Bonus Bailouts

By Trishan Arul    March 24, 2009

Despite a couple good weeks in the stock market, the public is still very upset about the AIG bonus payments. The amount of money and the fact that these are guaranteed payments for the very people who brought down AIG is appalling to say the least. There are many good reasons to pay people bonuses, but this is about more than that. It is about the public resenting executives who unconscionably enrich themselves while leaving their companies and the economy in shambles.

Last weekend, I met a pilot from Virginia who was in town for layover. Over drinks he asked my opinion on this issue while stating that he was a “free market guy”. That’s good to know, but this has nothing to do with free markets. This is another example of powerful people gaming the system for their own benefit – when things go well its a private free market so they should be paid as much as possible; when things go badly then the government needs to step in because its not their fault and they shouldn’t have to suffer with lower pay. Same line of reasoning for CEOs – each year their pay gets set (at least partially) by comparing it to the pay of other CEOs and since every company wants to believe their CEO is above average, they need to get paid above average. Guess what happens to the average in the following year? The median pay spirals upwards with no ceiling, no link to performance, and certainly no shareholder input. Oh, and the Board of Directors approving the pay consists of CEO’s from other companies who like the system just fine. Great system if you’re an executive at that level. But it is nowhere near a properly functioning free market.

I do believe people should get rewarded for their efforts in creating long term value for their company and the economy as a whole. But they should also pay for failures. Entrepreneurs know this all too well. For every Sergey or Larry at Google, there are thousands of people who try to start a business and fail. Obviously timing and luck have something to do success but, IMO, the founders and executives make the most significant contributions. Success is rewarded handsomely but failure is very costly. That’s creative capitalism in a nutshell and its what makes market economies thrive. Since executives at “too big to fail” institutions (and corporate America in general) have shown zero willingness to make the system work fairly, something has to be done. Here’s my proposal:

1. Normal tax rates apply to all compensation up to a limit. Say 3 times the President’s salary – that’s about $1.2M and it will be indexed in the future. How many people will win the argument that they bring more value to the world than the President of the United States? Is earning just $1M really a hardship on anyone?
2. All short term compensation above the limit, including bonuses, is non-deductible to the company and incurs a penalty tax of 10X the amount. At the individual level, it is taxed at 90% (Congress’ current tax to recover the AIG bonuses).
3. Short term compensation above the limit must be approved by an absolute majority of shareholders each year (not just those who vote) and Directors’ cannot recommend a Yes vote on that item, i.e. if it is not actively voted, it is an abstained vote.
4. Long term compensation above the limit can be taxed at normal rates only if it is tied to the stock/value of the company relative to the overall market or industry. Long term compensation must be paid out evenly over no less than 5 years even if you leave the company.

Here’s an example: A company wants to pay its CEO $3.2 million this year which is $2M above the limit. First, over 50% of the shareholders have to explicitly agree to this at which point the company will pay a penalty tax of $20M and the CEO will pay a tax of $1.8M… was it worth giving the government $21.8M for the CEO to net $200K? Or you could give the CEO $2M in indexed stock options paid out over 5 years. If the company does well, he’ll  eventually get all that money or more but if it tanks during those 5 years then his payout suffers along with the shareholders and everyone else. If the CEO is there over 5 years then all those rolling payouts will add up to 100% of the average long term compensation, so they only have to worry about a lower level of comp for the first few years in which time they can prove that they are worth that kind of money.

This will reward long-term value creation, give shareholders a strong voice in obscene pay practices, and provide ample rewards for those who truly earn it. Note that there is still no limit on what a person could earn – this is America after all! This also solves the problem of people just getting paid when the stock market goes up – if the market rises 10% and the company stock rises 6%, did the CEO really do a good job? Regular options and restricted stock give execs an extra 6% for underperforming the market by 4%. Is that pay for performance? Let the people who truly make a difference, add value, and are deserving of multi-million pay packages get paid. Let the others stop getting a free ride based on “free market” excuses.

One of the things that isn’t often mentioned in this debacle is that the predecessor CEOs of these companies made off with tens or hundreds of millions of dollars. Money paid out because they took on massive risks & played games with the numbers just to collect short term bonuses. I actually feel bad for people like Vikram Pandit of Citibank and John Thain of Merrill Lynch – compared to Charles Prince and Stanley O’Neal these guys got stuck with a ticking time bomb, were hammered in the media, and got paid next to nothing for all that. The former CEO’s are much greater villains here and no one has asked for their money back.

Many people will have objections to my proposal. But in the interests of keeping it brief, I’ll end this post here and cover objections next time! Let me know what you think or any other ideas you have to fix a broken system.

Why Outsource?

By Trishan Arul    March 18, 2009

Full disclosure upfront, this is somewhat of a self-serving post since my company provides outsourced accounting services. However, having been on both sides of the coin, I do think I have a good perspective on the pro’s and con’s of outsourcing. Additionally, I think it is especially important for smaller companies to proactively consider how things get done – it’s too easy in the daily rush of things to end up with the wrong people doing the wrong tasks which can, over time, balloon into bigger problems.

