Category Archives: Building a Business

New addition to The Library in St. Pete

Related imageThe latest addition to The Library in St. Pete is Unlocking Creativity – How to Solve Any Problem and Make the Best Decisions by Shifting Creative Mindsets, authored by Michael Roberto. As his interview in Forbes magazine explains, creativity doesn’t typically come from the lack of ideas, but from barriers in organizations that stifle creative thinking.

This is the 3rd of Professor Roberto’s books to join our library, and the first one for which you can find both a brief introduction and a trailer for the book at Youtube.

From among the many terrific insights in the book, we’d like to highlight two:

1 – Shaping team climate is more important than an “obsession” with reorganizations (p. 94-98).  

(H)e presumed that organizational structure drives performance, as many business leaders do. Unfortunately, that causal link is much more complex than many executives realize, as the studies of mountain climbers and sports teams illustrate. Leaders can adopt a variety of organizational structures, and each comes with its own costs and benefits. We cannot simply crank up an algorithm and select an optimal structure that promotes creativity, innovation, and growth. No such perfect structure exists, no matter the strategy, industry, or circumstances…

Leaders need to think about how teams perform their work, and how they can create the conditions that will enable those groups to flourish. The best leaders pay close attention to team climate, behavioral norms and ground rules, and the design of the work itself…

Julia Rozovsky’s People Analytics team collected data on 180 teams throughout Google.  She explains what they discovered:

“We thought that building a perfect team would be pretty algorithmic in nature, because at Google, we love our algorithms.  [However] What our research showed us was that it’s less about who is on the team and more about how people interact that really makes the difference.”

Google identified five attributes of their highest-performing teams, and “a climate of psychological safety proves to be the most important by far.”

We could not agree more. As we ourselves have written, systems and processes are important but what makes a team great are the ‘robust social systems’ in which the members’ informal modus operandi ensure that all those well-designed systems function properly.

 It can take time for creativity to pay dividends (p. 172).

Remember, though, that many creative breakthroughs occur when individuals make connections between seemingly disparate concepts. Those links and relationship s may not become apparent overnight. Sometimes, it seems as though these breakthroughs are simply the product of luck. On the contrary, Harvard scholar Ethan Zuckerman argues that, “Engineering serendipity is this idea that we can help people come across unexpected but helpful connections at a better than random rate.”

Here too, we are in agreement, having echoed this line of thought many times. The difference between luck and serendipity is that the latter involves seeing meaningful combinations where others do not and is a skill one can develop

Some organizations are “luckier” than others because they tolerate an optimal degree of wastefulness based on the assumption that serendipity relies on loafing and savoring the moment, of wandering and loitering and directionless activity of all sorts. Serendipity is a close relative of creativity and can be encouraged by a few organizational factors.

Lest anyone think we’ve given too much aid and comfort to sloth, inefficiency, and other bad habits, we’ll close with Gary Player’s thoughts on the subject:  “The harder I work, the luckier I get.”

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NB:  We’d like to thank the good professor for comparing venture capitalists to Soviet planners (p.80). We’ve actually known and admired Professor Roberto for a long time, and in fairness to him, he is merely quoting an entrepreneur.  (Ahem, while not objecting…)

Here are a few other instances where we’ve cited the professor’s thinking here at Navigating Venture:

Why manners — and Southern etiquette — can make a difference in business

We saw this column by our friend, Frank Williamson of Oaklyn Consulting, in the Memphis Business Journal and thought it was excellent.  Frank captures well the way we, and many others in the Southeast, like to do business and both the importance and pleasure of focusing on building long term relationships.

 

Frank Williamson, Oaklyn Consulting

 

Source:  Memphis Business Journal

As a Southerner by birth, I grew up in a culture where manners were of paramount importance.

When interacting with authority figures and peers, I came to understand the social benefits of maintaining proper eye contact, saying “please” and “thank you,” and having a firm handshake.

Yet, out in the professional world, I’ve been struck by how the continued value of these and other niceties isn’t commonly discussed. According to some studies, social skills are 85 percent responsible for personal success, as opposed to 15 percent from learned technical skills.

