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SF Client Respirics Acquired by Hisun Pharmaceuticals Co.

dave — Fri, 03 Feb 2012 18:18:36 +0000

Zhejiang Hisun Pharmaceutical Co Ltd. Acquires Substantially all the Assets of Respirics Inc.

Princeton, New Jersey – Zhejiang Hisun Pharmaceutical Co Ltd, the parent company of Hisun Pharmaceuticals USA, Inc. substantially acquired all of the assets of Respirics Inc.

Included in the acquisition are Acu-Breathe™, a multi-dose breath actuated dry powder inhaler (DPI) device and MD-Turbo®, a companion product designed to assist patients who use metered dose inhalers by making them breath actuated. The latter was approved for marketing in the US in late 2005.

Mark Celeste, formerly CEO of Respirics, joins Hisun Pharmaceuticals USA and will be heading the respiratory business unit. Bob Casper, one of the inventors of the acquired technologies and a founder of Respirics, has been retained on a consultancy basis.

This deal propels Hisun into the respiratory market. Hisun expects to leverage its presence as one of the most prominent pharmaceutical companies in China to rapidly expand the market reach for MD-Turbo® and to further develop the DPI technology.

Scale Finance has provided part-time CFO services to Respirics, Inc.

About Hisun

Hisun is a leading biopharmaceutical group founded in 1954 focused on improving patient wellbeing and quality of life. Hisun has its headquarters in Taizhou (Zhejiang, China). The company operates two sites in the Zhejiang province and established its first international office in Princeton, New Jersey in January 2010. Hisun currently employs over 7000 people of which more than 600 support R&D projects. The company has an extensive portfolio of generic drugs and expanding its technology and new molecular entities portfolio. For more information about Hisun visit www.hisunusa.com

Contacts

Hisun Pharmaceuticals USA, Inc. (www.hisunusa.com)

About Scale Finance

Scale Finance LLC (www.scalefinance.com) provides professional CFO services, Controller solutions, and support in raising capital, or executing M&A transactions, to entrepreneurial companies. The firm specializes in cost-effective financial reporting, budgeting & forecasting, implementing controls, complex modeling, business valuations, and other financial management, and provides strategic help for companies raising growth capital or considering M&A/recapitalization opportunities. Most of the firm’s clients are growing technology, healthcare, business services, consumer, and industrial companies at various stages of development from start-up to tens of millions in annual revenue. Scale Finance LLC has offices in Charlotte, NC, the Triangle, the Triad, Southern Pines, and Wilmington with a team of more than 30 professionals serving more than 100 companies throughout the region.

Board of Directors Versus Advisory Boards

dave — Fri, 03 Feb 2012 18:06:29 +0000

To survive and thrive in a competitive marketplace, companies need to secure help and guidance from a wide range of sources. To do so, many companies create advisory boards, or more formally, a board of directors to help guide them and hopefully facilitate growth.

If your company plans to go public, it will be required to put a board of directors in place. However, prior to that time, you may be faced with the decision as to whether to create a board of directors or an advisory board.

To determine which path makes most sense for your organization, here are some of the primary differences between a board of directors and an advisory board:

Board of Directors	Advisory Board
Considerably more expensive to form, manage and maintain than an advisory board. Typically, board members are paid to attend meetings and are reimbursed for travel expenses. The bigger your company, the higher meeting attendance fees are likely to be.	Advisory board members typically receive lower compensation for attending meetings. They often forgo a meeting attendance fee and travel expense reimbursement in exchange for a small equity stake in the company.
The role of the board of directors is legally defined by a set of bylaws or rules which spell out what matters the board will be involved in, how often it will meet, and how directors are elected, removed and compensated.	While a board of directors is a formal organization that must comply with bylaws, the advisory board is far less formal and able to “ebb and flow” with the needs of CEO and executive management. Specifically, members can be added or removed with relative ease depending on the needs of your company.
The board has a legal duty to the company and if mistakes are made, the members can be found liable. Without a directors and officers insurance policy (D&O) in place, potential board members may be reluctant to join the board and face potentially unlimited liability.	Members of the advisory board, with very limited exceptions, cannot be found liable for mistakes that they make while advising the company. Therefore, there is no need to purchase D&O liability insurance. With less inherent risk, potential advisory board members may be far more likely to accept a position.
A popular misconception is that a board serves at the discretion of the CEO and works in the best interest of the company’s executives. The board represents the interests of the organization and shareholders and it will consequently place those interests above that of management.	Advisory board members are chosen by the CEO and management team and can be replaced by them. The top priority of an advisory board is to advise and assist the CEO and top managers.
A board of directors is likely to be more motivated — financially and legally — to help a company succeed. Also, since directors typically receive far more information from the company than advisory board members, they are conceivably able to make better, more informed decisions.	Since the chances of being held liable for the advice they provide is highly unlikely, advisory board members may provide much more information than they would if they were on a board of directors. However, the free flow of information is a double-edged sword in that it may result in less forethought.
Although rare, a board has the power to remove the CEO from the company. The likelihood of such an event is far higher if board seats are allocated to investors.	Unlike a board of directors, advisory boards do not have the authority to make decisions. They are only there to provide advice and ideas. Management makes the decisions.

