SPEAKER_01: All right, everybody, welcome back to startup basics. I love doing this series because I got a lot of friends in the industry, they help my startups do things right, so that they can focus on their product, their team and their customers, and not worry about the risk of ruin that comes from illegal, human resources, or most commonly, actually, an accounting or finance problem with me, my good friend Scott Warren from Cruz. Cruz is an accountant consultancy that does a ton of startups, they got 800 customers, I believe something crazy like that. That's us 800 you 800 and that's a lot of
SPEAKER_01: startups. And men, startups love what you do. You guys always have that white glove service, you take care of the two person startup as well as you take care of the 200. So we really are thankful for that. Today on startup basics, I get a lot of my startups talking to me about this employee retention credit, erc and you see you hear these like, they're kind of sound like drive by asbestos lawsuit people, but people getting bombarded with emails, hey, you got to get your employee retention credit. It's free money. It's free money. Don't listen to your accounts. Explain to us what erc fraud is, yeah, and why startups and VCs need to be aware of this and to not take chances. Yeah, you got to be super careful employee retention
SPEAKER_00: tax credits were a COVID era stimulus. And there's a ton of good stuff that came out of that era. Like the PPP was really helpful kept a ton of startups alive. And there's a couple different versions of the ERC. There's one ERC that if you just started your company after February 15 of 2020, like they gave you a pretty good chunk of cash, we had a lot of companies take advantage of that totally legal totally on the up and up. The other version of the ERC is the one where hey, your company experienced the shutdown, or there's a government mandate that crippled your company or things like that, which is was very well intentioned, I think about $250 billion has come out of the government and stimulus. But this is the crazy part. 100 billion has come out this year, like three years after COVID. Right. It feels a little suspicious, maybe that three years later, all this money is coming out. And what's happened is, there's kind of these like ERC farms, like the asbestos analogy is such a great analogy. Like they're, they're cold colony, I don't know about you, but I get like three or four of these phone calls a day. Nobody knows my number. No office
SPEAKER_01: number. We have this great partner open phone. They're sponsored here on this weekend startups, we use open phone. And we got these phone numbers, not my mobile phone. Nobody gets my mobile phone. I love it. I love it. You got to be careful. Yeah, these guys are calling. They're they're like boiler room and they're trying to get you to know how does it mechanically work? What do they do after they get you on the phone and say, Hey, do you want to have all your employees salaries from COVID paid back? That's what they're doing. They're saying
SPEAKER_00: like, you can get 26,000 bucks per employee. But the but the twists are, they kind of fudge everything. So like, Oh, was there a government shutdown that hurts your company? Well, his founder might be like, Well, we had to work from home for a month that kind of sucked, you know, and they'll be like, Great, let's file. And realistically, if you were able to telecommute during that time, you weren't shut down. That was that's not gonna hold water. You know, there's a bunch of like, just edge cases like this that they kind of, it's just like preying on unsophisticated people. They're sophisticated people are super smart engineer salespeople. They're not sophisticated tax people nine these companies, right? No, it's like a specific government program. Totally. And it sounds
SPEAKER_00: official. And, and they run as all kinds of stuff. And so you just have to be super careful. It's so that the fraud got so out of control that now the IRS is openly talking about it. And they have a couple solutions here. First of all, if you're a startup, and you've applied, but you kind of know you shouldn't have applied, you can actually write in and walk away right now, as long as you haven't taken the money. And right, I highly, highly recommend this. Okay, the second pathway is if you've taken the money, you thought it might be a little too good to be true at the time. But now you're having second thoughts because the IRS is saying they're going to come after people pretty hardcore in this. You can there they haven't initiated this program yet, but they're talking about letting people voluntarily pay the money back and preemptively get out of the crosshairs. So so if the reason why I kind of want to talk about this is like, we were super careful with our client base and guided people away who you know, again, they just didn't know. So they're asking about it. But most of the companies in our portfolio of clients didn't qualify because these were these were not you know, there's this didn't hit the these have specific benchmarks that you have to hit. And they