Out of the 10 U.S. cities boasting the highest levels of business growth, seven are located right here in the South, according to a recent CNBC article. The past five years have seen huge levels of business and employment growth in Southern cities, including Nashville, Orlando, and Charleston, South Carolina.

I don’t think this is a coincidence. Although our region’s economic success certainly can’t be attributed to solely etiquette, as a Southern business owner, I feel that it has played a part in businesses deciding to establish themselves here.

With civility seemingly on the decline in our world, it’s worth thinking about how we can incorporate this general attitude of courtesy into both our work and personal lives.

Respect in the negotiation process

First impressions are everything. When you treat a business partner with a lack of respect during the process of making a deal, you shouldn’t count on the relationship continuing. But, by bringing a different attitude to the negotiation process — treating it as an opportunity for both sides to solve a problem rather than as a situation where only one side wins — you have the potential to build a relationship that extends beyond a single deal and may result in a more mutually beneficial agreement.

In my experience, those who adopt the attitude of a hard bargainer are being short-sighted, trying to extract some kind of immediate value from a deal instead of seeing it as the first step in a lasting partnership. Naturally, you have to prioritize your interests in any negotiation, but empathizing with what the other party hopes to achieve can make a huge difference in the way you relate to each other.

I saw this dynamic play out recently with a client, a family-owned business that was up for sale. One buyer stood out from the others by the level of consideration he showed toward the family, which was understandably concerned with continuing its legacy. The buyer’s approach took into account the benefits of maintaining a strong, lasting relationship, while keeping his own business interests in mind. In the end, both parties felt the sale was a positive experience.

Balancing work and life

Some business owners may disagree with me, but I believe that the time we spend away from work is as valuable as the time we spend building our businesses. It may not always seem wise to leave work undone just so you can make it home for a family dinner. But, there’s a good argument to be made that the Southern tradition of keeping a healthy work/life balance has the long-term benefit of setting up the next generation for success.

I’m not advocating giving short shrift to business matters. However, there is real value to leaving the office at 5 p.m., staying largely offline during dinner and through the evening, and letting your home life be your primary focus until the next morning.

A major part of Southern civility is our continued devotion to passing on our values to each successive generation, both in our families and through nonprofits. By putting time and effort into this, we raise up a new generation that will eventually enter adulthood with an understanding of how Southern etiquette can be applied to their personal lives and business relationships.

Memphis Business Journal Article:  https://bit.ly/2PQLV7v

Startups Discover the Allure of the C Corporation

The individual income tax-rate cuts of the 1980s helped make LLCs the default business structure for startups – but the 2017 reduction in corporate tax rates, coupled with the capital gains tax rate increases in the 2010s, have changed the dynamic.  

As last week’s Wall Street Journal explains in “Startups Discover the Allure of the C Corporation,” in some circumstances the ‘C’ structure creates potential tax benefits for entrepreneurs and their investors:  

For years, Mr. Bisges started ventures using limited-liability companies, known for their flexibility and tax advantages. But when Mr. Bisges and his nephew, Aaron, started planning StillFire Brewing, their accountant suggested the C corporation.

Mr. Bisges is pinning this part of his business plan on Section 1202 of the Internal Revenue Code, an underused provision expanded under Mr. Obama, and one that is gaining new attention after the 2017 Tax Cuts and Jobs Act made it more attractive.

The strategy is particularly advantageous for business founders who expect to start small, keep earnings inside the company, make annual profits and then cash out. If a taxpayer holds C corporation stock for five years and follows the technical rules, capital-gains taxes on a subsequent sale get erased—on gains up to $10 million or 10 times the original investment, whichever is greater.

In a nutshell, the article argues that it may now be tax advantageous for entrepreneurs to realize their profits in the form of long-term capital gains instead of ordinary income because they can exclude from federal income tax 100% of the gain from the sale of qualified small business stock.