Best Practices for a Board of Directors or Advisory Board

Regardless of which path your company chooses to pursue, there are best practices that can apply to both options. Consider the following:

1. Choose wisely. To avoid “group think”, where people tend to think along similar paths, don’t engage individuals that possess experience and views that are similar to the CEO and executive management. Look outside your immediate network. Diversity of experience and thought can be translated into a competitive advantage. A prospective board member should have:

A track record of success.
High ethical standards that they are not willing to compromise.
Industry knowledge or a willingness to gain the appropriate knowledge.
Sufficient time to dedicate to the role.

2. Identify today’s challenges. Before forming a board of any type, take stock of where the company is today, as well as the future aspirations and challenges it will face. For example, if your company plans to enter a foreign market within the next year, it makes sense to include an individual with this type of experience on your board.

3. Don’t over or under build. It is possible to have too many members in either type of board, and it is also possible to have a board that is too small to bring about change. Many corporate governance experts recommend that in order to be effective and accomplish all of a traditional board’s legally mandated responsibilities, seven to nine board members are needed.

An advisory board can certainly be smaller than a traditional board and still be effective since it is less formal in structure and nature. In either event, first identify the company’s challenges and the skills needed to address them, and then choose the optimal number of members. A small, yet ineffective board is just as problematic as a large, overstaffed board.

4. Focus at the committee level. In the case of a board of directors, there are typically three to four crucial committees — audit, compensation, nomination, and executive. Each committee should have a clear mandate and meet regularly to discuss the issues it is charged with addressing.

As you can see, there are significant differences between a board of directors and an advisory board. By examining them, you can decide what type of board is best for your business. Keep in mind that an advisory board offers many of the benefits associated with a board of directors. Depending on the size and maturity of your company, it may be the most viable option to pursue.

About Scale Finance

Replacing CEOs in VC-backed Companies

dave — Fri, 03 Feb 2012 18:00:16 +0000

Source: Ho Ham, General Partner, Altos Ventures

I regret to say that I’ve personally served on a dozen boards of venture backed companies that have replaced CEOs. It’s usually not a good sign. It doesn’t mean those start-ups were doomed; but it does mean drastic change was needed.

The decision to replace a CEO is never taken lightly. Replacing any CEO is difficult enough. Replacing a founder/CEO is even more traumatic and fraught with risk.

Although I have never seen a case in which a CEO, even a founder, is indispensable, over the years, my partners and I have formed a strong preference for founders.

Most founders have never been a CEO. Some may have never even had a corporate job (Mark Zuckerberg, for example). Yet we prefer to work with them as they learn on the job.

I won’t get into why we prefer founders (not the main topic of this post) but I’d recommend checking out these articles discussing the merits of founder CEOs:

I first wrote about our preference for founders three years ago: Ousting the Founder
Ben Horowitz wrote this more recently: Why we prefer founding CEOs
Steve Jobs’ Law: Why Founders Make the Best Leaders

When my partners and I first got started more than 15 years ago, we replaced CEOs quite often (though I’d estimate it was about average for the VC industry as a whole. I’ll share actual data later in this post). In contrast, my eight most recent boards have yet to replace a CEO.

One data point which reflects the presence of founder CEOs in venture portfolios is CEO ownership. When we tell people that the typical CEO in an Altos backed company owns more than twice the equity of a typical venture backed CEO, they assume it’s because we invest less money (resulting in less dilution). While this is true, the bigger factor is that most of our CEOs are founders.

On average, the minute a board replaces a founder/CEO, that company’s CEO ownership percentage drops. For example, when Eric Schmidt was hired at Google, the CEO ownership stake dropped to 4%, far lower than Larry Page’s stake.

Another reason we replace CEOs less often is selection bias. We are less likely to invest in the first place if we believe a new CEO will be needed. I’m always surprised when a VC submits a term sheet that calls for the retained search for a new CEO from day one.

We’d rather not make an investment, if we don’t know who the CEO will be. As the saying goes, “go with the devil you know versus the devil you don’t.” We must believe, at least in the beginning, that the person we’re backing can develop into a great CEO.

In the case of backing a “professional CEO” we must believe that the person has what Warren Buffett calls “owner mentality” (it might not be as good as founder mentality, but it’s better than most).

Of course, this does not mean that we will never fire a founder or replace a CEO. We make plenty of mistakes. To see if we might learn from them, I decided to look at some data from our current and past funds.

After studying a data set of more than 60 companies, I found that the probability of a CEO change increases dramatically with each new round of financing, unless a company is already profitable. A CEO who can control her own destiny is much less likely to get replaced.

