This Week in Startups - End of year startup accounting checklist | Finance Basics with Kruze Consulting’s Scott Orn | E1334

Episode Date: November 29, 2021

Kruze Consulting COO Scott Orn shares the seven tasks founders need to complete before years end. Jason and Scott discuss efficiently navigating compliance and tax deadlines, taking advantage of tax incentives for VC-backed startups, financial planning and more.

All right, welcome back. It's another startup basics. We're talking about finance with my friend Scott, Orn, from Cruise Consulting. You can see all the basics we've done over the years at this week in startups.com slash basics. Why do we do this show? Because people ask me the same basic questions over and over again. And then I have vendors and partners I work with kind of like our default people. When we invest in a company, they say, hey, do you have an accountant, do a lawyer. I say, here's a short list. Yeah, meet with these two or three people. And on the short list is Scott and Cruz. They do a great job. They've worked with a company. They've worked with a company. They've worked with a company. the bunch of companies that I've been lucky enough to be in the seed round before the products were even launched Com, density, superhuman, you know these names. They've been incredible companies for me to work with and incredible companies for Scott to work with. Welcome back, Scott. Thank you, Jason. Thanks for having me. My pleasure. Okay, so now, one of the things that's happened during the pandemic, since we last did Start of Basics last year at the start of the pandemic, is people have decided, and not just WordPress, and not just envision and, you know, quirky companies that believed in remote work like 37 signals.

Everybody is 100% remote in our industry or hybrid, which means if you were only hiring within 25 miles of your headquarters in San Francisco, New York, or Miami, or Austin, you're now open to people being anywhere. But that causes a lot of problems, doesn't it, and challenges? We're all fishing in a much bigger pond now. And I think it's amazing because there's all these people across the United States and across the world that wanted to work with the best venture-back startups who now get the opportunity. So, like, it's a rising tide, lifts all boats type of thing.

And it's, I love it. I think, and Cruise is remote. So we live this. Like we dog food us ourselves. And so we've learned a lot. And we've also had the benefit of working with tons of startups that are not just nationally remote, but internationally remote. And so there's a lot of things we can share with your audience here on how to do it correctly and

how to do it well. Yeah. And there are management issues, and then there are operational issues. I mean, on the management side, there's been a lot of talk about how to do you slack or reporting or start of day, end of week reporting systems. But let's talk about the things on an operational basis and accounting basis, HR basis that come up. So if I want to hire people in Canada or Europe, what do I need to know? Yep. Well, there's, the idea is if you go into another country, your U.S. Delaware C Corp, which is what,

VCs like to invest in. 99% of our companies are that. You either have to create a subsidiary that can then run, you know, have a bank account, run payroll, or you do what's called an international PEO. And international PEO, just to help your audience, is very similar to the PEOs in the United States, professional employer organizations. And what they do is they employ your company's employees directly. So you are not actually.

the employer of record, the PEO is. And this has been around for a long time. People did this. Since the 90s, I started using a PEO in New York in the 90s. Yeah, exactly. And it was a great innovation, but it wasn't until COVID hit and all of us went kind of remote, the real major benefit you got was that by pooling all these employees across many different companies, they could negotiate really good benefits packages and

and save you money on the benefits packages. Of course, it was a little bit of like they created value, and then their fees were mysteriously almost the exact number of the value. Go figure. Funny how that worked. 150 bucks a month, 125 bucks a month. That's exactly it. I basically, and then you could literally do the calculation.

Okay, I've hit 50 employees. It's costing me $70,000. An HR person to come in and manage this would be X amount. Okay, we're... That's exactly it. But now when, and I don't know if you've seen this across your portfolio, Jason, I assume you have, when COVID hit, people started moving away from San Francisco in New York and Austin and moving to all these other states. And so companies found themselves having employees in many different states overnight, which means you have state and local tax requirements, meaning you have to register in that state to do business and you have to register to pay payroll taxes. And what's cool about PEOs is that was like kind of like a side benefit that they've always done

because again, the employees are working for the PEO. And so no one really assigned a lot of value to that. But now we've actually seen the PEO market share in Cruz clients go from 15% to 30% in one year. So doubled. It feels like it's just picking up steam. Now the alternative is your friendly CPA firm like us will actually do your state and local tax compliance, but it's not something we love. And it's kind of nice to simplify your life and let the PEO do it. And so that was like the major catalyst for national PEO adoption. And then

a funny kind of little thing happened with COVID where founders historically, you may see this too, they historically had hired internationally in a cluster or a center of excellence. So they might have in Canada or India. We have a Toronto office in Canada. You get five or six people, the costs of setting up there for us and the bank accounts and managing it gets spread across five people. It suddenly makes sense. That's exactly it.