LLCs, S-Corps, and C-Corps each offer different advantages and restrictions, and choosing poorly can lead to expensive and difficult changes down the road. There are many complexities and issues to consider and no one right answer. Just as people shouldn’t decide to have children for the tax benefits, we advise founders to not view tax considerations in a vacuum when choosing the legal structure for their businesses.  They need to think hard about the long term goals for the business and seek expert advice on the optimal legal structure.

You can, however, reduce the number of future headaches (and possibly legal bills) if you choose the structure that is most appropriate for both your current situation and your long-term objectives.  Aside from avoiding personal exposure to business liabilities, the main considerations when choosing from among the three structures are tax consequences and corporate governance issues. 

We ourselves have invested in both C’s and LLC’s, and have found the defined governance structure of a C-corp is almost always preferable.  For a more expansive view of our thinking on the subject, we recommend you check out our 2010 white paper, To LLC or Not to LLC.

Astroball > Moneyball

Regular readers know that we’ve often covered the limits of decision models, the importance of chemistry, and what makes a team work well together.  And that we’re baseball fans (especially of our Rays).

recent review of “Astroball” in The Wall Street Journal. covers that same ground with the terrific story of the 2017 World Series champs.  Astros GM Jeff Luhnow figured out how to get scouting and analytics to work together and combine that with team building to go from last place to World Series champs in 3 short years.

It was no easy task, “(B)ut it was done, and the team made a series of sound, even brilliant, choices as it drafted, traded and signed players.”

An excerpt:

This roster-creation, all by itself, did not bring home the championship. Building an exceptional team is one thing, but making it work as a team is another. “Fault lines” exist in all complex organizations—including baseball teams. If these lines can be bridged or eradicated, a team is likely to win more ball games. To use another bit of old-fashioned terminology, a team needs chemistry.

Carlos Beltrán, the veteran outfielder signed by the Astros after the 2016 season, immediately took on the role of chief chemist. Among other things, he created a postgame ceremony that awarded prizes for excellence in the field and instituted a postgame “court” for those who failed to attend: The fine was $500. Mr. Beltrán also had a singular ability to study opposing pitchers and determine their “tells”—gestures and small changes in behavior that signaled whether or not the next pitch would be, for example, a breaking ball or a fast ball. Finally, Mr. Beltrán had a strong desire to close the gap between the English and Spanish speakers.

His biggest ally in this quest was Alex Bregman, who professed to speak perfect Spanish. In fact, it was far from perfect, but Mr. Bregman worked hard to communicate with his Spanish-speaking teammates, including going out of his way to befriend first baseman Yuli Gurriel, who joined the team in 2016 after coming to the United States from Cuba and who spoke no English at all. Mr. Gurriel was exactly the sort of player who can become isolated and resentful in many American clubhouses. But Mr. Bregman refused to let that happen. As Mr. Reiter explains, “The two yammered at each other in Spanglish all day long.”

Add to all this the signing of pitcher Justin Verlander, acquired during the 2017 season, and a dash of good luck, and there’s no reason why any of us should have been surprised that the Astros won their World Series right on schedule. Mr. Reiter’s superb narrative of how the team got there provides powerful insights into how organizations—not just baseball clubs—work best.

We have previously suggested  that in baseball there’s just a slight correlation between more analytics and more success.  It remains tough to eliminate the usefulness of having more money than other clubs, and with technology and best practices so widely disseminated and articulated (in baseball, at least) the early Moneyball advantages may have been arbitraged away.  So excellent teamwork or a hot stretch of cluster luck can make the difference.

The fan inside us is fascinated by new thinking on the topic, and the prospect of advantages to be gained in the short term, but over the long term our conclusion remains the same:  big data may help make accurate predictions or guide knotty optimization choices or help avoid common biases, but it doesn’t control events.  Models are useful in predicting things we cannot control, but for those in the midst of the game – players or entrepreneurs – the results have to be achieved, not just predicted.

New addition to The Library in St. Pete

The latest addition to The Library in St. Pete is Thinking in Bets – Making Smarter Decisions When You Don’t Have All the Facts,  authored by Annie Duke, the professional poker player who began her career when, at age 26, she quit the cognitive-psychology doctoral program at the University of Pennsylvania.  The Wall Street Journal review of her book calls it “the dissertation she never got around to finishing.”