Given that the companies in this data set have raised more than a billion dollars from over a hundred different venture firms, I suspect that there is a similar pattern for the entire VC industry, even if specifics vary from fund to fund.

In the chart below, each bar represents a group of companies based on how many rounds of funding were required to get to profitability or exit. The height of each bar represents the percentage of companies that replaced CEOs.

In companies needing only one or two rounds to get to profitability or exit, CEOs were replaced less than 14% of the time. At the other extreme, if a company needed four rounds or more, the replacement rate sky-rocketed to 85%. For companies that required three rounds, the rate was 53%, which is about average for the industry (see article below).

Given this data, I’d advise start-up CEOs to get their companies to profitability sooner. Control your own destiny. Otherwise, deliver an exit before you run out of money and have to raise another round.

Other Factors:

When a CEO is replaced, the rationale is usually quite subjective. “The team has lost confidence” or “lack of leadership” are typical quotes from board members considering a change.

For me personally, I’ve learned that my stress level about any particular company goes up and down with confidence in the CEO, regardless of how the company is doing. Let me try to explain.

Even if a company is doing really well, if I do not have confidence in the CEO, I tend to worry a lot because things might fall apart; and sooner or later, the shit usually does hit the fan.

In contrast, even if a company is struggling, if my confidence in the CEO is high, I stress less because I know there is a smarter and more capable person staying up at night not only worrying about things but doing something about it.

That said, other than obvious reasons such as lying, cheating or stealing, I believe the following are other, more objective, factors correlated with change in CEOs:

Time – eventually, all CEOs retire, die or get fired.
Lack of growth – a flat profitable business might be OK for some but not for VC backed companies that promised high growth to investors.
Employee turnover – higher than normal turnover happens for two reasons: great people are hired but are repelled or mediocre people are hired and must be replaced. Successful companies typically have turnover rates that are significantly lower than industry averages.
Burn rate relative to cash balance (key metric we track is months of cash remaining)

More Data:

The following article has some interesting statistics. Out of 50 high-profile VC-backed companies in 2010, 54% had replaced founder CEOs: “Do VCs usually fire founder CEOs?”

I’d also recommend checking out these questions on Quora for more info and discussion:

Final Note

I’d like to emphasize that the data points out a strong correlation, not causation. For example, it’s possible that VCs are more likely to replace CEOs in companies that run out of money and have to raise more rounds. It’s also possible (and very likely) that start-ups that hire professional CEOs tend to raise more money and go through more rounds of funding.

Founders are much more sensitive to dilution compared to professional management that are granted more options if a company goes through a massively dilutive round. Founders also want to maximize control. The biggest fortunes have been amassed by founders who have been able to retain quite a bit of control over their companies, sometimes decades after the IPO.

The punchline of the article should be “get profitable” rather than “avoid the 4th round.”

About Scale Finance

#1 Predictor of Failure – Premature Scaling

dave — Fri, 03 Feb 2012 17:50:05 +0000

In the wake of Solyndra’s revelation of an impending bankruptcy filing, the latest report from The Startup Genome Project makes for a timely read.

The report, published last week, crunches data from a set of more than 3,200 companies, seeking to identify the qualities that make startups most likely to either succeed or fail.

Researchers found that certain factors – such age and gender of founders, location, and previous entrepreneurial experience – have little bearing on a startup’s likelihood of failure. The most consistent predictor of failure, rather, was a startup’s propensity to engage in premature scaling.

What is premature scaling? The authors define it as “focusing on one dimension of the business and advancing it out of sync with the rest of the operation.” For example, a startup may overspend too early on customer acquisition, hire too many employees, or focus too much on engineering at the expense of customer development. It can also raise too much money too early, a problem that one of the researchers’ interviewees, venture investor Michael A. Jackson of Mangrove Capital Partners frames in automotive terms: “Getting venture money can be like putting a rocket engine on the back of a car,” he says. “Scaling comes down to making sure the machine is ready to handle the speed before hitting the accelerator.”

The report estimates that 70% of companies studied exhibited some form of premature scaling. They also estimate that 74% of high growth Internet startups fail due to premature scaling. A common mistake, they note, is confusing a few early adopters with a market.

Researchers at the Startup Genome project, an eight-month-old effort supported by a collection of startup industry insiders and academics, also churned out some other interesting findings related to startup success. Insights include:

Pivoters do better: Switching a core facet of one’s business model, or pivoting, is sometimes the only way a startup can stay competitive in a fast-changing market. However, is there such a thing as over-pivoting? Or under-pivoting?

Probably. Researchers found startups that pivot once or twice raise 2.5 times more money, have 3.6 times better user growth, and are 52% less likely to scale prematurely than startups that pivot more than two times or not at all.