Or in India, Argentina, Ukraine, all these places. And so an international PEO was the same thing where you didn't have to set up a subsidiary, which costs a lot of legal dollars and compliance dollars. And an entity in that country would employ your. international employees directly. The same thing we just covered. Now, the interesting thing that we're seeing is that all of a sudden founders said to themselves, if I'm going to hire internationally, why don't I just pick the best people regardless of what country they're in? So no more centers of excellence as or maybe not as much. And capitalism is amazing. A whole host of companies

that are international POs. And I don't know if you want to get into any names. I can name the names if you want. I'll see the names out. Every time I mention a name, then the competitor or somebody else gets mad at me. So I always just. Totally got it. Yeah. So these companies have filled the void and now almost like a virtual layer can let you

hire in all, not all, but most countries across the world. It's kind of like, you know, some of these payment processors will allow you to accept payments from 190 countries overnight because you dropped in some code. That's what's happening with these PEOs. You drop in this little bit of code. You start a relationship with them. And, you know, sometimes employees also have to figure things out because they might have been domiciled, let's say, in California. And then they decided they were going to go to Florida or Austin, but they kept their place in California.

Now where are they paying taxes? Okay, where do they spend most of the month? What is your system saying? Where are they withholding taxes from? You might get into a situation where you're withholding taxes in the wrong place. And you need somebody to help you with that, too. That happens a lot. and it's a hot button for a lot of employees who moved either nationally or internationally

because California, New York, where a lot of startup employees were, are high-tax states. So if they're going to move, we see people moving all over it, but the generally lower tax states, they want that change to happen immediately. It's more dollars in their paycheck. So yes, but operating all this stuff actually takes a lot of work. And on the international side, the cool thing about these services is there's an emotion, I feel like there's an emotional benefit to being able to call yourself an employee, even if you're in another country.

And oftentimes there's a tangible benefit where you can get benefits. Like, you know, there's people need benefits wherever they live. And so having this international PO aspect actually solves a couple of those problems and makes recruiting these all-stars a heck of a lot easier. I'll tell you one of the most delightful things about having an office in Canada is, we have many more employees there who will stay longer. For some reason, people in Canada, I think maybe because we're, you know, maybe you don't get to work for a venture capital firm and live in Canada.

There might not be that many there. So if you get to work for us as a venture capital firm, well, you'll stay with us longer because there aren't a lot of options. So the loyalty goes up. Also, they have their health care already taken care of. So we hire somebody there. And you have the dollar, I think, does pretty well. going to Canada, it might do worse in other countries. So you do have this like pluses and minuses

in each region. I think it all nets out basically the same. The biggest win, of course, is being able to fill a position with a qualified person faster. That's the big win I see across my portfolios, you know, this, oh my God, we need a product manager in Los Angeles who's willing to go to the office in downtown L.A. And it's like, okay, so that's one, one thousandth of the product managers in the world. Now we open it up to anywhere and it's like, okay, now we have a We have 999 more candidates that we're going to compete against. We don't have to compete against. And if their cost basis is lower, too, I don't know if you're seeing this, but I think

payroll was going to the moon in the Bay Area and then all of a sudden it levels out and in some cases has trended down on average, which means, you know, you can not only hire faster, keep people longer, but maybe your cost went down 30% on average. We definitely see that. And people, there's a lot of discussion around, I don't really agree with us, but people talking, existing companies lowering people's salaries who moved? Yeah, Facebook said they would do that. Yeah.