SPEAKER_01: wanted them to go to people who had a restaurant that got shut down. They wanted a hotel and airline something that was grounded and could not in any way, you know, compete and the numbers are crazy. Like, if you look at the timeline of this, it was like 3 billion or so in 2020 and then 10 billion than 58 billion in 2022 with a half million employees or so, and it got to 152 billion in 23. I mean, this is like insane. And there's something it got to like 230 billion. It's for got
SPEAKER_00: paused. It's a huge amount of money. And you can imagine if these these folks, you know, the boiler and folks are probably, you know, sailing on yachts right now. But that's the stuff that all gets kind of taken away later. So just be careful. Like we, you know, we talked on the cash management episode, you're not in business to speculate or take unknown risks, like your job is to build a company and get users right. And so just be really, really careful. And we've all been around the block enough in the startup world, like if it's too good to be true, it probably is. And one of the telltale signs is they will tell you not to be true. And they'll say like, your CPA is wrong, or don't talk to your CPA or things. There's, there's also some stuff around how the ERC intersects with already tax credits, like most companies that launch invest in, are going to be eligible for already tax credit, because they're investing in, you know, really innovative stuff. Yeah. And so the ERC cannot be you can't do a double dip on already tax credits and ERCs too. So there's, there's just a lot of risk. And getting caught would be could be the risk of
SPEAKER_01: ruin, because they could just audit you. And I mean, the worst case here is your company just goes out of business, right? And then I don't know if they're putting people in jail for this kind of stuff. You know, and I'm guessing they would just give you fines up the wazoo. Yeah,
SPEAKER_00: I think so too. And probably a lot of bad press, which your startup doesn't need. You don't want people googling for your account, you want people to be a user, then finding out that the first result is a ERC fraud conviction. So just be careful
SPEAKER_01: about this stuff. If you were going to pursue this, the proper path would not be some rando calling your cell phone. And given a high pressure tactic. I think if I was going to pursue this question, I call my guy, Scott a cruise. And I say, Hey, or whoever your accountant is, I say, Hey, CPA spent a lot of money going to school to get your CPA didn't you Scott?
SPEAKER_00: Yeah, luckily, Vanessa, Vanessa Cruz, the cruise consulting is a CPA and she's the best darn tax person in Silicon Valley. And we have a 25 person team that handles this stuff. So like, right, yes, you want to go through a methodology, a checklist of eligibility. And then if you are eligible, you want to file correctly. And this stuff even gets reflected on your annual tax returns to it's not just like you've sent in a form and count the money. There's a lot of complexity, not a scratch off ticket. First, yeah, and here's the thing about a CPA. CPAs spend a
SPEAKER_01: lot of money to get that. And they make a decent bit of coin. Having a CPA that's important distinction. They don't risk it. Yes, they don't want to risk their own license. So there, it's like a pilot on a plane. You know, you can the pilot doesn't want to crash the plane either because they're on the plane. When you have a good partner, a good CPA, or you got a good lawyer, they don't want to put their firm in harm's way. And they don't most of all want to put you in harm's way. So you're sitting on the plane together, you're going to the destination. Nobody's doing barrel rolls here. Nobody's going to you know, try to fly under the Golden Gate Bridge and do a flyby. Keep it tight, keep it right. Don't take chances. And honestly, do you really need this? Yeah, I really need 26k across your six employees to get like 150k just focus on your product, get your stats going, you can raise more money if you got growth, you can you can charge more to your customers get more customers. That's what you should be doing. That's the way
SPEAKER_00: I totally agree. And also as a positive, the research and development tax credits actually going up, like, for the 2023 tax year, so we'll be all doing those next year. That's going at the 500k. Okay, so if you're if you're a launch company, and you're spending, you know, 5 million bucks on R&D, you're gonna you're gonna get into that 500k zone. So you're gonna be picking up this tax credit in a different difference between me
SPEAKER_01: building software, I'm building my app, and doing R&D for my app. This has always been confusing for me, there's a
SPEAKER_00: four part test to see if the engineering you're doing on your app actually qualifies for research. So I'm embarrassed. Again, I'm not the taxi pa I some most of the time I know this, but there's basically has to be like in the hard sciences like biology, chemistry, electrical engineering, things like that has to be very new. But basically, we walk every company is for this. Yes. And the technological nature of it
SPEAKER_01: is important. Exactly. And it has to be novel is the word I
SPEAKER_00: was searching for. Ah, yes. But there's two other qualifications. So there's elimination of uncertainty and
SPEAKER_01: process of experimentation. That's exactly it, actually.