Co-founders scale faster: Researchers found solo founders take 3.6 times longer to reach scale stage compared to a founding team of two, and they are 2.3 times less likely to pivot.

Business and Technical Partners Outperform: Teams with one business and one technical founder raise 30% more money, have 2.9 times more user growth, and are 19% less likely to scale prematurely than technical or business-heavy founding teams.

Founders are ridiculously over-optimistic: Researchers found that startups need two to three times longer to validate their maker than most founders expect. Startups that haven’t raised money, meanwhile, tend to over-estimate their prospective market size as 100 times bigger than it actually is.

Interestingly, while premature scaling is quite common, its opposite, which the authors call dysfunctional scaling, is quite rare. A possible example they point to is Friendster, which many believe lost its early lead in the social networking space to do a failure to adapt its site quickly enough to accommodate a massive influx of new users.

Curious to see if you’re committing any of these startup sins? The Startup Genome Project has a tool for companies to test whether they are scaling prematurely.

Source: Joanna Glasner

About Scale Finance

Venture Capital Market Update

dave — Fri, 03 Feb 2012 17:40:35 +0000

Source: WRAL Tech Wire

North Carolina Trends

Venture capitalists made nine investments in North Carolina in Q4 2011 with the deals generating some $59 million, a slight uptick from the third quarter but down more than $1 million from the same quarter in 2010. However, for 2011 deal making totaled only $325 million across 47 deals, the lowest total since 2005 when one excludes the recession year of 2009. North Carolina, the nation’s 10th largest state, ranked 12th nationally for the year and for the quarter.

Nationally, the investment trend was much stronger. Investments jumped 22 percent to $28.43 billion, in 3,673 deals. That’s up from $23.26 billion in 2010, when the money went to 3,526 deals.

Still, Laura Hoke of PricewaterhouseCoopers in Raleigh said some of the data was encouraging, especially for early-stage funding. “We had 12 deals for early stage totaling $113 million,” Hoke said. “That’s way up from prior years.”

Industry is “steady,” Triangle VC says. Read here.

Nationally, funding surges. Read here.

Hoke also noted that biotech and life sciences dominated fourth quarter deals with six in biotech or medical devices. “It seems like ever since I’ve been doing MoneyTree since 2007 that life sciences have really dominated,” she said.

David Jones, a venture capitalist at Southern Capitol Ventures in Raleigh, described the state of the VC industry as “steady.” (Read details here.)

Meanwhile, Suzanne Cantando, spokesperson for Intersouth in Durham, said the southeast’s largest venture firm, is upbeat. “We thought it was a great year to invest,” Cantando told WRAL Tech Wire. “We actually closed three new deals (in Baltimore – CSA Medical, Atlanta – SimplifyMD and Florida – Vergent Medical Systems) in the fourth quarter and several of our Triangle-based companies raised follow-on financing. We’re seeing strong valuations for companies that are raising later rounds, which is also a very good sign.

“Quarter-to-quarter numbers for NC can be deceptive because our data set is fairly small – and a deal can easily slip from one quarter into the next and make the numbers look dramatically up or down.

“The fact that we’ve got more early-stage investing (those 12 deals) means that the number of dollars invested will be lower, too – so I don’t think there’s any real bad news in there. The important thing is that we’re still seeing lots of new companies get created. Triangle Startup Factory’s announcement [in Durham] is exciting – just further indication that there’s a lot going on here.”

Other VCs contacted by WRAL Tech Wire also said they are upbeat about the coming year despite a sluggish 2011. The biggest deal of the quarter was the $27.5 million raised by Greensboro-based 911Interact.

National Market Trends

Funding for startups rose 19 percent in the fourth quarter as venture capitalists fueled money into more companies in the Internet, clean technology and other sectors. According to a study released last month, startup investments grew to $6.57 billion in the October-December quarter from $5.52 billion in the same period in 2010. The volume of deals, though, did not keep up with the amount of money invested. There were 844 deals completed in the fourth quarter, down from 861 a year earlier.

Called the MoneyTree report, the study was conducted by PriceWaterHouseCoopers and the National Venture Capital Association based on data from Thomson Reuters.

“As previously projected, venture capital investing in 2011 exceeded 2010 levels and ranks in the top three years for VC investing in the past decade,” said Tracy Lefteroff, global managing partner of the venture capital practice at PricewaterhouseCoopers.

“We saw a resurgence in investments in Clean Technology and Internet-specific companies in 2011, as well as a bit of a jump in average funding in the Internet sector. However, while venture capitalists continue to show their interest in these areas, they are acting prudently and not chasing excessive valuations. Accordingly, despite the increase in investing, we’re unlikely to see these sectors overheat like we saw in the 1999 to 2000 era.”

For all of 2011, venture investments jumped 22 percent to $28.43 billion, in 3,673 deals. That’s up from $23.26 billion in 2010, when the money went to 3,526 deals.