Facebook is doing it. And I think Google's doing it too. Yeah, I'm not a huge fan of that because I feel like if they were providing that service and they were doing a good job and all this kind of stuff, and you're kind of opening yourself up for poaching and things like that. But what we do see is companies starting salaries for new people to hire at lower dollar amounts in other states. And it's going to kind of, you know, overtime raises and things like that will balance things

out. But you're right about the speed. And also like in Canada, especially, the engineering talent is phenomenal. And there's tax credits there. Yeah, people don't know about that. Yeah, you can get a hundred percent tax credit for somebody who's doing R&D or 50 percent. Australia has that. Some European Union countries, I think, have it. So that's just another added benefit. Yeah. You know, on the salary thing, you know, I understand both sides of it. I think it's a really horrible thing to have to execute. But here is the counter argument. I'm curious your thoughts on it. You and I started in Austin, Texas, we were engineers at 125K. You said, oh, you know, the mothership wants me to come work in the valley. They know it's going to cost me,

you know, 50K more or 30K more in rent. They gave me a 30K bonus. So now I'm making, you know, whatever 30K more than you. And then I decided to go back to Austin after the pandemic. And now we're sitting next to each other and I get the 30K bonus and I get to keep it. Yeah. You're definitely right. That is a problem. Um, It's just so tough because the hiring environment is so hot right now that there's this, the classic like taking something away from someone always leaves, you know, it creates some anxiety. I think freezing is the way to do it.

Yeah, I think that would be my thought is, hey, listen, you know, we're paying people in Canada this. We're paying people awesome this. You know what? That's all over. Anybody who got paid a higher amount is going to be frozen for the next three years. Sorry, I know that's difficult. anybody else is going to get a little bit extra and we're going to just try to make it fair across the board.

That's actually exactly what I recommend. That's what I would do too. Yeah. Is that the best practice now? It seemed commonsensical. But it just is hard to execute. It's bad feelings on both sides. All three sides of the table. The person underpaid, the person overpaid and the company having to make this hard decision. Yeah. Also reminding people sometimes that they get to live in a lower cost, like all the other non-monetary perks of living in Wyoming are monetary. They know it too. Like they made that decision. So I noticed when I had that discussion with folks, even at our company like, hey, we're not coming back to the office. And everybody was paid this, you know, fees as if we were in the office and people were paid differently.

I think they get that. They're like, yeah, I'm able to afford a house. I'm able to afford half their. My rent costs went down a half. And I'm happy for people to arbitrage it. I don't need to do that arbitrage. Zuckerberg doesn't need to do that arbitrage. But I think he's probably, yeah, he's Zuckerberg.

Yeah, exactly. Some people can't let it go. Some people can't. I'm letting it go. I'm like, you know what? Because you know what? I might do it at some point. So I can't look at my people and say like, hey, you did the arbitrage.

And what if I moved to Miami and I'm like, yeah, my expenses went down half as much and I don't pay state tax anymore or wherever I wind up. But, you know, if I wind up in Puerto Rico or, you know, I take some deal in the arbitrage is going to be there forever. And people are going to move on at some point. And it's just, you know. pitch me on Portugal. Portugal is like, we want more Jakehouse. We want more besties. Can you guys move to Portugal?

I was like, never been to Portugal. Kind of a tough sell, but, you know. The beaches are beautiful, but the time zone is tough, you know. I mean, the time zone thing can also work to your advantage. I don't know if you've had this, but now at inside.com, I'm hiring writers. And the writers there can be writing earlier than the ones here, obviously. And you can kind of use that time arbitrage to get product out the door at 6 a.m. or 9 p.m., whatever your choice is by going east or west. That actually works. I mean, Fred Wilson's blog gets delivered at like 6 a.m. Pacific time.

So I read it every day because it's there. You know, it's in the inbox. So for inside, I think that makes a ton of sense. Yeah. It's a great little hat. Okay. We talked about virtual cards and these things on a previous episode. These things are great, especially for international and for remote workers.

You can give them a little bonus. They can set up their home office, etc. Are people starting to, where does the home office sit on all of this in terms of who gets credit, tax credit expenses for this? Or are people saying, listen, you got to work from home enough. You buy your desk. You buy your chair. It's your responsibility.

