Nicola introduced us to the founders of two of the winners of MindTheBridge’s 2011 Business Plan Competition. First was Luca Rossenttini of D-Orbit. D-Orbit, as the name implies, is developing technology to safely remove debris from space. Next was Francesca Cavallo of Timbuktu Labs. Timbuktu is creating the next generation of editorial products that connect kids and grown-ups.

RC Williams, Francesco Baschieri and I also discussed the operational implications of various choices of structuring a business either as a corporation, LLC or sole proprietorship.

You can hear a replay of the program here.

The Free COO program airs live on Thursdays at 4:00pm on Spreaker.

We discussed funding startups, how to create an advantage or “form-factor” for your company and many more insights from Stewart’s career as an Investment Banker and entrepreneur.

The VC’s were really saying, “If your company is not the first to market with an idea, we’re not interested”, the conventional “first mover advantage” theory.

But Facebook’s S-1 is another piece of growing evidence that first mover advantage is not the most important criteria for success. Nor is it a guarantee for success. In fact, a highly visible market first mover might be the critical and essential element for the success of a market follower. Let’s explore this.

Here is a list of some companies and products that were highly touted as innovative market leaders: Novell Netware, Lotus 123, @Home, Yahoo, Palm, RCA, Sun Microsystems, Wang, Ashton Tate, AOL, Monster, Digital Equipment, 3Com, MySpace.

Several of these companies are gone and, of the ones that are still around, it could be argued that they are irrelevant. Yet, the products and services they created are not gone. In every case, they have been out paced by a second or third generation of similar products created and marketed by other entrepreneurs.

For example, @Home was the leader in cable modem. Now, Comcast is. Novell, Lotus, Wang and Ashton-Tate were all out-paced by Microsoft (Wang first by WordStar). Monster by LinkedIn; Palm, first by Blackberry and ultimately by Apple; 3Com by Cisco; MySpace, crushed by Facebook. Groupon? We’ll see.

To be sure, some first movers have maintained their lead: FedEx, Kimberly-Clark, Public Storage. But, for the majority of first movers, there may be a first mover disadvantage.

Imagine you’re trying to cut your way through a mile of thick forest with a machete. You blaze a trail but, emerge from the forest exhausted. Now imaging a bicyclist who happens upon the trail you just opened. They ride right through and pass you like you’re standing still because you are.

First movers have to expend massive resources on design, manufacturing, building product awareness, distribution, educating users, marketing and sales. Second movers get to study the market, assess the overall demand and look for the deficiencies in existing products. Isn’t that what the Sony did with televisions and what Honda and Toyota did with cars and trucks?

Plus, second movers, may be able to take advantage of new technology and start from a more advanced position. Think of the expansion in China. The US is saddled with an infrastructure that was designed and evolved from World War II era technology. China is building out with modern equipment, computerized design and knowledge of all of the shortcomings of western infrastructure.

More importantly, in any field, if you can produce a product of equal or higher quality at lower cost, shouldn’t you go for it? You might even have a similar or inferior product but, with superior marketing and better customer service, capture a huge market share. Does Southwest Airlines come to mind? Heck, if you throw in convenience, you might even have a commodity product and sell it at a premium price just like Starbucks.

So, just because someone who appears to be an authority on business and investing tells you that you shouldn’t try something, don’t give up and don’t be discouraged. Just think what Mark Zuckerberg would have done.

You can listen to the Premier show here:

Follow our show on Spreaker, Facebook or @thefreecoo to receive notification when the show goes live. We’ll typically broadcast on Thursday afternoon around 4:00 pm Pacific time (+/-).

You can join the discussion in real-time by sending emails to thefreecoo@spreaker.com or send a Skype connection request to thefreecoo. On Skype you can text message your question and then we’ll call out to you when we’re ready to take callers.

I welcome your feedback on the show both positive and negative. Your comments and suggestions will make the show better since, this is a new endeavor for me. Send me your recommendations for guest COOs or other interesting people and we’ll do our best to book them on future shows. If you have access to people who might be of interest to you and our audience, please send an introductory email to me and the other person and we’ll be sure to give you a shout-out on the show for making it happen.

Thanks and I look forward to hearing from you and speaking with you on Spreaker.

If you want to operate as business entity with any name other than your own personal name you will need to register the name with your state or county.  Next, in order to open a business checking account, accept credit card payments or establish most other business services you’ll need to provide the bank or merchant service provider with proof of your business entity.

Setting up a corporation or limited liability company can costs hundreds or thousands of dollars initially and, in states like California, will cost $800 per year in minimum state taxes.  However, filing a fictitious business name at your local county registrar’s office typically costs between $25 and $50 and is valid for five years.  The only other mandatory cost is publicly announcing your fictitious name in a local paper which again, is typically $25-$50.