Venture capitalists piped $133.9 million into 80 seed-stage companies in the fourth quarter. That’s down from $233.2 million going to 90 such startups in the fourth quarter of 2010. The decline suggests some caution on the part of venture capitalists looking at the newest, often most risky, startup investments.

A total of 364 early-stage companies snapped up $2.27 billion in venture funding during the quarter. That compares with $1.48 billion going to 318 early-stage startups in the last three months of 2010. The report said 222 companies in the expansion stage received $2.36 billion in funding, compared with 270 companies snagging about the same amount a year earlier. In the later stage, 178 startups received $1.8 billion in the fourth quarter, while $1.4 billion went to 183 companies a year earlier.

Note of Caution

“While venture capital investment grew in 2011, it is important to note that deal volume growth did not keep pace with dollar growth,” said Mark Heesen, president of NVCA. “In most industry sectors, round sizes increased significantly, driving the higher investment levels across most stages of investment. Reasons for this phenomenon differ depending on area of investment.

“For some, the higher rounds are driven by the challenging exit market which requires venture capitalists to fuel their existing portfolios longer and at greater investment levels than in the past. This is particularly acute in the life sciences and clean tech sectors.

“In other sectors such as Internet, software and media, the higher rounds speak to increasing valuations. Given the diversity of the venture investment landscape, we expect these notable distinctions to continue into 2012 as our industry sectors are impacted differently by the continued economic uncertainty and ongoing opportunities in the market.”

Cautious Optimism

By industry, software companies received the most funding with $1.76 billion snagged in the fourth quarter, followed by biotechnology with $1.27 billion.

San Francisco-based internet storage locker Dropbox Inc. got the single-largest investment during the quarter, $250 million. In second place was Better Place Inc., which is based in Palo Alto and builds infrastructure and systems for electric vehicles, with $200 million.

John S. Taylor, head of research at the National Venture Capital Association, said the figures show “cautious optimism.”

About Scale Finance

New $2.3M Angel Fund Launches in Triangle

dave — Fri, 03 Feb 2012 17:20:41 +0000

Source: WRAL Tech Wire

Startups in the Research Triangle area have a new source to tap for funding. Triangle Angel Partners, formed by some 40 individuals from around the area, is officially in business after having raised a first round of $2.3 million.

Backers include Rich Lee, the former owner of Hosted Solutions which he sold to national telecommunications provider Windstream Communications. Craig Stone, an entrepreneur himself who has built HireNetworks into one of the area’s most successful employment services firm, is also among the founders. Merrill Mason, a partner at the Smith Anderson Law Firm, and Rich Harris, managing director of Synergy Commercial Advisors, also helped launch the new fund.

Scale Finance’s (www.scalefinance.com) Eric Johns manages accounting for the new fund.

Startup capital is one of the most difficult sources of funding for new companies in the Triangle to attract. Angel investments often help new companies grow to the point that they have products and revenues, two factors crucial in attracting institutional capital from venture capital firms. Early-stage funds in the Triangle include NC IDEA Fund Partners and Southern Capitol Ventures. Intersouth Partners, the southeast’s largest venture firm, also will make early-stage deals.

The angels in TAP includes a mix of high net worth individuals, some of whom are entrepreneurs and experienced investors themselves. “This group was formed to leverage our networks and gain access to the vast amount of deal flow in this area,” Stone said in a statement. “We are all passionate about entrepreneurship and look forward to helping our companies succeed.”

TAP investors also plan to be actively involved in startups from roles on boards to serving as advisors while also providing links to venture firms and other angel networks.
Eric John serves as the fund’s manager.

TAP plans to have meetings on a monthly basis where startups will be interviewed for potential investment. Companies first have to be screened through a selection process set up by TAP.

Investment Criteria

The fund’s investment criteria as spelled out on its website:

Management Team

We look for teams of high-quality entrepreneurs with a track record of leadership and performance, either in the company’s specific industry or in prior entrepreneurial ventures. We also look at your team’s passion for and commitment to the new business idea, and your ability to inspire confidence among future stakeholders, including employees, potential customers, and investors. As we will be working together as partners, your team’s credibility is essential. In addition, your team must be open to and comfortable with receiving input provided by angel investors.

Market Opportunity

Your company must demonstrate a strategy to claim significant share of the target market. There are plenty of great business ideas, but not all businesses will generate returns that justify angel investor and venture capital financing. Therefore, providing a solution to a problem with a large potential market is essential.

Use of Proceeds

Funds must be used to accelerate your company’s achievement of key milestones that increase the company’s value. We generally fund activities that include research and product development, building a sales and marketing infrastructure and hiring key executives.

Growth Potential

We look for companies that can grow quickly and manage the scale necessary to succeed. Your company must demonstrate a plan to generate significant profits beyond the initial product idea. Do you have a strategy to achieve multiple sources of revenue? We also require well-conceived financial projections, based on sound assumptions, demonstrating consistent profits and cash flow growth.