Or we're going to give you a little bit of extra money to work at home. What's happening there? Well, typically our best practice we recommend and we do is we actually pay for a full setup, not like a desk, but we pay for all the computer monitors, computers, comfortable chair, you know, all that kind of stuff. Oh, even the chair too. That's nice. I can't remember if we pay for the chair or not, but we spent, I know we spent over

$1,000 on every new person. The hard part with the chair at the table is, what are you going to do with it? Send it to the next employee when you leave. And nobody wants to go through that. So buy your own chair. And fit and aesthetic. It's like, you know, someone may not, you know, whatever. But the cool thing is if you can line this up, like we have a package of stuff we

buy for every new team member on Amazon, boom, center their house. So nice. A couple days before they start working, it gives them a lot of confidence. Like they know they're joining an organized company. And they've got all this stuff taking care of. So I actually recommend that. Some people like to do cash, but I find that there's so much anxiety for people, even if they're super excited about joining a new company, like setting all that stuff up can actually

be a little nerve-wracking for them and going to Home Depot or whatever they got to do. So we just send it to their house and we actually offer to walk them through setting everything up. Have you seen this? Have you seen this crazy thing where the employee gets the laptop for 30 months, let's say, and you take the laptop, it's a $3,000 laptop, it's $100 a month. And there's a schedule for the value of the laptop. The employee leaves that month 20 and there's 10 months left. They either send it back or they pay the difference in cost and they can keep it.

I've heard variations on that. It seems like a little bit of an adverse incentive type of thing. So we don't really do that. We just recycle it. Because remember, all that data can be, like, especially us, right? We have a lot of sense of data. So we actually require the laptop to come back. And then we dispose of it in a very professional, safe way.

Our IT services firm actually does it for us and wipes everything. Because you don't want like a rogue laptop out there four years later, you know, that kind of thing. Yeah. I think there's some people. who've had rogue laptops, yeah, wind up in the wrong hands. It doesn't work out well for anybody. Exactly. Have you, um, I wonder if you have a take on this, since we're going down the remote worker rabbit hole. There are companies now that are locking down the laptops they send and have monitoring tools on it. You have compliance issues. You know, people on their laptop watching

Netflix or Spotify or, you know, God knows what in an incognito window. Are, our employees told, hey, this is, or what is the best practice you're seeing outside of your company, this is your work laptop. Do not do anything personal on it. Get your own laptop for that because this one is monitored, keystrokes, screenshots, data, VPN, we know what you're doing on this laptop. We have it recorded. We're not monitoring you all day or long.

But I know some people with customer service, those computers are monitored all day long. Stock traders are monitored all day long. Every screenshot is recorded, you know, for compliance. people don't know this, but that's what happens in finance, right? Like every DM, every screenshot, it's all recorded somewhere. Yeah. So we don't monitor, but I totally understand where people are coming from. The big trend is virtual desktops. And so you send the person on the computer, but they log in on that computer into a virtual desktop.

Like Microsoft's made a lot of advances. Amazon Web Service has a solution. And so that way, the data never gets downloaded to the actual laptop. And so it's a really strong layer protection. The other thing you mentioned is VPN. And I cannot recommend that enough. There's so many stories of people working in a Starbucks, not on a VPN. And they don't know the like two tables down is a hacker.

Who then is on the same network, who then fishes them, sends them an email that looks legit. They click it. Now that hacker is in the company's systems. I've heard stories of people. of hackers getting in the system, mimicking all the invoicing, like the actual templates and the look and feel, then sending invoices. We have a friend. Send the wrong bank routing number.

That's exactly what they do. And now people think they're paying for ads on this weekend startups and they're sending it to Russia or wherever. And it's like one friend's had some, an executive who should know better did this. And they had a $350,000 wire go to Russia. and guess what? A million dollars of litigation costs into it. It just gets worse and worse.

I guess food never gave it back. But a VPN can save you so much headache. For five bucks a month. And make sure that people have to have it on before they can actually access the internet. You can actually do that. Let's talk about sales tax. This is so confusing.