Ms. Duke writes that “our brains weren’t built for rationality” and “they aren’t changing anytime soon” so decision-makers have to “figure out how to work within the limitations of the brains we already have.”

As with many of our irrationalities, how we form beliefs was shaped by the evolutionary push toward efficiency rather than accuracy.  Abstract belief formation (that is, beliefs outside our direct experience, conveyed through language) is likely among the few things that are uniquely human, making it relatively new in the scope of evolutionary time. (p.51)

Duke maintains that the highest-level performers in any field have developed habits to compensate for cognitive biases and unconscious habits.

Among her recommendations are organized skepticism and truth-seeking accountability groups, as well as assorted forms of “mental time travel”:  backcasting, premortems, Ulysses contracts, and moving regret in front of a decision.

The WSJ review nicely summarizes Ms. Duke’s thesis:

Ms. Duke suggests recasting our judgment calls as bets. “We don’t win bets by being in love with our own ideas,” she writes. “We win bets by relentlessly striving to calibrate our beliefs and predictions about the future to more accurately represent the world.” Thinking about choices this way brings with it a profound attitudinal shift, from binary right-wrong thinking to a “probabilistic” approach, in which we choose “among all the shades of grey.” This reframing has a clarifying effect. “The more we recognize that we are betting on our beliefs (with our happiness, attention, health, money, time, or some other limited resource),” Ms. Duke writes, “the more we are likely to temper our statements, getting closer to the truth as we acknowledge the risk inherent in what we believe.”

Moreover, when we state our judgments circumspectly in the form of a bet, we are more inclined to revise them with the arrival of new information. “When confronted with new evidence, it is a very different narrative to say, ‘I was 58% [certain] but now I’m 46%,’ ” writes Ms. Duke. “That doesn’t feel nearly as bad as ‘I thought I was right but now I’m wrong.’ . . . This shifts us away from treating information that disagrees with us as a threat.”

She also argues that the role of skill and luck in sports and business makes it difficult to just “work backward” from outcomes to the decisions we made.

Think about this like we are an outfielder catching a fly ball with runners on base.  Fielders have to make in-the-moment game decisions about where to throw the ball:  hit the cutoff man, throw behind a base runner, throw out an advancing base runner.  Where the outfielder throws after fielding the ball is a bet.

We make similar bets about where to “throw” an outcome:  into the “skill bucket” (in our control) or the “luck bucket” (outside our control).  This initial fielding of outcomes, if done well, allows us to focus on experiences that have something to teach us (skill) and ignore those that don’t (luck).  Get this right and, with experience, we get closer to whatever “-ER” we are striving for:  better, smarter, healthier, happier, wealthier, etc.

It is hard to get this right.  Absent omniscience, it is difficult to tell why anything happened the way it did.  The bet on whether to field outcomes in the luck or skill bucket is difficult to execute because of ambiguity.  …

Outcomes don’t tell us what’s our fault and what isn’t, what we should take credit for and what we shouldn’t.  Unlike in chess, we can’t simply work backward from the quality of the outcome to determine the quality of our beliefs or decisions.  This makes learning from outcomes a pretty haphazard process. (p.86)

Interested, dedicated, fascinated by the job

Today marks the 48th anniversary of the Apollo 11 landing and the first steps by humanity on another world.  In honor of the man who took those first steps, we’d like to reprint the 8/28/12 piece we wrote on the occasion of his passing. 

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Astronaut Neil Armstrong passed away Saturday, and The Wall Street Journal reported something the pioneer once said about the success of the 1969 Apollo 11 mission – the odds of which he had placed at 50/50.

Mr. Armstrong described the required reliability of each component used in an Apollo mission – statistically speaking 0.99996, a mere 4 failures per 100,000 operations – and pointed out that such reliability would still yield roughly 1000 separate identifiable failures per flight.   In reality, though, they experienced only 150 per flight.  What explained the dramatic difference?