Competitive Advantage

Your company must have some proprietary features that distinguish you from potential competitors or provide barriers to entry that prevent other companies from capturing your customers with a similar offering. Attributes that convey competitive advantage include intellectual property protection, exclusive licenses, exclusive marketing and distribution relationships, strong brands, scarce human resources (i.e. knowledge and skills), and access to scarce raw materials.

Fit

TAP members have significant executive experience in a variety of fields. One of the benefits of working with angel investors is the active coaching and contact network that such investors can provide. As such, there must be a fit between members of our group and your idea.

Technology

We prefer to invest in first-of-a-kind new ideas, rather than incremental enhancements to existing products and services. However, we approach highly complex, esoteric technologies with caution. The concept behind the technology must be proven and verifiable. Further, we avoid science projects that don’t demonstrate a clear path to commercialization. Any breakthrough innovation must be accompanied by a strong business plan.

About Scale Finance

Red Flags That Can Trigger an IRS Audit

dave — Thu, 02 Feb 2012 18:07:39 +0000

The possibility of an IRS audit worries many taxpayers. But if you know what the targets are, you have a better chance of avoiding an IRS examination.

Of course, there’s no way to guarantee that your tax return won’t be examined since the IRS randomly chooses some returns to audit. So you should always keep meticulous records to prove your deductions. With that in mind, here are 12 audit red flags:

1. Not reporting all income from third-party payers. The IRS is adept at “matching” the income reported about you by employers, banks, and brokerage firms against what you put down on your tax return.

2. Missing deadlines. The IRS notices — and penalizes — taxpayers who mail their returns even a few days late. Auditors may wonder what other rules were disregarded.

3. Being self-employed If you work for yourself and file Schedule C, you have a greater chance of an audit. The IRS is especially suspicious of businesses that look like hobbies. (If you want to turn a hobby into a business and protect yourself from IRS scrutiny, read our previous article by clicking here.)

4. Collecting valuable fringe benefits. Auditors zero in on non-cash fringe benefits given to highly paid employees. These tax-favored perks include deferred compensation, stock options, split-dollar insurance and golden parachutes.

5. Claiming losses from part-time activities the IRS considers a hobby, such as horse breeding or photography. However, taxpayers have successfully fought the IRS on this issue by keeping accurate records, following industry practices and showing a profit in three of five consecutive years (two of seven for some horse businesses).

6. Not reporting stock trades. Keep scrupulous records of your investments. The IRS is aware that some taxpayers make numerous trades online and don’t keep track of the transactions as the law requires. (Under a tax law passed in 2008, more investment sale information is being provided to the IRS by brokerage firms.)

7. Dealing in cash. IRS auditors are trained to search every nook and cranny of the cash-based financial world to detect cheating.

8. Setting up an illegal trust. Uncle Sam has a hit list of fraudulent deals, including “family residence trusts” and some foreign trusts. Don’t believe claims that you can establish a trust that allows you to avoid taxes, yet still own and control the assets.

9. Donating a car to charity and taking a deduction that’s too big. Under current tax law, charitable donations of vehicles have strict rules for deductions in excess of $500. Beginning January 1, 2005, a donor’s allowable write-off depends on how the donated asset is used by the charity.

If the organization sells the asset without using it significantly for charitable purposes or making material improvements, the donor’s deduction is generally limited to the amount of gross sales proceeds received by the charity. The fair market value of the donation, allowed years ago, is no longer relevant.

10. Stepping out of bounds. IRS computers compare your return with those filed by other taxpayers with similar incomes. If your deductions are significantly higher, you may be asked why. Of course, this doesn’t mean you shouldn’t claim every deduction you are entitled to. You just need to be aware of how the audit process works and hang onto the proper records.

11. Deducting prohibited or suspicious items. You just can’t write off certain expenses, such as funeral costs and country club dues. There are other deductions the IRS is often skeptical about, such as expensive meals and home office write-offs.

12. Being a “tax protestor.” Some people refuse to pay because they claim taxes are unconstitutional. The IRS has little patience for these arguments.

Important point: Even if your return is audited, an IRS examination is nothing to lose sleep over. In many cases, the IRS asks for proof of certain items on a tax return and “closes” the audit after the documentation is presented.

Keep in mind that the 12 items listed above are only some of the IRS red flags. The tax agency changes its targets regularly.

Still fear a meeting with the IRS? Keep in mind that you probably don’t have to attend an audit. You can stay home and designate your tax adviser to act on your behalf.

