5 of the Dumbest (and Most Costly) Startup Mistakes, Part 5

For those of you who just joined in, I am a corporate partner at a Gunderson Dettmer – a Silicon Valley based law firm that works exclusively for technology companies and VC’s. I make my living working for startup companies but I want to help you spend less money on lawyers.

I spend an awful lot of time (usually on short notice the night before an important deal is supposed to close) fixing preventable problems. An awful lot of these problems relate to hiring, compensating and incenting early employees. All of them cost money and time that I would rather see invested in building teams and product.

Over the next few Wednesdays I’ll be posting a few short pieces that may help you avoid, last minute fire drills, unnecessary accounting or legal fees, angry investors and perhaps an occasional lawsuit or regulatory audit. Hopefully by highlighting a few of the most common employment related problems I can help you avoid them.

5 of the Dumbest (and costly) Mistakes Startups Make with Their People, Part 4

1. MISTAKE # 1 OF 5: Not Understanding Obligations to Prior Employers

2. MISTAKE #2 OF 5: Failing to be Informed About Employee Rights with Respect to Wages

3. MISTAKE # 3 OF 5: Employees Versus Independent Contractors

4. MISTAKE # 4 OF 5: Failing to File Those 83(b) Elections

5. MISTAKE # 5 OF 5: Ignoring Internal Revenue Code §409A One Last Tax Code Reference – Section 409A

By now, most in the startup community have heard of this 2004 amendment to the tax code ostensibly designed to address pension plan and deferred compensation abuses post – Enron but chock full of unintended consequences.

It’s a complex set of rules with lengthy regulations. I’ll just point out two key areas to watch out for 409A:

First, 409A imposes some nasty tax penalties on taxpayers who receive discounted options (options with a strike price less than fair market value). The introduction of this element of 409A has dramatically changes the practices to private startup company boards who historically had priced options using their business judgment and some simple rules of thumb based on discounts from the most recent preferred stock price.

Section 409A recognizes the burden placed on private companies who can’t just look to the ticker to confirm the appropriate stock price and adopted a number of safe harbors that Boards can rely on in their pricing decisions.

For the startup founder, it’s important to understand the safe harbors and to be mindful of 409A anytime options are being priced. This is another hot button due diligence issues for VCs and potential acquirers.

Second, 409A doesn’t just impact options. The regulations pick up a number of kinds of “deferred compensation” and companies can inadvertently fall into 409A problems when structuring everything from bonuses to earn outs to severance packages and salary deferrals and carve out plans. As with many of the issues above, seemingly small problems can cause significant cost and delay when they have to be solved under the scrutiny of an acquiring company’s accountants and counsel.

That makes all 5 of the mistakes I wanted to highlight. I hope you enjoyed reading these posts and found them helpful.