I can only attribute that to the fact that every guy in the project, every guy at the bench building something, every assembler, every inspector, every guy that’s setting up the tests, cranking the torque wrench, and so on, is saying, man or woman, “If anything goes wrong here, it’s not going to be my fault, because my part is going to be better than I have to make it.” And when you have hundreds of thousands of people all doing their job a little better than they have to, you get an improvement in performance. And that’s the only reason we could have pulled this whole thing off. . . .

When I was working here at the Johnson Space Center, then the Manned Spacecraft Center, you could stand across the street and you could not tell when quitting time was, because people didn’t leave at quitting time in those days. People just worked, and they worked until whatever their job was done, and if they had to be there until five o’clock or seven o’clock or nine-thirty or whatever it was, they were just there. They did it, and then they went home. So four o’clock or four-thirty, whenever the bell rings, you didn’t see anybody leaving. Everybody was still working.

The way that happens and the way that made it different from other sectors of the government to which some people are sometimes properly critical is that this was a project in which everybody involved was, one, interested, two, dedicated, and, three, fascinated by the job they were doing. And whenever you have those ingredients, whether it be government or private industry or a retail store, you’re going to win.

Related image

Exhausted unshaven and lovin’ it

Interested, dedicated, fascinated by the job – Armstrong’s explanation could serve as an excellent description of the esprit de corps we find in good private growth companies.  Not too long ago we quoted Ben Dyer, president of Techdrawl, about how entrepreneurs need to inspire all the members of their team to share the founder’s drive in the early stages of a company:

All those textbook methods of performance reviews, pay incentives, etc. will come in handy when you get to the 50th or 100th employee, but right now you’ve got to be the one out front – with inexhaustible energy, enthusiasm, creativity, and a clearly articulated vision.

In a bit of serendipity we stumbled on this related post, from Richard Martin, which makes an interesting distinction between esprit de corps and teamwork:

Cohesion and esprit de corps are even more intangible. Where teamwork is built on the willingness of individual team members to subsume their own interests in favor of group interests, esprit de corps is built upon the willingness to sacrifice oneself, if needed, for the interests of the group. This is a level of commitment that few organizations in business achieve.

Mr. Armstrong described himself (with characteristic humility) as:  “I am, and ever will be, a white-socks, pocket-protector, nerdy engineer.”  Perhaps that, and a bit more, Sir.  Godspeed.

How to recruit a Board of Directors, continued

A recent article in Forbes offers excellent advice for recruiting a board of directors – in the form of the Top 10 Questions High Performance Directors Ask Before Joining a Board.

We think looking at the subject from that point of view is a very useful exercise that can help entrepreneurs with one of their most critical tasks.  Here’s how we ourselves once put it, in a 2012 post entitle How to recruit a Board of Directors:

While the “owners” of public companies often get to pick their board members more in theory than in practice, owners of private companies get to pick both their investors and their board members. Choosing partners who best fit over the long term requires as much rigor and thoughtfulness as any decision an entrepreneur makes.

Many small private companies have no or underdeveloped boards.  We encourage all our portfolio companies to build great boards and then use them constantly.  Entrepreneurs are almost always surprised how much value a good board can bring to their companies, and the best boards are a function of both the quality of the people involved and, just as importantly, how they operate.

We encourage you to read the entire Forbes piece, but for our purposes we chose 2 of the 10 and offer a handful of supporting links to related posts here at NVSE.

2. Will your management team be open to listening to board level input? Is resistance futile? Is dissent embraced in discussion?

Recruiting strong board members gives an entrepreneur the opportunity to create an environment of mutual accountability in which team members trust and challenge each other and compensate for the all-too-human tendency to learn only after it’s too late.

7. Does your company have institutional or professional systems and processes in place? Does the machine run smoothly, or is it held together with chewing gum?

While professional systems and processes are (of course) required to grow a high-growth company out of the garage, it’s also important for leadership to remember to also build the ‘robust social systems’ in which board members’ informal modus operandi ensure that all those well-designed systems function properly.

