Perhaps the only upside to the 409A panic in the start up world has been some of the urban legends that have already popped up. Jason and I aren’t your lawyers, so don’t take this as formal advice, but if your lawyers are advising you of the following, at least ask some questions. We’ve personally heard some senior partners at big-name law firms say some crazy things regarding 409A. The following are actual quotes. We will not disclose names to protect the innocent, er.. guilty.
“ISOs (incentive stock options) are exempt from 409A, so don’t worry about it, just grant ISOs.” : This is perhaps our favorite statement. In fact, the statement is factually correct, but logically stupid. In order to qualify for ISO status, the grants must be made at fair market value or higher. Given that ISOs cannot be given to consultants, nor are most executives eligible for ISOs, no company will ever get by granting just ISOs. Since NSOs (non qualified stock options) are subject to 409A, there will be some sort of formal valuation report (whether done internally or by a third party) that will determine the fair market value of the stock, which will in turn determine the price of the ISO. In other words, 409A does affect ISOs.
“Restricted Stock is exempt from 409A, so don’t worry about it, just grant Restricted Stock.” : Another factual statement that may work for very early stage companies but just doesn’t work in reality for most companies. When a restricted stock grant is made, the award itself is a taxable event and the grantee immediately holds voting stock. Perhaps granting restricted stock awards to the first half dozen employees of a company when the valuation is extremely low works, but for any somewhat mature start up, this doesn’t make much sense. Note that Restricted Stock Units and other deferred compensations units are subject to 409A. There are some workarounds for 409A, but they are pretty dense and confusing. For example:
“Such units will not be subject to Section 409A if settled (whether in stock or cash) before the later of (i) two and one half months after the end of the employer’s fiscal year in which vesting occurred, or (ii) March 15 following the calendar year in which vesting occurred. If the units qualify as performance-based compensation under Section 409A, the holder may make an initial deferral election at any time prior to the last six months of the performance vesting period”
See, we told you so.
“Directors are personally liable for screw ups concerning 409A.” : Jason was pelted with calls on this after a name-brand firm went around telling its clients this. Frankly, we aren’t sure where this is coming from, because there is nothing specific in the regulations which say this. Our best guess is that this stems from improper withholdings that are associated with 409A blunders. Should the company undervalue its options and therefore subject the employee to income on the spread versus the true fair market value, the company should also make withholding payments to the IRS on this “income.” Traditionally, failure to properly withhold for taxes can be a personal liability of officers and directors, so perhaps this is the chain of thought that elicited this statement. In our opinion, we’d be very surprised if the IRS chose to prosecute except in the most egregious situations, so we aren’t losing any sleep over this.
While writing this, the trailer for the season premier of 24 just aired and we’d rather think about all the dudes Jack Bauer kills this year instead of 409A, so we are done with this post. Don’t worry – we’re also almost done with torturing you on 409A.
When I woke up this morning, I decided that I wanted to see how hard it was to implement a map using the Google Map API (god only knows why I think of things like this when I wake up.) I’m no longer much of a programmer, but I can hack around with the best of them, especially if someone else does all the hard work and all I need to do is play trial and error with some HTML, CSS, and Javascript.
I got my Google Maps API Key and tossed up the “Hello, World” of Google Maps on my web site. Pretty easy. I then started trying to get the size, zoom, and center point set the way I wanted it. Suddenly, I had to find the longitude / latitude points and – to make sure I was putting them in the right place – began digging through the Class Reference which is well documented, but doesn’t give me much of a clue about the actual boundary parameters (e.g. I figured out that map.centerAndZoom (latLng, zoomLevel) was what I wanted and I could figure out the latLng, but I didn’t know how to determine zoomLevel without trial and error.)
I found an easy latitude / longitude geocoder site and started monkeying around with the addresses of the five marathons that I have run. I kept thinking there should be something that would generate the code for me as it was starting to get a little messy and it seemed like I was trying to create a pretty simply map – centered on Colorado, with five locations with some text associated with them.
As I was looking for other geocoder options, I stumbled upon Map Builder which did everything I wanted (including embedding the geocoder in its UI.) Ten minutes later, I had the source code for the map. I had to muck around with it some to integrate it properly into my Marathon page on my web site, but it’s up, functional in Firefox, IE, and Safari, and in pretty good shape.
After I run my next marathon, I’ll work on creating an XML file with the data and actually feeding both the map and the table with the data (e.g. I’ll clean up the code from Map Builder and put an abstraction layer in place.) In the mean time, I’ve satiated my need to play around with the Google Map API for now.
