Author Archives: Zach Shulman

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July 30, 2011

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Startup Life

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Reblog – Finance Fridays

Brad Feld just sent out his first Finance Fridays post called “Getting Started -Allocating Equity and Founder’s Investment”.

This post is not about financial statement literacy, but is meant to begin setting the stage for the hypothetical company that will be the subject of the Finance Fridays series.  In particular, this first post deals with allocating initial equity between 2 founders.  I posted a comment to the post as follows:

“Brad, the split could have been 50/50 regardless of Jane’s $$ contribution, right?  My point is that while Jane and Dick negotiated the split is was basically arbitrary.

Also, someone recently argued with me that in your scenario Dick would actually have taxable income on the value of his shares based on the value “attributed” to the shares derived from Jane’s investment and implied valuation.  I argued “no” and that Jane’s cash investment would just increase the tax basis of her shares.   Do you agree?”

My comment was based on a situation that I was just encountered in which one founder was putting in real cash and the other 2 founders were putting in IP and sweat.   An advisor took the position that if Founder “A” put in $60K and got 33% of the company, then the other Founders “B” and “C” (who also got 33% of the company) would have taxable income of $60K each.  I argued against this position instead saying that Founder A would simply have $60K added to his tax basis in his shares (so that when Founder A sold the shares later his gain would be $60K less).  And that Founder B and C would be unaffected…….and that this situation happens all the time!

Hopefully I will get some responses to the comment and let you know.  Chime in.

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July 23, 2011

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Board of Directors, Management, Public Service Announcements, Startup Life

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Reblog – Look Out for Brad Feld’s new Blog Series on Financial Statements

Brad Feld announced today the format for his upcoming educational posts on startup financial statements and financial literacy.  See the announcement here.  This is going to be fantastic!  “Finance Fridays” – I will reblog them for sure.

I am a big believer in the power of the blog as an educational tool.  It is my primary motivator to write actually.  Selfishly, it saves me time to write down useful information because I can continually reference folks back to the blog posts.  But I think the most powerful reason is just to make the startup ecosystem more efficient, particularly in underserved markets like upstate NY.  Brad Feld, Fred Wilson and Martin Zwilling are among the best at educating via their blogs, and I have a strong suspicion that that is what motivates them as well.

If you have startup topics that you think would benefit from a post, let me know.  If I cannot handle it I will punt it over to big boys……

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July 23, 2011

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Startup Life

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Secondary Markets

Secondary markets are fascinating.  And potentially a royal pain in the ass for the private company involved.  Simply stated, secondary markets are highly unregulated exchanges on which shares of private companies are traded.  Importantly, the given private company must consent to the trades so there is a self imposed regulatory function.  You have likely read about secondary market trading in Facebook, Twitter and Zynga.  Numerous companies are actually involved, but those are the 3 that get most of the press.

The most noted secondary markets are SecondMarket and SharesPost.  The innovation behind the creation of these sites and the services they provide is awesome.  The legal issues surrounding the exchanges are not fully fleshed out and many questions about liability (among other things) exist.  For example, even though Facebook, as a private company, does not publicly disclose its financial results, could the active secondary market trading in Facebook stock impose liability on Facebook or a Facebook stock seller for non-disclosed material information about Facebook?  Likely.

A short article today in the NYTimes is worth reading.

I hope that all of your companies get big enough and popular enough for you to have to worry about secondary market issues!

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July 18, 2011

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Management

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Insider Trading

Ok, this post is going to be a bit off the usual startup/VC path.  Insider trading is not typically associated with stock in a private company (like a startup) simply because there is no public market on which to trade the stock.  Fraud rules embodied in state and federal statutes certainly apply to both public and private companies, but it is really difficult to insider trade in a private company.  In fact it is practically impossible.  It is not impossible to commit securities fraud with private company stock. Insider trading is just one type of fraud, and there are plenty of other types of fraud that can snag private company transactions.

Keeping the concept simple, “insider trading” is buying or selling stock while in knowing possession of material non-public information about the company whose stock is being traded.  “Material” means that a reasonable person would want to take the information into account with respect to the transaction.  “Non-public” means that it is not known by the public/public markets.  And “knowing” means that the person trading knew (or should have known) that the information is not public.  A classic example would be when a CEO of Company X tells his/her spouse about upcoming good news that has not been publicly released (like a positive earnings report) and then the spouse goes and purchases a bunch of stock in Company X.  That is insider trading.  The CEO owes a duty to Company X’s shareholders and that duty is transferred to his/her spouse (via arcane case law rules involving “tippers” and “tippees”).  Another example would be when the CEO tips off his buddy at Hedge Fund YY and the buddy uses the information to trade (buy or sell) to make a profit or avert a loss for the hedge fund.  However, if a taxi cab driver hears the CEO chatting in the back seat about the good earnings release and then buys some stock in Company X prior to the release being made public, then the taxi cab driver is not insider trading in the legal sense because he does not owe any duties to the Company X shareholders.  Kind of nuts actually.  Insider trading laws and court interpretations are complex.

I just read a short piece in The Week magazine (one of my favorite magazines – the other is Smithsonian) in which the author argued that insider trading should be legal because there really is no victim and the government should go after the truly damaging securities fraud crooks (like Madoff).  The Week only provides short summaries; here is a link to the full article.

To me, this is 100% bogus.  There certainly is a victim (the person on the other side of the transaction) and since when should small time crimesters not be sought out?

In my view, the simplest and most efficient route would be to make knowingly trading on material non-public information illegal.  No caveats for duties to shareholders.  No caveats for tippers and tippees.  No caveats for all the other case law theories on the topic (and there are many of them).  My rule would capture the taxi cab driver. It would capture anyone who “knows” the information is non-public.  A jury would decide whether or not the information is “material”.  Juries are supposed to interpret subjective matters.

My bottom line on this issue is that stock trading on material non-public information is immoral and should be illegal.  Simplification of the body of law would be a step in the right direction.