Successful people invest in relationships

Good article in Entrepreneur about how true success is not possible unless you build great relationships.  The piece hits several themes that we believe are critical to a successful vc-entrepreneur marriage: maintaining long term relationships, communicating good news and bad, promoting honesty in business, how useful failures can prevent epic ones, and maximizing board effectiveness.

The chemistry between entrepreneur and venture partner in private companies is more cooperative, longer-term, and (mercifully) not subject to the quarterly reporting pressures of public companies.  Both will have real “skin in the game” and the same incentive to understand the nuances of the business and focus on long term value creation.

You will spend a great deal of time, effort, and money together with a new partner, so the chemistry ought to be productive and enjoyable. It should add conviviality in the good times and take the edge off the bad times.

Here are a few highlights from the article “How Successful People Build Exceptional Professional Relationships.”

They help without having to be asked.

People who build great relationships pay close attention so they can tell when others are struggling. Then they offer to help… but not in a general, “Is there something I can do to help you?” way. Instead they come up with specific ways they can help.

That way they can push past the reflexive, “No, I’m okay…” objections and then roll up their sleeves to make a difference in another person’s life.

And they do it not because they want to build a better relationship — although that is certainly the result — but simply because they care.

They take the undeserved hit.

She’s willing to accept the criticism or abuse because she knows she can handle it — and she knows that maybe, just maybe, the person who is really responsible cannot.

Few acts are more selfless than taking the undeserved hit. And few acts better cement a relationship.

They answer the question that was not asked.

Where relationships are concerned, face value is usually without value. Often people will ask a different question than the one they really want answered… Behind many simple questions is often a larger question that goes unasked. People who build great relationships listen carefully to discover what lies underneath so they can answer that question, too.

They step up when they have acted poorly.

Responsibility is a key building block of a great relationship. People who take the blame, who say they are sorry and explain why they are sorry, who don’t try to push any of the blame back on the other person… those are people everyone wants in their lives, because they instantly turn a mistake into a bump in the road rather than a permanent roadblock.

They know when to dial it back.

People who build great relationships know when to have fun and when to be serious, when to be over the top and when to be invisible, and when to take charge and when to follow.

Great relationships are multifaceted and therefore require multifaceted people willing to adapt to the situation — and to the people in that situation.

They value the message by always valuing the messenger.

Smart people strip away the framing that comes with the source — whether positive or negative — and consider the information, advice, or idea based solely on its merits.

People who build great relationships never automatically discount the message simply because they discount the messenger. They know good advice is good advice, regardless of where it comes from.

And they know good people are good people, regardless of their perceived “status.”

 

Which is better for an entrepreneur: an LLC or a C corp?

We have written from time to time on the question of which legal structure is best suited to private growth companies looking to raise outside growth capital.  Not surprisingly, there is no one right answer to the question, but recent tax legislation should compel entrepreneurs to give serious consideration to the C-corporation structure.

This article in last week’s Business Observer contains important news about the potential tax benefits of a C-corporation for entrepreneurs and their investors.

However… just as people shouldn’t decide to have children for the tax benefits, we advise founders to not view tax considerations in a vacuum when choosing the legal structure for their businesses.  They need to think hard about the long term goals for the business and seek expert advice on the optimal legal structure.

The author of the article (Pamela Schuneman,  C.P.A.) first argues that the prospects of federal tax reform may tip the scales towards choosing a C-corp:

Now, with tax reform on the horizon and a push to lower the corporate tax rate, current tax savings on C Corporation earnings could be substantial if the corporate rate drops to 15% and the top individual rate only drops to 33%. That’s an 18% difference — $18,000 more on $100,000 of income.

It’s a little more accurate to say the corporate rate drops “closer” to 15%, which compares favorably to an LLC structure where investors are taxed at their individual income tax rates on income that is “passed through” to investors.

Next she explains that a 1993-era tax provision governing a type of capital gains, originally scheduled to expire at the end of 2010, has been made permanent.  And this change, in our view, is a potential game changer.