A fictitious business name is essentially a sole proprietorship just like operating under your own name.  Therefore, it does not provide your personal assets the protection of a corporation or LLC but, it does allow you to legally operate as a business and is recognized by banks, merchant credit card providers, the post office, landlords, the phone company and others as a legal entity.

With your fictitious business name in hand, you can order inexpensive business cards from online vendors like Vistaprint or, better still, just buy some Avery business card stock for under $20 and print your own.  Go to your local post office and rent a PO box for as little as $50 per year.  You can get a free phone number from services like Google Voice, search online for banks that offer free business checking (typically with a $100 minimum deposit), get a free email account and that’s it, you’re in business for under $200.

Thanks to my friend PPCIan for posting a great article on his blog “Making your Affiliate Marketing Business Legit” and inspiring me to write this.

Now go out and change the world!

As always, I welcome your comments and, if you have any questions, feel free to post them here and I’ll be glad to expand on this or other topics.  Please feel free to RT as well.

SEO – Search Engine Optimization
SEO is the art of creating content on the internet that, when indexed by search engines, will show up at or near the top of the results page for a given search keyword or phrase. To show up near the top of a results page the content needs to be rich in relevant keywords, readable by search engine robots and referred to by links from external websites.

There are two forms of content needed for an effective SEO strategy:

• Deep content pages on the company’s web site
• External websites with relevant content and links to one or more of the company’s pages

SEO strategy includes content on a company's site and external sites

For example, deep content pages for a company selling plumbing supplies should include at least:

• “how-to” tips
• articles on trends in plumbing tastes and products
• the history of the company
• case studies of projects that the company and or their partners have worked on
• testimonials from customers
• links to manufacturer’s sites or other relevant content and articles on the web

Each content page or article should be rich in keywords such as plumbing manufacturer’s names, parts names and other plumbing related terms. These pages should be static HTML content that are no more than three links from the home page so that search engine robots can scan and index the content.

Simply posting a page of manufacturers logos or deploying a searchable parts database is not a good SEO strategy. Search engine robots cannot make sense of the logos and cannot query the database for each part in order to ascertain text and keywords for a company’s site. The search engines need plain text to read and index. Therefore, logos and other images need ALT text and catalogs pages need to be text accessible from direct links close to the highest levels of the site.

External sites for the same plumbing supply company might include a community forum website for do-it-yourself types, a trade referral site for plumbing contractors, a product review site for plumbing products, an archive site of plumbing manuals, etc. These sites could be produced by the plumbing supply company or may be existing sites on the web that personnel from the plumbing supply company frequently contribute to.

Additionally, external sites should include partners or other related pluming information sites that can post a link to the plumbing supply’s website from the external site. Examples of external sites might include trade association sites, sites of architects, designers, or manufacturers.

Think about the pages that you see near the top of your search queries. Typically they include a Wikipedia link, perhaps the one or two largest manufacturer, and then general article pages. The reason why Wikipedia pages show up so frequently is due to the sheer volume of deep content on so many topics. Each Wikipedia topic page is rich in keywords that match the search term and includes links to other related pages. There are many links into Wikipedia as well. All together this makes a Wikipedia page authoritative and highly relevant to search engines.

A company’s goal should be to make their website as relevant and authoritative as possible. Doing so will increase the number and quality of visitors to their site. Increased visitors will result in increased customers. Increased customers is the ultimate metric for a company’s SEO strategy.

Once your product is ready for market, the challenge of selling even the best IP can often be more difficult than creating it in the first place, particularly if your target customer is a medium to large enterprise. The sales cycle for enterprise B2B software or to get a fabless semiconductor design embedded in a larger SOC or System On a Chip, can be at least six months and often more than one year. Even after your product passes all the technical due diligence, it turns out that one of the main reasons a sale falls through is that it’s difficult for a startup company to convince the decision maker of a large enterprise that your company is viable enough to warrant a strategic relationship.

Put yourself in the shoes of the large enterprise decision maker and consider a report published by the US Bureau of Labor Statistics’ Monthly Labor Review in May of 2005 which concluded that over 60% of all Information companies fail within their first four years. Will he or she be serving the best interests of the enterprise’s shareholders and board by taking on the risk of doing business with your company? If the decision maker’s job is ultimately on the line, then even if your company’s product is outstanding, they would be statistically right to pass on your deal more than 60% of the time. So, is there something you can do mitigate the risk of doing business with your firm? The answer is yes.

