This week, Ivan Gaviria walks us through the 5 mistakes startups make with their people… A mistake a day.

Ivan is a partner at Gunderson Dettmer’s Silicon Valley office, practicing in the Corporate and Securities Group. He has extensive experience working with startup and emerging growth companies through their entire lifecycle as well as representing venture capital, private equity and other investors.

MISTAKE #5 OF 5:
Ignoring Internal Revenue Code §409A

One last tax code reference – Section 409A.

By now, most in the startup community have heard of this 2004 amendment to the tax code ostensibly designed to address pension plan and deferred compensation abuses post-Enron but chock full of unintended consequences.

It’s a complex set of rules with lengthy regulations. I’ll just point out two key areas to watch out for 409A:

First, 409A imposes some nasty tax penalties on taxpayers who receive discounted options (options with a strike price less than fair market value).

The introduction of this element of 409A has dramatically changed the practices of private start up company boards who historically had priced options using their business judgment and some simple rules of thumb based on discounts from the most recent preferred stock price.

Section 409A recognizes the burden placed on private companies who can’t just look to the ticker to confirm the appropriate stock price and adopted a number of safe harbors that Board’s can rely on in their pricing decisions.

For the startup founder, it’s important to understand the safe harbors and to be mindful of 409A anytime options are being priced.

Second, 409A doesn’t just impact options. The regulations pick up a number of kinds of “deferred compensation” and companies can inadvertently fall into 409A problems when structuring everything from earn outs to severance packages and salary deferrals and carve out plans. As with many of the issues above, seemingly small problems can cause significant cost and delay when they have to be solved under the scrutiny of an acquiring company’s accountants and counsel.

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MISTAKE #1 OF 5 (posted on Monday): Not understanding obligations to prior employers.

MISTAKE #2 OF 5 (posted on Tuesday): Failing to be informed about employee rights with respect to wages

MISTAKE #3 OF 5 (posted on Wednesday): Employees versus Independent Contractors

MISTAKE #4 OF 5 (posted Thursday): Failing to file those 83(b) elections

ABOUT GUNDERSON DETTMER:
Gunderson Dettmer is a leading law firm for entrepreneurs, emerging growth companies and the venture capital firms that support them. With 125 lawyers in four offices – Silicon Valley, Boston, New York, and San Diego – we represent companies in every stage of development from incorporation through entry into public markets and beyond. We provide counsel on general corporate and securities law, mergers and acquisitions, venture capital services, intellectual property, strategic alliances, and tax matters. We combine our experience, industry relationships and expertise to provide practical, business-oriented advice tailored to the needs of the emerging growth company marketplace.

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