On Friday, Jason and I received an early Festivus / Hanumas gift from an attorney who asked to remain nameless, but we thank him nevertheless. He clued us in to a release from the IRS on December 23rd where the IRS issued some additional guidance related to prior grants. In a nutshell, the IRS said that stock option grants made before 1/1/05 are safe from 409A if they were done in accordance with the good faith valuation rules of the ISO regulations. Furthermore, grants between 1/1/05 and the effective date of final regulations just need to be done under a reasonable valuation method.
So what does this really mean? Most importantly, it means that 409A is a moving target and the story is changing faster than we can crank out blog posts. We’ll wait for some of the “pundits” to decipher the IRS statements (ya gotta love how everything the IRS releases to give guidance usually causes even more confusion), but it looks like this is a step toward sanity. Best case, as long as the board of directors were doing good analysis of fair market values when making grants, then perhaps past grants (prior to 1/1/05) are effectively exempted out of 409A. This would be huge and welcome relief. See our prior blog on the official NVCA comment letter – this “grandfather” clause was one of the major tenets of the letter.
As for grants done in 2005, this sounds pretty good but no one really knows what a “reasonable valuation method” means yet, so we’ll reserve judgment at this time.
I spent a delightful few days in Aspen with Amy, my uncle Charlie, and his wife Cindy. My first computer experience was at a Frito-Lay office in Dallas when I was 10 where Charlie sat me down in front of a terminal with a green screen, fired up an APL interpreter, gave me a big book called APL: A Programming Language, and then left me alone for the next five hours. Over the years Charlie and I have worked together on a variety of things, most recently when I was a major investor in his previous company, The Feld Group (acquired by EDS in January 2004).
We covered a wide range of topics over a dozen meals and several long walks together (neither of us are skiers). One theme that we kept revisiting was the current decline of the United States in the world order (ahem – China, India anyone?) I’ve been rolling around the idea of living in a country equivalent to post-Edwardian England (e.g. we peaked, life can still be great, but we aren’t at the top of the mountain anymore) since a rollicking dinner with Pat Kenealy a few months ago and have started to get comfortable with the idea.
While I accept that the United States can’t be the unambiguous leader of the world (if you disagree with that statement, read Thomas Friedman’s The World Is Flat again), the future of the United States as defined by Atlas Shrugged is profoundly unappealing. On the heals of yet another piece of empirical evidence that our government is trying their hardest to emulate the moochers in Atlas Shrugged (e.g. “Oops – yes – we were spying on you – a lot – even more than we said we were – but it’s for your own good”), it’s hard not to be just a little bit discouraged.
As someone who has been playing in the sandbox of entrepreneurship and innovation his entire adult life, I’ve never really thought much about the need for a catalyst for our country since I have always been immersed in a zone of endless overstimulation. However, as I get older and watch many of my venture brethren hop on airplanes to Beijing, Shanghai, and Mumbai, I’ve been thinking about the United States’ place in the next wave of innovation. As the Web 2.0 meme finally starts to fade (or maybe it’s just that 2005 is coming to an end), I’ve been waiting for something to replace it, just to see if anyone had any new non-China/India innovation juice.
While sitting at the St. Regis in Aspen the other day having a hot apple cider, Charlie said something simple, but completely profound. “We need another Sputnik.” I hadn’t been born yet when the Sputnik Crisis happened, but as a kid I was fascinated with space (like most nerd-boys) and it always stuck in my mind how Sputnik focused and rallied the United States around innovation.
I don’t know what the next Sputnik is for the United States, but I’m keeping my eyes open for it.
I’ve been training for my next marathon (The Miami Marathon on 1/29/06). Given that it’s winter in Colorado I’ve been spending a lot of time on my treadmill to avoid the darkness, snow, and ice. However, I’d much rather run outside so when we got to Aspen last week I went looking for a pair of Yaktrax so I could run up and down the mountains.
I picked up my Yaktrax (yeah – poor impulse control), but the person that sold them to me recommended I try a pair of IceBug MR Dry BUGrip’s. While the name is a little goofy, the IceBugs (which are made in Sweden) are unbelievably great. At first glance, they look like typical trail running shoes. However, when you look at the cleats carefully, you notice that some of them are made of metal. When you put enough pressure on the metal studs, the ends (the metal part) retract slightly (according to IceBug, they are “smart studs” – Amy’s favorite kind.)