Before your IP is used as part of an online service handling millions of transactions a day or embedded on a chip and shipped all over the world as part of some electronic device, your client, the large multinational bank or giant electronics firm, needs to know that support will be available a couple years down the line when a bug is found or an upgrade is needed. The sad truth is that even you can’t know if your company will still be around, so you need provide some form of insurance that your client’s business won’t be impacted if your company does fail. That’s where an escrow agreement comes in.

An escrow agreement between two or more parties establishes the rights to access or take possession of IP in the event of a set of predetermined conditions (usually the bankruptcy of or failure to fulfill some obligation by the owner of the IP). The agreement specifies a neutral third party who will hold a copy of the IP on behalf of the parties to the escrow agreement and establishes procedures for taking possession of IP by a beneficiary in the event a condition is triggered.

With an escrow agreement in place, a large enterprise can be assured that if your startup company fails, is purchased by a competitor or otherwise is unable to meet its obligations, they will have the right to continue to use your IP and, if necessary, have access to the actual formulas and know-how so that they can assume responsibility for long term maintenance and support of the IP for as long as it is embedded in their products or services.

Escrow agreements usually require that a copy of documentation and or electronic data be placed on a disk or other media and stored at an escrow service. When software, designs and/or data is updated, a new copy of the IP is sent to the third-party escrow service at some predetermined interval so that the beneficiary is assured that it will have the most recent version of IP in the event that it needs to exercise its escrow rights.

The cost of escrow can be borne by either or both parties as agreed in the terms of the sale or partnership. Escrow services typically require a setup fee, update fees and some sort of fee in the event that a beneficiary claim is triggered. For an extra fee, some escrow companies can also provide independent validation of software or data based on criteria provided by one or the other of the escrow parties.

Here is an example of how an escrow agreement might work:
Your company is a startup that collects data and sells restricted access to that data via the web as a business to business service. Your intellectual property is the data, your methods of gathering the data and you infrastructure for providing the data as a web service. Your target customers are large banks that need to look up a record from your company’s database in order to provide services to their customers.

You’ve been in negotiations with a very large client for a number of months and the client’s CIO is concerned that your company’s infrastructure may not be robust enough to sustain millions of transactions each day. The CIO is also worried that you won’t have the financial wherewithal to scale your company as their needs grow and may ultimately declare bankruptcy and “go dark” on them.

In order to close the deal you offer to put an entire copy of your database, software and description of your data collection methodology in escrow. You agree to update the database monthly and the latest version of your software at least quarterly. You do not allow the client to see your software or your methodology documentation, but you do agree to allow the client to have the escrow company test the data after each update. You allow your client, at their expense, to specify up to 1,000 random queries for the escrow company to run against the data. The escrow company will verify that the data in their possession contains the results required to satisfy your client’s queries.

In the event that your company fails or is acquired by a competitor of your client who might cut off access to the data, your escrow agreement provides for your client to instruct the escrow company to release the data, software and methodology to the client so that they might maintain their operations and have their own developers establish and continue operation of the data service.

Your escrow agreement might have language specifying a single lump sum payment or ongoing licensing fee in the event of an escrow action. It might also include restrictions on resale or sublicensing of the IP to third parties after your company fails or is sold.

The CIO of your prospective client is fully reassured by the escrow agreement. In fact, he is so impressed with your company’s confidence in its long term prospects that he signs a longer term partnership agreement than you had hoped for and even agrees to absorb the cost of the escrow service, so that your startup can devote all of its resources to growing the company.

In Conclusion
So if your startup venture’s age comes into question when pursuing an enterprise customer, think of ways that you can insure your company’s performance even if you can’t insure your finances. It’s still up to you to run your company well, but an escrow agreement should allow you to overcome viability as an objection to a long term contract.

But there are some legal pitfalls to hiring independent contractors that most startups (and many established companies for that matter) don’t understand. This post is the first of a three part series that helps to explain some of those potential pitfalls, so that you can make an informed decision before hiring an independent contractor.

There are many aspects to engaging with contractors including the fundamental question of whether or not to hire or contract for a given role, managing contractors to get the result that you want, and sourcing a quality contractor, to name a few. Once you’ve made a decision to hire a contractor, perhaps the most important thing for you to do is to make sure that a contractor cannot be construed as an employee of your company. Get this right and contractors can help you rapidly launch your startup. Get it wrong and it can be a costly and time consuming problem for you about one to three years down the road, just when you can least afford a serious distraction.

Before we go any further, let me clearly state that I am not a lawyer and the following should not be construed as legal advice. Before hiring independent contractors you should speak to your own legal and tax professionals for advice on whether or not any of this applies to your specific situation. Still, I have been an independent contractor, was CEO of an IT consulting company for thirteen years and, as COO of two startup companies, have hired hundreds of independent contractors. So, I think I can provide unique insights into the company-contractor relationship from both sides of the equation.