About Scale Finance

John Schefke

Naga — Wed, 01 Feb 2012 09:16:57 +0000

Senior Controller & Director
919.622.4200
schefke@scalefinance.com

Corporate Controller, House Autry Mills Inc., Four Oaks, NC (2009 – 2011) Responsible for managing accounting, budget, audit, and tax functions of corporate headquarters for a national manufacturing company in the food industry.
Controller Principle, Tatum LLC, Raleigh, NC (2007 – 2008) Provided part-time and project based Controller services to multiple clients in various industries including Manufacturing, Private University, Health Services and Services.
Controller Consultant, Horn Murdock Cole, Atlanta, GA (2006) Served as Interim Controller of a cabinet manufacturing operation.
Corporate Controller, Digital Recorders Inc., Durham, NC (2000 – 2005) Responsible for managing accounting, budget, audit, and tax functions of corporate headquarters for a global public manufacturing company in the transportation industry.
Division Controller, United Dominion – Mueller Steam, St. Pauls, NC (1998 – 2000) Managed Accounting and Information Systems of a national manufacturing company in the valve industry.
Consultant, Houston TX, (1996 – 1997) Provided interim financial services to companies in the clinical research and pipeline industry.
Division Controller / Audit Supervisor, Crane Co., Stamford CT (1984 – 1996) Served as Audit Supervisor and Division Controller of a Fortune 500 international manufacturing company in the valve, building products and defense industries.
Bachelors of Science, Accounting, University of Missouri-St. Louis

5 Mistakes Entrepreneurs Make When Pitching Angel Investors

dave — Thu, 12 Jan 2012 02:06:36 +0000

An effective elevator pitch can be crucial for entrepreneurs trying to secure funding from angel investors. The goal of the pitch — written or delivered face-to-face — is to briefly share the “who, what, where, when, why and how” of your business, while piquing an investor’s interest. The tricky part is cramming all of that into one explanation that, hypothetically, should be delivered in the time span of an elevator ride.

“The pitch has to grab me quickly,” says Paul Silva, manager of Springfield, Mass.-based angel group River Valley Investors. “For instance, with written pitch applications, we read the first few sentences and then toss half to two thirds of them away.”

The best pitches, he says, describe the market the business is in, explain what problem it solves and demonstrate a track record. The worst ones fail for countless reasons.

Here are five of the worst elevator-pitch mistakes entrepreneurs make — and how to avoid them.

Mistake No. 1: You don’t explain what problem your business solves.
Some entrepreneurs spend too much time talking about how his or her product or service works and not enough time explaining what problem it solves, says William C. De Temple, founder of investor group Maximize Angel Investments Orlando Inc. “People buy solutions to problems,” he says. “Don’t tell me about how your lawn fertilizer works. Tell me about my lawn.”

The Fix: Share why customers will buy your product or service.
“If you don’t understand or can’t explain what problem you’re solving and why customers want to give you money, then we’re probably never going to want to invest in your company,” says Kyle Harris, a managing director at New York City-based angel fund Liquidity Works. Harris poses three questions to startups that you should be able to answer in your business: Who’s your best customer? How much money do they make from buying your product? And, how much money will you make from selling it?

Mistake No. 2: You offer too many facts and numbers.
Entrepreneurs often use statistics to help explain their business. While some figures — such as your sales and revenue — are important to establish a track record, don’t go overboard, Silva warns. Leave out the “step-by-step numerical proof of your market size,” he says. “Be compelling. Save the reams of facts for later.”

The Fix: Tell a story.
To capture an investor’s full attention, explain your business by telling a story. Silva suggests using personal examples about how your service or product has solved a problem in your own life. Or, put the investor into your story. “If you’re selling a product for people who are blind, don’t start off talking about the difficulties blind people face. Instead, say something like, ‘Imagine if you or a loved one were to go blind tomorrow…’” Silva says.

Mistake No. 3: You tout sales forecasts.
Early-stage sales projections often don’t carry weight with investors because they aren’t supported by actual sales history, De Temple says. As businesses grow, revenue streams, prices and even entire markets can change, rendering preliminary forecasts useless.

The Fix: Focus on the benefit your business offers customers.
To help make up for the fact that you might not have a long sales record, De Temple says, it’s better to explain the benefits the business will provide customers and how the company is different from the competition.

“Answering services companies have been around for centuries, but if yours, for example, uses technology to deliver messages immediately without the client having to call in and pick up messages, that solves a problem and has potential to create excellent revenue and profit,” he says. “That’s what’s attractive to investors.”

Mistake No. 4: You’re too attached to your business plan.
For some investors, it’s a red flag when entrepreneurs aren’t willing to work outside the protocol outlined in their business plans, Harris says. “Say for instance you have a device that monitors electricity and, according to your business plan, you sell that device to customers for a fixed price,” he says. “But when a customer wants to lease the device instead of owning it, and you tell them you can’t do that, that might be a problem for an investor.”

The Fix: Embrace new revenue opportunities.
If there’s a new way to consider packaging or selling a service, a “true entrepreneur,” Harris says, will seize the opportunity to make money. “Being flexible and willing to accommodate customers when they want your service in a slightly different way than you already offer is good,” he says. “The goal should be to make your product as sellable as possible.”