SPEAKER_00: Yes. Thank you. So those four things are in, believe me, the founders when we're because we do an already tax credit call with every company and make sure they're qualifying. Because of course, you know, sometimes people are tempted and they'll say, of course, I qualify. We actually go through it line by line and make sure like, for example, you can't do qa qa is not engineering. That's novel, right? Yes. Sometimes you'll have people trying to throw their marketing span or crazy stuff like that. And that's building an app. And I'm doing
SPEAKER_01: an AI algorithm that's never existed before sounds pretty novel to me. That feels R&D ish to me super novel. There's also
SPEAKER_00: one important thing, which is to get the US already tax credit, they have to be either engineers on a US payroll, or they have to be contractors who are based in the US sometimes will have companies offshore everything to Poland or Ukraine or wherever, right China, that those people don't pay payroll taxes on their salary. So the government can't really give you the money back on those payroll taxes.
SPEAKER_01: So the goal of this from the US government is to encourage R&D in America and spend and jobs. So that's why they have this credit to begin with. So once again, you know, it's good for you to learn about these things. It's good for you to take advantage of them if you are entitled to them. But you're going to need to go through that process with an expert. And this is secondary to your core business. So you don't want to waste a ton of time in this. You know, if it's a fit, your CPA is going to tell you if it's not a fit. They're going to tell you that too.
SPEAKER_00: Exactly. And like you said, the CPA is signing the tax return, like Vanessa signs the tax returns. So I've seen her a million times be like, what's this number? Or why is that that doesn't look right to me and go back to the companies. And so because you're right, there's no way Vanessa is ever going to risk her license on some flight fly by night already tax credit or something like that. Right. So so the the CPA is you signing section is gonna be really careful.
SPEAKER_01: Yeah. And just tight is right, as always, what should a year one startup just ballpark? You know, you raised your let's say C round of 500 k, you got three or four employees, what should they expect to spend to do their taxes and their finances properly? They don't have tons of invoices going in and out there in that product market. What would you spend in that first year year one of your startup, you know, I would say just to do your accounting is like 500
SPEAKER_00: bucks, 600 bucks a month at the very baseline stage. And then the taxes are going to be somewhere around like $3,000. One of the big variables is how many states you're in. So I'm sure you guys saw this in your portfolio. Companies now are hiring in many different states, including crews, like we've got we're in like 25 states, right. And so every extra state you have employees in or a lot of sales, and you create tax nexus, and you have to start filing a tax returns in those states and registering to do business. So if a company is very spread out, it's going to be more. But if they're in California, New York, Texas, wherever, they have to be employees, this is where
SPEAKER_01: contractors can be a great way to avoid these issues. If you have freelancers and contractors who are hourly, and they're like in Canada or another place, you know, it's not going to trigger that in all likelihood. Again, your CPA, it's talked to you
SPEAKER_00: baby, because if you are buying them a lot of equipment, or you're paying for their office lease, or things like that, it can trigger things. So there's always the devil's in the details on this stuff. But if you're in a very, you know, one state, two states going to be around 3000 bucks. And that includes the, you know, the companies you invest in are going to be Delaware C corps all day long, I believe. So you're going to do your Delaware franchise tax, your California, New York, Texas franchise taxes, one of those additional are extra, they're also going to help you with 1099. People forget, we have contractors, you have to issue them at 1099 every year, because they need that to do their taxes. And the IRS has pretty substantial fines for not issuing 1099. So always do that. And then of course, you've got your annual state tax term, the federal tax return. And then there's also stuff like asset filings, like if you know, Jason, if you invested in like a heavy equipment company in California, they have to file some taxes on all the assets they purchase things like that. But those are the big ones, Delaware, amortize the cost of
