should you be optimistic about your corporate growth?

Planning for future space needs after COVID.

One of the most obvious observations I make with growing company CEO’s is that planning for a new office is done with an optimistic view of the future, incorporating planned space that compromises only slightly the measured needs for the next three or more years as outlined in the financial forecast. Yes, we can mitigate that with starting with a reduced size given the current remote and hybrid work environment.

But… Do we still plan for growth in our infrastructure?

Signing a lease for space enough to handle the growth called for in the business plan, is a predictable group behavior I’ve come to label “The tyranny of the new office.”  The company plans a move to a new facility with plenty of space that is probably built out but not planned for use until the company grows to the next stage of need.  Office employees expected to work in the office regularly move into their new cubicles and offices, spread out far more than in the previous facility.  The excitement and noise of working in too close proximity to cohorts suddenly becomes an unexpected near silence, as everyone notices that they do not have to raise their voices any more to be heard above the din of noise.

And the result of this empty space before the growth spurt?

[Email readers, continue here…]    The exciting sounds of an office filled to capacity functioning in a growth environment are exhilarating to most that have experienced it. The distractions are dealt with using earphones with their smartphones, concentration and tolerance; but they are dealt with by all.  The change to a near silent environment is so startling that, many times, employees express a bit of resentment or even depression, masked by the common statement that “it is so much easier to get work done without the noise.”  It is the excitement of activity that generates more and better output for most, not the isolation of silence.

But back to “the tyranny of the new office.”

Two predictable outcomes almost always follow a move into an office much larger than today’s needs. First, you’ll find subtle moves by employees into the unused, reserved space.  After all, it is there and unneeded for now.  Why not make use of the space until needed?

And second, management sees the open space and often finds it easier to justify acceleration of one or more new hires since the facility is available and infrastructure complete.  Unconsciously longing for a bit more of the excitement from the noise of the previous office, managers often make subtle unrecognized moves to fill the void with new hires earlier than planned.  That’s why the label, “tyranny” even if the word seems out of context.

If and when asked, I always recommend more frequent moves as opposed to longer-term leases.  It seems from experience that both the company and the employees gain from such staggered moves.

Next week: It is time to examine the CEO’s relationships with con-temporaries, coaches, good board members and great resources in the community and industry.

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If you must lease an office, make it a short one!

 Avoid long-term commitments!

It is statistically true that at least half of the young companies funded by angel or venture investors will not survive three years from funding to demise, and more than that percentage will die with two years if not well financed.  The greatest burden of either a growing company or one needing to retract and reduce expenses is the office lease – especially in these years after COVID and remote work.  Although payroll is almost always the greatest cost, companies have flexibility as to how to handle both rapid growth and rapid decline in the personnel arena.

Rapid growth?  Home workers? Business contraction?

The most difficult thing to deal with in any of these events – now or future – is the office lease.  A five-year lease may be cheaper per month than a three-year lease and may provide for more free rent and tenant improvements.  Those benefits pale in comparison to the high cost of retaining or buying out a longer-term lease when growing or reducing in size or misjudging number of at-the-office employees – which is most of the time for early-stage companies.

What is flexibility worth in higher cost?

[Email readers, continue here…]   From personal experience with many companies in my portfolio and from many board experiences over the years, young companies are unpredictably unstable in their facilities requirements. Flexibility is worth a few percentage points of fixed cost when companies are in high growth mode or are at early stages of proof of market.

Yes, it’s a hassle to move offices.

It is a hassle to move, requiring time and planning.  It is much worse to worry overpaying for two leases each month and tying up two large deposits.  Or honoring a personal guarantee if the company cannot pay.

Then there is the dread of “The tyranny of the new office” to worry about. But that is a story for next week’s insight…

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