The choice of professionals - lawyers, accountants, consultants - could make or break your entrepreneurial career. The professionals you choose to help you build your fledgling company, must be exactly that – professional. They must have the requisite experience, skill, and knowledge to provide you with added value and help you as early as possible avoid the numerous traps that start-ups can fall into. The damage is usually permanent.
This is especially true in relation to accounting and financial issues. Mr. Joseph Lipsky, CPA has provided Enable with an overview of financial issues start-ups must deal with "at the beginning of their life cycles". But first, Enable provides a few tips for choosing the right professionals and for working with them.
Choosing Professionals
I have seen too many start-ups use family members and friends as their initial professionals, primarily to save money. This typically ends up costing the start-ups much, much more than any short-term monetary savings. Be advised that while many professionals will profess to being proficient in the areas crucial to start-ups – few are.
Nothing beats experience. Only work with professionals who have proven experience and expertise in working with start-ups. When deciding on your professionals, try to get referrals from successful entrepreneurs and start-ups. The chemistry you have with your professionals is just as important as the level of service they provide. Ask all potential professionals for references and check these references very carefully.
Ask the references about the service they received, and whether they were given lots of attention initially, and then ignored. Ask if they were talked down to, shorted on advice, or given less than preferential treatment. You should also ask about the quality of work, any special added value provided, and what the reference liked and disliked about the particular professional, and what, if anything, you should watch out for.
Tips For Working With Professionals
From the outset, you must obtain a very clear understanding of the fees of the particular professional. The most expensive professional on an hourly basis may in fact be the cheapest in the long run. In other words, while you should shop around, you should not skimp on fees. Do not avoid a certain professional just because you think you cannot afford him/her. Most professionals that work with start-ups have special fees and payment plans specifically devised because they know that start-ups are strapped for cash. Don’t be shy about asking for special reduced fees. However, try to avoid giving straight equity for services. Use options as an alternative, but only as a last resort.
Make sure that there is no gap of expectations regarding the services the professionals are supposed to perform. Get written proposals and work orders. Do not rely on oral statements. Raise any concerns as early as possible. Also, do not be shy about repeatedly phoning your professionals. But remember that if they are good, they should be very busy and may not call you back as fast as you would like.
If you are very lucky, your relationship with your professionals will mellow over time into friendship, mutual trust and respect. If this happens, it is a sign that you have been spared untold grief and aggravation.
How Accountants Give Added Value
Entrepreneurs of a start-up firm from the outset should adopt a correct attitude towards business management. All firms at every stage of development require professional financial management, proper accounting and an efficient real-time reporting system, but all of these are especially important for a start-up business at the beginning of its life cycle. In such a business it is vital that the management team be aware of every financial step they take. This awareness can be achieved through proper periodical financial reports.
These reports include the following: cash flows, investment reports, profit and loss statements and complete financial reports. These reports are crucial to the firm’s day-to-day operations and are a necessity when applying to potential investors, commercial banks, and other institutions. It is also important for the firm’s management to be constantly informed of the firm’s status.
Cash flow forecasts and other projections are prepared once a month, or at least quarterly, the frequency being a function of the firm’s volume of operations and specific significant events taking place in the course of operation.
There are also legal demands for the firm to comply with such as: value added tax reports, employees withholding, social security reports and other payroll reports.
All of the above mentioned requirements necessitate the hiring of a high standard professional consultant and therefore engaging the services of an accounting firm from the very first days of operation. The appointed accounting firm should be able to grant other services such as "non traditional services", aside from the standard auditing and taxation services. The non-traditional services are diverse and include the following:
- Consulting in various fields such as grant applications from institutional sources such as: Chief Scientist, Export Institute, Manufacturers Association and other financing sources.
- Financial consulting such as: preparing feasibility analyses, projected cash flows, evaluations of shares and projects, preparation of business plans etc.
- Employee stock option plans and taxation aspects.
The hired accountant will actually function as the firm’s personal advisor in handling all of the above mentioned matters.
Employee Stock Option Plans
Due to the increasing popularity of employee stock option plans, their tax aspects must be elaborated on.
It is becoming more and more popular to attract high potential employees with issuance of stock options in order to tie them to the organization and increase their commitment to it. Allocation of securities is actually a form of compensation and therefore there are tax consequences as well as different accounting issues to be considered. The accounting treatment and presentation of a stock options issuance can significantly affect the outcome of operations as presented in the financial statements. Israel is still "in the dark" as to defined standards regarding the accounting treatment of stock options, and no binding professional pronouncement has been publicized.
Generally accepted accounting in the US requires firms issuing options to record the underlying monetary benefit attributable to these shares. According to US standards there are two ways to approach the benefit rewarded when issuing shares.
- The "Compensatory plan" - this kind of issuance contains an underlying benefit to the employee since it is received at preferred terms when compared to the market terms and prices.
- The "Non Compensatory plan" - this kind of issuance does not contain benefit and is therefore treated like regular placement.
Issue of stock options is a taxable transaction divided into three phases as follows:
The initial phase occurs when actual allocation takes place. The entire benefit that derives from the allocation is taxable to the employee. The value of the benefit is calculated as the difference between the market value of the options granted and the cost to the employee. Since in many cases the companies granting the options are not traded on any market, there is a slight difficulty in determining the market value of the options granted and hence in properly evaluating the benefit’s monetary value.
The second phase occurs upon conversion of the options into shares- the benefit being the difference between the market value of the shares and the actual price paid by the employee.
The income tax authorities permit consolidation of the two phases thereby deferring the tax payment. The reason for this concession is that employees often find it difficult to pay the tax while receiving a non-cash benefit from the employer.
The final phase occurs upon realization of the shares. If the shares are not traded the transaction will be taxable as a capital gain and if the shares are traded the entire transaction may be exempt from tax subject to certain conditions.
Next week, we begin a series on capital raising for start-ups. Again, my special thanks to Joseph Lipsky, CPA, a partner in the firm Levite, Lipsky & Co. for his contribution to Enable.
Published by Israel's Business Arena on November 16, 1999