Mistake No. 5: You discuss ownership stakes.
While it might seem natural to explain how much ownership you’re willing to offer investors, don’t do it in the initial pitch, warns Silva. “It is like the sticker price on a car,” he says. “If it’s too high, you don’t even talk to the salesman. You just walk off the lot.”

The Fix: Save it for the follow-up.
Details about who gets what after an investment generally come up after an investor has finished researching your company. If an investor asks about ownership terms early on, Silva recommends you simply say you’re “flexible.” “Remember, your goal in the pitch is to build a relationship with the investor,” he says. “Get them to fall in love with your idea.”

Source: Jason Fell

About Scale Finance

Be Careful With Those Shares!

dave — Thu, 12 Jan 2012 02:05:12 +0000

Source: Dan Shmalo, 360 Venture Law

In the early stages, growth companies often sell shares of stock (or units, or membership interests, or…) too readily. Raising money is probably the most difficult task for an early stage company, and it often leads entrepreneurs to ask “friends and family” for money. But, as they become successful, such companies will often layer on various classes of preferred stock. Growth companies and their investors should be wary of the pitfalls that may follow. Although these share issuances may comply with federal and state securities laws, a large number of shareholders can complicate an exit.

As time passes on the way to an exit event, stock issuances can add up. Investors may grow impatient for liquidity and may want to sell their shares. Employees may exercise options (if there is a very low strike price), and if there are no constraints imposed by the option plan and/or shareholder agreements, employees and investors may attempt to sell their shares. In today’s market, the path to liquidity for growth companies is fairly long (most studies show 7-10 years on average). Over that period of time, such companies can often find that their shareholder base has grown substantially and that many of their shareholders are nonaccredited.

What’s the Problem?

In a potential sale of a company, a large corporate buyer may prefer to use stock instead of cash to make the acquisition. Most buyers (whether privately held or publicly traded) will wish to consummate the acquisition quickly and cheaply, which, in the case of a stock-for-stock exchange or merger, means that the buyer will likely propose issuing its shares pursuant to a private placement exemption rather than in a registered offering (SEC registration).

This is the point where a company’s management (or lack of management) of its shareholder base can become critically important. The shares to be issued by the acquirer in a stock-for-stock acquisition will only qualify for a private placement exemption if the number and nature of the target’s stockholders make the private placement available — which for most transactions will require (under Rule 506) that there be no more than 35 nonaccredited target shareholders. In the event that the target company has not closely monitored its shareholder base, and if, at the time of the transaction, more than 35 of the target company’s shareholders are nonaccredited investors, the acquirer’s desired acquisition structure may become more complicated. This is the so-called “widely held private target problem.”

There are ways to ameliorate the widely held problem (e.g. registered shares as consideration, different compensation for unaccredited, fairness hearing), but the details of these solutions are beyond the scope of this article.

What Should a Growing Company Do?

There is no magic formula that will enable all growth companies to avoid road blocks, or speed bumps, at the exit event. Even with the best planning and advice, certain things are outside of a company’s control, and financing needs and other considerations often override these potential issues. Nonetheless, here are a few pointers that growth companies and their investors should consider as they develop their capital-raising and equity incentive strategies.

Do not issue securities to unaccredited investors.

If possible and practical, growth companies should only sell securities to accredited investors. This is standard advice from an experienced corporate/securities lawyer, but the number of times in practice that this is ignored (out of ignorance or otherwise) or not heard (by lawyer-free entrepreneurs) by growth companies is staggering.

Restrict the transferability of equity in shareholder agreements. Growth companies should closely manage their shareholder agreement provisions that restrict the transfer of shares (for example, by providing a right of first refusal (see below) and by providing that investors cannot transfer shares except in compliance with applicable securities laws). Growth companies can significantly impede the expansion of their shareholder bases by including mandatory notice requirements in such provisions, and by closely monitoring all transfers to ensure they are made in compliance with securities laws. As typically drafted, these provisions give a private company some leeway in determining whether a proposed transfer is being made pursuant to a valid exemption and may provide a company with a legitimate basis to discourage transfers to unsophisticated (or nonaccredited) investors.

Adopt a detailed equity incentive plan and manage it closely.

To limit the risk that option exercises by departing employees will swell the ranks of unaccredited investors, growth companies should include in their equity plan documents a right to repurchase options or shares held by employees within a specified period of time following the termination of employment. The exercise of options in advance of a sale can also dramatically increase a company’s nonaccredited shareholder base. Equity incentive plans should include a mechanism that allows the board of directors, at its election, to provide for the conversion of options into options to purchase acquirer stock or to cash out options upon a change of control. In addition, as a part of the implementation of any equity incentive plan, growth companies should include in the equity incentive plan or a shareholder agreement a provision granting the company a right of first refusal to purchase any shares proposed to be transferred by employees.

About Scale Finance