If you’ve ever run up a mountain on snow and ice, you know that it can suck if you only have regularly running shoes. With the IceBugs, it literally felt like I was running on dirt. Zero slippage, no traction issues, and no snow/ice anxiety. Downhill was even more fun as I could really cruise while staying completely in control. Whenever I hit concrete (yes – Aspen has a bunch of heated sidewalks – how decadent), I could heard the smart studs clicking but didn’t feel like I was running on spikes as the tips retracted slightly. Perfect.
If you are a winter mountain runner these are worth ever penny of the $125 they cost. You can buy them online at Amazon or Garmont. It’s only the second day of Chanukah – you’ve still got six more days to buy them for a friend.
I’ve been using FeedDemon 1.6 RC2 (the version that synchronizes with NewsGator Online) for the past two months as my feed reader. I monitor over 400 blogs a day and have found that FeedDemon is the only way I can handle this volume effectively. As an investor in NewsGator, I regularly use all the NewsGator products (very convenient since they almost all sync – NetNewsWire sync should be out soon for you Mac users – so I can easily switch between them.) I also play with many of the other aggregators to make sure I know what folks are up to. Nothing comes close to FeedDemon for high volume RSS feed reading / management.
Nick Bradbury – the creator of FeedDemon – has put up some teaser screens for FeedDemon 2.0. A number of the new features are aimed at helping with RAT (relevance / attention / trust) which is important for anyone dealing with a large number of feeds. NewsGator / Nick decided not to release 1.6 and go directly to 2.0 to take advantage of a number of new things coming in NewsGator Online.
If you are curious about FeedDemon 2.0, take a look at a few of the screens:
Unread feed view – yum. Awesome stuff Nick.
An inevitable question to ask is “okay, the valuation firm came back and said the FMV of the last option grants should have been $.25 and the grant price was $.10. Now what do we do?” Good question. Unfortunately, we don’t have a good answer until the IRS gives us more guidance. But here is what we know so far.
Despite the fact 409A is not a final regulation and is still subject to the comment period (more on this later), the IRS says that if you have a 409A “problem” you can fix it by December 31, 2005 (enjoy your holiday “break”) by electing one of the following:
Now remember, you need to get all of this done by year end. And again there aren’t enough valuation firms in the world to get the valuations done before year end, so even if these weren’t preposterous “fixes” everyone is still screwed.
So what if you don’t fix problem options by December 31, 2005? It’s unclear to us at this time. The IRS says that one has until the end of 2006 to at a minimum raise the option prices of grants to FMV. Note that if the option price changes it blows ISO status (although we’ll discuss why this doesn’t matter later) and will likely severely piss off option holders. We are also hearing a lot of “noise” ranging from “you’re screwed, there is no tomorrow” to “don’t worry about it, the IRS will never audit any of this despite 409A.”
After 2006, it’s strict compliance and nothing can be fixed, presumably.
So given this, what to do about past option grants? Should you skip the holiday dinner and “fix them?” Our opinion is “no” because the fixes aren’t feasible (plus, holiday dinner is yummy.) You have all of 2006 to decide what/if to go back in time and look at each grant date and re-evaluate the FMV at that time. Given our previous post on what it costs to get a valuation done, this is quite the harrowing thought.
We are still looking out our own portfolio to decide what to do. On a case by case basis, we’ll have to look at the company after getting the first formal valuation done and see how different that number is compared to previous stock grants. If the valuations are radically different, we may indeed have to formally value past option events and make changes where necessary.
The Internet (and the candy industry) is always good for a little sex.
It was another PayDay and I was tired of Mr. Goodbar. Then, I saw Miss Hershey throwing me Kisses on the corner of Clark and 5th Avenue. In no time I pulled out my Whoppers and began feeling her Mounds with my Butterfinger. “Hey, how’d you like to Crunch on my Tootsie Rolls?”, I asked. Well, she did and it felt like pure Almond Joy. Then, I let her have my Choco Taco. She let out little Snickers and moaned,” Oh Henry it feels Good & Plenty. Even better than the 3Musketeers. Oh, those beautiful Sugar Babies!” She asked if I was into M&Ms. I said, “Why don’t you take my Whatchamacallit and slip it in your Bit-O-Honey and feel my MilkyWay?” Hey, I know men are from Mars and women are from Venus, but soon she began to get a little bit Chunky and nine months later out came Baby Ruth.
Thanks Chris (and Chris’ dad Martin).
Every VC’s friendly neighborhood trade association (the NVCA – National Venture Capital Association) just submitted an extensive and comprehensive comment letter on 409A to the IRS. If you are paying attention to this issue, it’s well worth a read.