When you're selling software, you got a headquarters, but you got a salesperson in Bangladesh, you got one in France. You got three in Canada. seven in Miami. How does it all work? And how do you make sure you're paying your taxes properly? Yep. So let's talk about the U.S. first. When you have, remember we talked about like companies having employees go to many different states. Well, that can actually trigger tax nexus. And the definition of tax nexus basically is if you have people, property, assets, or a certain

amount of sales in a state, that means you're doing business in that state. It means you need to file a tax return in that state. So your federal and state income tax return. And if your sales are high enough, generally speaking, like 100K is kind of like the ballpark number in that state, you have to file sales tax returns. So there's some really great software out there. Quick Google search I'll show you. But what we typically do is when we start seeing companies getting that kind of escape velocity on revenue and starting to get close to those thresholds. We put them on the software. It's like the same way you use QuickBooks to do your accounting, you want to use a sales tax software to do your sales tax. And we'll often help the

companies. The sales tax software will often file the returns automatically and it'll simplify it. And then you will be compliant. But like it's very important to do. This is kind of like a new world. Like three or four, I think it was three years ago, the Supreme Court ruled in favor of South Dakota against Wayfair, making sales tax kind of like open season for the states. And of course, the states are like, hey, another revenue stream. Let's do this. But so that was the thing where a lot of like CFOs of bigger companies, even public companies were freaking out because this mass exodus out of California and New York

was creating tax nexus and sales tax nests in many states that they were not prepared for. So people were kind of a little more aware of it now, but it's something that a lot of startups, because they haven't been revenue producing yet are now just kind of like all of a sudden they're doing a couple million. Yeah, time to grow up. That's a very good way of saying. I have to grow up and make sure you're paying.

Here's the thing about taxes. Like be happy to pay them. We live in a free, like great country and other states that you get to do business in. Just make sure the tax stuff is done properly. Because fixing it in the review mirror takes twice as long penalties, yada, yada.

And some of these states really take it seriously and they'll chase you. And I know people who have gotten, you know, they have never operated in California and they're getting notices. And they're like, what's going on? And, you know, they had a we work. They rented for some period of time for one worker. And now for the rest of their life, California is like,

well, obviously you're headquartered here. And it's like, no, we had to address once for a worker. They're not here anymore. Like they could be, I don't want to say overreaching, but they can be aggressive in their pursuit of tax. That's a great way of saying it. And you're right. If you file a tax return with a California address or they, you know, they get we work to turn all those addresses over.

Boom, $2,000, $3,000 levy against your bank account. You didn't file anything. They pretend like they didn't know what the number was supposed to be. So they take more than if you just would have filed it. Yeah. I mean, listen, states, cities, governments around the world are trying to increase their tax bases. You need to make sure you understand what you're required to pay. and just be on point about it.

It's annoying. I know it's annoying. But get your stuff dialed in. Tight is right is always the best advice here. Yeah. It's also not that hard if you have, like, I don't want to be self-serving here, but have a good partner.

It's like this is the cool thing about when your startup is there's many other startups. So like the tax compliance process for one startup is not dramatically different. Same thing with HR. Same thing. It is the thing. When it comes. to like the product, design, customer support, you know, sales, those are things that you're

always going to have in-house. You're not outsourcing those. Legal, HR, PEOs, tax compliance, counting. These are things that, you know, until you get very large, you're probably not going to have in-house. And even if you do bring legal in-house or accounting in-house, you're going to have outside auditors. You're going to have outside counsel. You just have to learn to work with vendors. And in terms of like the costs of all this for young companies, it's not that much. You guys are not trying to make money off the small clients. You kind of want to grow with them, correct? That's exactly it. You said it perfectly. And by the time that your company has grown up, guess what? You're the founder, you're the CEO. You will hire people to handle this

for you in-house. So like, as long as you set up correctly early on, it will never be a headache for you. And as your company gets ready to IPO, you'll have a whole team of legal people. You have a whole team of accounting people. So just do it once, do it correctly, and your life will be so much easier. All right. Listen, Scott, thanks again for coming on the program. Everybody can go to this week and startups.com slash basics. See all the basics we've done over the years. And you can go to cruise consulting.com slash twist to get in touch with Scott.

And thanks for doing it. Thank you, Jason. And we'll see you all next time. Bye bye. Bye, bye. Ted is right.