The gain exclusion for Sec. 1202 was originally set [now made permanent – ed] at 50% for stock acquired [in private C corps – ed] on or after Aug. 11, 1993, increased to 75% for acquisitions after Feb. 17, 2009, and expanded to a full 100% exclusion for acquisitions after Sept. 27, 2010.

The 2010 law also removed of one of the main drawbacks of this tax provision – the alternative minimum tax preference.

In a nutshell, Sec. 1202 allows taxpayers (other than corporations) to exclude from federal income tax 100% of the gain from the sale of qualified small business stock (“QSBS”). The amount of gain excluded is limited to the greater of $10 million or 10 times the adjusted basis of the investment.

There are requirements to qualify for the tax break, which we outline below.  But first we’d like to share one more excerpt from the article to emphasize the importance of this legislation to founders and their investors:

For example, Tom and Jane decide to start a software development business. They purchase stock for $10,000 each and have a 50-50 ownership interest in the C Corporation. The stock is eligible for Sec. 1202 treatment if held for five years. In six years, they sell the stock of the company to Google for $10 million. They each have a $4,990,000 gain on the sale of the stock and their tax on the transaction is zero.

Of course we see this as a positive development for the high-growth companies responsible for all net job growth in our economy.  Reasonable people will disagree on what tax rates should be.  But can we at least agree that there are some forms of investment activity which promote economic growth, and that those forms ought to be encouraged, perhaps with favorable tax treatment?

RELATED STORY:  Warren Buffett and after tax returns

If a company’s stock is qualified small business stock (QSBS) then the Internal Revenue Code (§1202) provides a tax break on the equity investments.  To qualify as QSBS and for the 0%  federal tax rate on gains from the sale of QSBS, the following requirements must be met:

1.)  Original issue.  The taxpayer recognizing the gain must be an individual, partnership, S corporation or estate and must have acquired the stock at original issue from a US domestic C corporation.

2.)  Five-year holding period.  The taxpayer must have held the stock for more than five years prior to selling the stock.

3.)  After September 27, 2010. The taxpayer must have acquired the stock at original issue after September 27, 2010, in exchange for cash, property other than cash or stock, or services.

4.)  $50 million Gross Assets Test.  The aggregate gross assets of the corporation that issued the stock cannot have exceeded $50 million at the time of (including immediately before and after) the issuance of the stock to the investor.

5.)  Active Business Test.  During substantially all of the taxpayer’s holding period of the stock, at least 80% of the issuing corporation’s assets must be used by the corporation in the active conduct of one or more qualified trades or businesses.  (Certain types of businesses, including some pure service businesses like consulting firms or doctor practices, don’t qualify, but many businesses do.)

6.)  No significant redemptions.  The issuer of the stock must not have engaged in specific levels of buybacks (redemptions) of its own stock during specified periods (typically one year) before or after the date of issuance of the stock to the taxpayer.

The amount of gain eligible for this 0% rate is subject to a cap, however. Section 1202(b)(1) states that the aggregate amount of gain for any taxpayer regarding an investment in any single issuer that may qualify for these benefits is generally limited to the greater of  (a) $10 million, or (b) 10 times the taxpayer’s adjusted tax basis in the stock. For a taxpayer who invests cash in the QSBS, basis would generally be equal to the cash purchase price.

Like all issues tax-related, entrepreneurs need to consult with their tax counsel and accounting firm to determine if their businesses qualify for QSBS status.  If a business does qualify, an entrepreneur must decide whether these potentially significant tax savings outweigh other considerations.  In our view, Congress has now put its thumb on the scale firmly on the side of choosing the C-corporation structure.

Risk-taking in the NFL

The WSJ recently analyzed NFL play calling this season and concluded that the coaching profession could use more risk-takers.  Despite “a legion of mathematicians, economists and win probability models urging them to take more chances most NFL coaches “reach for the conventional choice by habit.”