Let’s start with the potential drawbacks:

• Loss of control: You have to rely on another person to accomplish tasks and in some cases they are remote so you can’t “see” them.
• Increased communication: The nature of the relationship requires that you spend more time defining projects up front. You’ll need to keep in contact on an ongoing basis, even if it’s just to check in.
• In-house talent: Using an outsourced provider means that your own staff isn’t developing the necessary skills to perform certain job functions.
• Cost: This is normally a benefit but hiring a good, experienced provider may cost more in the short term than having one of your staff take on more work

I would argue that many of the oft perceived drawbacks are actually beneficial in the long term. For example, losing some control and having to clearly define processes will often result in improved internal control & work flow. Even the cost issue is a misnomer. Many companies I’ve worked with made the mistake of having someone with no accounting experience fumbling around in Quickbooks. This results in many weeks of work to clean up months or years of errors. In those cases, doing it right the first time would have been much cheaper in the long run.

Let’s also take a look at the direct benefits:

• Expertise: An experienced professional will be able to offer specialized skills that would otherwise be unavailable to your business. They can stay up to date in their field (critical for fast moving areas like IT), will be able to oversee/mentor junior staff, are more efficient, and have probably seen & solved your current problems in the past.
• Cost: If you only need a part time person, an outsourced provider can provide that service at a comparable or cheaper cost because they have greater efficiencies of scale. And tying into the previous point, you can get an experienced person that you would otherwise have not been able to afford. Further, you can avoid one time capital costs such as buying software or servers.
• Scaling: Some businesses, especially project based, need to scale up & down rapidly to meet changing business conditions. Outsourcers can handle this variable level of work which eliminates the need to hire, train, or use temporary workers which could result in poor performance and potential layoffs.
• Focus: In my opinion, this is the most important reason to outsource. It allows your company to focus on the skills that set you apart in the market. A successful business does something far better than its competitors and whatever that is needs to be you team’s core focus. Let someone else handle the tertiary tasks involved in running a business while you keep a strategic view of the company and build on the key competencies that make your business unique & successful.

That’s a high-level rundown of the pro’s and con’s of outsourcing. At the end of the day, what really matters is that you spend time to choose the RIGHT outsourced provider which can make all the difference in your company’s success..

Look for a provider:

• with deep experience in their specialty
• who has worked with similar types & sizes of business
• with the infrastructure necessary to service your business
• whom you trust and have a good rapport with

For small business, it usually comes down to the person that you will be working with on a daily basis. Don’t be afraid to ask probing questions and speak with references. Make sure that person fits in to your company culture and shares your long term goals for the company. That will lay the groundwork for a successful outsourcing relationship.

Stimulating Entrepreneurs

By Trishan Arul    March 11, 2009

Given the companies and people whom I work with, it should be no surprise that I strongly support entrepreneurship. The sad thing about the current economic problems is that small businesses have been hit harder than big corporate giants yet NOT A SINGLE POLITICIAN has bothered to help in any meaningful way. Yes, the economic stimulus package allows for bonus depreciation but that is useless if your business doesn’t have money to buy new equipment and, despite Republicans’ fanatical belief in tax cuts, its a very poor incentive to induce spending.  A number of columnists and writers such as Thomas Friedman have advocated common sense changes to foster innovation.

Some things that will help are:

• making it easier via tax incentives for people to invest in early stage companies
• providing operating companies with loans to weather through the downturn

On the first point, Sramana Mitra (whom I have plugged before) wrote a good article on Forbes.com advocating for President Obama to add entrepreneurs to his circle of advisors. Among the changes she advocates and I support is policy that would allow:

An aspiring entrepreneur ought to be allowed to create a tax-free pool of income for use as personal venture capital. Such a pool of capital would go a long way to help kick-start new ventures.

This is just the first step in many policy changes that the government can make to help foster new businesses.

On the second point, an innovative idea related to providing financing to existing businesses was written about by Andrew Field, an entrepreneur himself, in a comment article. He advocates small business loans for every employee hired by a company. The alternative for most is to cut payroll, something that will just make the recession worse since small businesses employ most of the people in this country.

Let’s hope someone in Washington DC is listening. Or better yet, write your congressional representative and US senators and tell them how they should be allocating the trillions of our tax dollars being spent on fixing the economy! I already have.

Start-Up Basics

By Trishan Arul    March 5, 2009

These are the notes from a session where myself and others offered advice to people who were considering starting their own business. This was a session on Tuesday at LaidOffCamp SF, the first OST style conference in what will probably be a series of conferences around the country. Many people were blogging and making videos of this unique concept. It was a great event and I hope all the attendees found the information useful. A lot of it is straightforward information which is helpful for anyone who has not started a business before. And yes, for those of you who watch KRON 4 TV evening news, that was me speaking for 5 seconds during the story about LaidOffCamp.

Please feel free to add more suggested resources in the comments section. I will occasionally update the PDF to include that information. If you attended our session, please feel free to email me with feedback – what was good, bad, helpful, confusing, or even tips on dressing better!

Click Here for Start-Up Basics Session Notes