SPEAKER_01: that is that the word over time, they would they would
SPEAKER_00: amortize that on their tax return. Yes, they also have certain just it's called a 571 out where they have to file tackling a small tax rate on their asset base, basically, not to get too complex here. Yeah, but long and short of it in a
SPEAKER_01: 10k a year, probably what you could expect to pay, keep everything nice and tight. And that's super reasonable. It's
SPEAKER_00: in its money. So what's because I tell the founders like you're buying your time back, like are you going to do this? And then the payoff is you go to coffee with someone like you or someone that you introduce them to, right? And they're interested in the company and they come back and they're like, Hey, I want to give you a term sheet. Are your financials accurate? Can you send them to me? Can you send me your model? Hey, if we get into diligence, are you going to pass all the tax compliance checks, right? Like, that's where not like sometimes founders think they can sprint and catch up. But really, you can't once that once the that motion starts on a fundraising round, it's almost impossible to catch up. So doing it preemptively, we say due diligence ready day one at cruise when you come out of onboarding, you are due due diligence ready. Like if if you have coffee, Jason Calcana, and he wants to invest, you're going to be able to sign that term sheet and have confidence that deals going to close without hiccup, right? That's what you want as a founder.
SPEAKER_01: It's super important. One of the things we have in our database is reasons to not invest in a startup. We have 25 of them we've identified 25. You know what one of the top ones that
SPEAKER_01: comes up is? We call it the accounting nightmare. Oh my gosh. And literally, when we're doing diligence, if Ashley or Jackie or Kelly or any of my people check off accounting nightmare, it's like, boop, boop. And we have to pause everything. And we say, Listen, get yourself an account to clean this up. You're doing cash based accounting, the numbers you gave us for your revenue. We don't know what's going on here. You took a year, you're charged one group of people unlimited lifetime subscription for your sass, you got other people paying monthly, you got another group paying for a two year subscription, you got a salesperson who was selling some custom stuff, and you just did cash based accounting. Yeah, yeah. And so your your your cash is going like this. When are you recognizing this? You know, if you did a lifetime subscription, and it was a one time for life thing, how does that get accounted for? Okay, you know, this is complicated. I'm not saying don't do it. You're you? How do we know what the actual trajectory of the startup is? We now don't. Yeah. And sometimes that happens after we decided to invest in the company and move them to diligence. And then now we can't. Now you got to clean it up. How long does it take to clean something like that up after a year or two? I mean, full sprint a month at least,
SPEAKER_00: you know, and you break a month or two, and maybe you only had
SPEAKER_01: six months of runway. And now you're, you know, basically dancing on the cliff for no reason. Well, unnecessary. Also,
SPEAKER_00: I'm sure you're talking about the revenue aspect of that. But I'm sure you see this on the cash based accounting for expenses where they think they've got 12 months left or, you know, and all of a sudden, they pay a bunch of invoices one month, and they've got six months of cash left because the the the denominator has gotten so big, right? You know, so like, there's no no easier way to freak out your board at a board meeting than to cut your runway from 12 months to six months because you paid a bunch of invoices, right? And so I do, I
SPEAKER_01: have a very simple way to defend myself. I've done this for my entire career since I was in my early 20s to start my first companies. I just have a weekly report. What's getting paid? What came in? How much cash is in the bank account at the time you sent me this Friday email, and then they put everything else in there. But I just like to know, hey, what's the cash in the bank? And they're like, Oh, well, we have a P&L here, it comes out on the 15th. This happens. Okay, yeah, that's great. Open up Bank of America, open up Silicon Valley Bank, whatever it is, tell me what the number you see in there is, I just want to know what the cash balance is. And then I can look at it myself and eyeball it. And then I say put the payroll in there. I want to know the payroll. And I want to know when the pay periods are and what we actually paid. And I'm