From Why NFL Coaches Take No Chances:

The Journal analysis examines how coaches played their hand this season across three broad categories of game management: fourth downs; play calling (blitzing on defense; passing on early downs or with the lead on offense) and special teams (going for a 2-point conversion and onside kicks when ahead)…

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University of Pennsylvania professor Cade Massey, who researches behavior and judgment, said many NFL coaches habitually choose to postpone the certainty of losing in football for as long as possible—even if doing so actually lowers the likelihood of winning in the end, such as opting to punt on fourth-and-short in overtime…

There is some evidence that coaches are seeing the benefits of riskier decisions. They are just becoming more aggressive at a very conservative pace.

In a 2002 paper, University of California Berkeley economist David Romer expressed hope that coaches would begin acting rationally in maximizing odds of victory when the related data became more widely available. And this year, coaches have gone for it on fourth down needing two yards or less 29.7% of the time—converting nearly two-thirds of attempt).

That’s up from 23% just before Romer published a paper entitled, “It’s Fourth Down and What Does the Bellman Equation Say?” Alas, at the present rate, going for it nearly all the time as the models advise would take over 100 years.

We think this is an excellent illustration of two ideas relevant to starting and running a high-growth company, over and above the obvious exhortation to take intelligent risks:  (1) the opportunity for a contrarian advantage and (2) the combination of data and gut instincts required to make the right call.

First, an excerpt from our  12/8/14 post, We challenged the dogma, and it was incorrect:

[The story about EOG Resources, a discarded division of Enron ] is an absorbing look at the “shale revolution” and touches on several of our favorite themes:  iterative collaboration, how to fail the right way, the incremental, adaptive ways by which success is achieved, and even the role of luck – although we’d describe it a bit more favorably as “serendipity.”

EOG is a great example of a contrarian definition of entrepreneurship:   see economic value where others see heaps of nothing, combine the self-confidence to defy conventional wisdom with the determination to overcome obstacles, and distinguish yourself more by the ability to achieve the impossible than the originality of your thinking.

Next, an excerpt from our 4/13/16 post, The Hidden Power of Trusting Your Gut Instincts:

(S)tudies show that those who rely on intuition alone tend to overestimate its effectiveness.  They recall the times it served them well and forget the times it didn’t.  Keeping a list of every time intuition is your only guide might be eye-opening.

“Common sense” justifications can be found for almost any conclusion, and as a result it can be shockingly unreliable and something that we over-rely on to the exclusion of other methods of reasoning.  Here’s how we put it in Everything is obvious once you know the answer:

It is “rarely practical to run the perfect experiment” before making a decision but we can be “more deliberative and reflective as we gather and analyze facts to inform our decisions.”  When we over-rely on common sense alone, we risk “rejecting a more thorough effort to solve a problem and settling for an easy one.”

… In our experience the best results often come from a combination of deliberation and intuition.

Finally, in the spirit of the (NFL playoff) season, we’d like to recommend two other pieces about NFL coaches that speak more to leadership challenges than data-driven decision making.

From 1/29/13, The imperfect perfectionist.  On the extent and limits of Bill Walsh’s innovative genius:

Coach Walsh’s West Coast Offense won the 49ers four (or five) Super Bowls, spawned copycats around the league and forced defenses to innovate in response.  Not a bad day’s work.  But obsession with perfection left him badly burnt out and his organization unable to implement his vision without him.

From 2/8/15, The NFL’s Best Coach*.  On the extent and limits of Bill Belichick’s…  innovative genius:

We suspect his efforts to gain those “edges off the field” will also be a permanent part of his legacy.  His team hasn’t been in 6 Super Bowls over 15 years because of deflated balls, or illicitly videotaped signals, or (pre-Belichick) a snowplow driven by a convict on work release.  But you earn the reputation and invite the asterisks when you proudly display that same snowplow in an exhibit at your stadium.

To paraphrase the old adage: reputations are built over the long-term, and can be forfeited in just a moment.  In our business failure can be counted on to make (at least) a cameo, so it’s critical to learn how to fail the right way and make a distinction between business failure and personal failure.  An entrepreneur (or coach?) can try too hard to avoid an enterprise failure and pressure himself into a career-damning ethical lapse.

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