like, Whoa, what happened here? Why? Why do we pay 20% more than this at the last payroll, but I just like to have those numbers constantly reinforced in me. Because it's kind of like understanding how to play cards or backgammon or any of those games where once you have the statistic kind of memorized, you're kind of then figuring out your strategy. And so when I know how many people haven't put and then it's like, Oh, it went up 20% because we paid severance to somebody Oh, went up 20% because we've hit a bonus to somebody. Oh, there were sales commissions that got paid. And I'm like, Oh, okay, I get it. But just I like to see the numbers. I like a nice dashboard. And for me, I'm wrapping up my week. Everybody's getting ready for the weekend. And I just get that nice little email. Sometimes I check it Saturday morning when I have my coffee. And I know I'm safe because I have a fear, Scott, from my childhood of running out of money. Totally get it. Well, here's the thing too. When they do send that
SPEAKER_00: email to you every month early in the month, they're building confidence with you. Right? Yes, I would say that, you know, folks like you have a speed dial. And when you decide you really believe in a company you pick up and you call five of your VC friends and they're gonna take that call, right? Sure. The speed dial doesn't happen if they're not sending you monthly updates in building that confidence and that you can track it right. There's no there's nothing worse than pick up the speed dial and sending a crappy company somewhere right that people find out probably so like, that's it's also it's like kind of like going to the gym every day. Like, yes, you know, if you keep yourself in shape, you're gonna your investors are going to notice that it's going to be so much easier. So I just
SPEAKER_00: sending those monthly investor updates early in the month and you're exactly right. All you got to do is look at your cash balance, you can subtract what it was last month, you know what your burn rate is. The other little pro tip is always the morning of a board meeting. Take that screenshot of what your cash balance is your bank and sit there with your laptop while you're having the board meeting and know that number. There's nothing scarier than when someone has to see or CFO of a startup. What's in the bank right now? And they don't know the answer. Terrifying. Yeah, right. Let me get back to you.
SPEAKER_01: Yeah. Oh, my God. Let me get back to you is the wrong answer. I've seen. Yeah, that will get you fired as a CEO, actually. Yeah. And let me tell you something. If you go and you say to the pilot, what's the altitude? You think the pilot doesn't know the altitude to plan? Hey, what's the speed? Okay, great. You need
SPEAKER_00:
SPEAKER_01: to know those numbers, folks. If you're flying the plane, they have their eye on that number. In fact, they show you that number when you're a passenger all day long on the flight aware, you're right. So you get to watch it. If it's good enough for the passengers, trust me, the pilots got that. That's front and center. That's amazing. And that's your burn. Amazing altitude and speed. Because you know what, if you don't get altitude and you lose speed, you stall. Yeah. And stalling and startups means running out of cash. That's not going to happen if you have a great partner like cruise consulting. So here's your call to action everybody. Go to cruiseconsulting.com slash twist. Talk to my guy, Scott. That's my guy. He takes care of me. I take care of him. We do this together. I have a problem with the startup. I say Scott, I got to fix this right quick. I love the startup. I don't like the accounting. You know what Scott does? Zip, zip, zip. I get priority service from cruise consulting and you will to cruiseconsulting.com slash twist. Go see my guy Scott. He'll fix it up for you this week and startups.com slash basics to see all of our basics. Great job, Scott. It's good to
SPEAKER_00:
SPEAKER_01: see you. Looking good. You look healthy. Thank you. By the way,
SPEAKER_00: I love the legal basics. That those are so helpful to like, I really recommend that for folks. Yeah, I mean, let's see. There's
SPEAKER_01: no stupid questions. Let's just be honest here. We just go over the basics and you know what we should do? It's time for a crossover. Oh my gosh, that would be awesome. I'm gonna get Wilson since and Cruz and we're gonna do an overlap episode and we're gonna do board meeting basics. Oh, so good. And the accounting and the legal things you got to get right. Coming to you soon folks this weekend service.com slash basics. Thank you, Scott. My man. Thank you, sir. See you next time, everybody.