A Brief History of the Issues with Hiring Independent Contractors
The Internal Revenue Service (IRS) is the body that requires companies to distinguish between independent contractors and employees. The history behind this is somewhat interesting, but it all boils down to who pays the IRS (a company or the contractor) and how the IRS can get its money as quickly as possible. Since the IRS is at the root of the matter, the issue of a potential employee-employer relationship being created by incorrectly hiring a contractor applies only to U.S. companies engaging U.S. based independent contractors. It does not apply to engaging with foreign contractors (however, there are some other considerations that come into play here as well).

It was Section 1706 of the Tax Reform Act of 1986 that changed the nature of hiring contractors by making it illegal for computer programmers, engineers, designers, draftspersons and several other technical professionals to claim a self-employed status. As with most laws passed by Congress, lawyers and accountants were exempted. After 1706 was passed, most states added similar language to their state tax laws.

Senator Patrick Moynihan of New York introduced Section 1706 ostensibly to offset or pay for tax revenue losses caused by the Tax Reform Act of 1986. However, I’ve heard two rumors as to the “real” reason for the law. Both involve IBM, whose headquarters being in Armonk, New York, made them an influential constituent of the senator. Rumor has it that 1706 allowed IBM to either reduce taxes on foreign professional service revenue, or it helped IBM protect its massive professional services business by squelching the burgeoning independent consultant trade caused by the confluence of the advent of personal computers and the dawn of corporate downsizing in the U.S. in the 1980’s. I tend to favor the later explanation over the former, but have no idea if either is true.

Senator Moynihan was able to convince his fellow senators that self-employed skilled technical contractors were a bad risk for making timely or full payments to the IRS of their self-employment taxes. In order to assure that the IRS get withholdings or estimated payments from self-employed contractors as soon as possible, 1706 made it mandatory for contractors working through brokers to become W-2 employees of those brokers or, in order to contract directly with clients, to bear the burden of proof that they were legitimate self-employed “businesses”. Because 1706 carries the threat of penalties plus payment of back taxes and benefits to companies hiring independent contractors, the law had the effect of putting thousands of independent self-employed skilled contractors out of business (you can decide for yourself if that would that be a good thing for IBM’s professional services division).

I had been an independent contractor to a large Silicon Valley high tech company for three years when 1706 passed. Then, in 1988, in order to continue working for the company, they gave me an ultimatum of either going to work for a broker or forming a corporation, either of which would make me subject to W-2 wages and withholdings from a “third-party” entity. My client would therefore be off the hook for any potential employee-employer relationship liability.

The provisions of 1706 exist to this day and it is imperative for you to be aware of the potential problems it could cause for your startup down the road. For example, in the mid 1990’s the IRS deemed Microsoft to be the employer of many of the contractors who had been working for the company for many years (the 80’s and early 90’s were Microsoft’s most explosive growth period). This led to IRS fines as well as civil litigation which Microsoft ultimately settled in 2003 by paying $97 Million to 15,000 former contractors and their attorneys.

What You Need to Understand In Order to Properly Hire Independent Contractors
Employees are paid wages and are subject to tax withholding. Employee withholdings are paid to the IRS and state agencies each payroll period. At the end of a calendar year companies are required to issue each employee a W-2.

Independent contractor fees are not subject to tax withholding (with some exceptions). Independent contractors are required to pay estimated taxes (on their own) to the IRS or other state agencies each quarter during a calendar year. At the end of each calendar year if an independent contractor is paid $650 or more, the hiring company is required to report those fees to the IRS and issue a 1099-MISC to the independent contractor.

Failure to treat the contractor/client relationship properly can result in the IRS deeming it as an employee/employer relationship with the company having to pay back-withholdings, penalties, interest and/or back-benefits. In other words, by establishing or maintaining the relationship improperly, the IRS can make a determination that an independent contractor is, in fact, an employee of the hiring company.

The IRS has establish some guidelines for determining if one is a contractor or an employee and these guidelines are generally referred to as the “20 Questions” (see Rev. Rul. 87-41). If someone can answer yes to most of the 20 questions, they are likely to pass muster as an independent contractor.

The surest way to be sure that an independent contractor cannot be construed as an employee of your company is to establish that they are paying regular withholdings as a W-2 employee of some other entity such as a third-party broker corporation, the contractor’s own corporation or as an employee of an LLC. In this case, your company will be contracting with a corporation or LLC and not with an individual sole proprietor. You are not required to issue a 1099-MISC to a corporate entity and corporations are not subject to W-2 withholdings.

Beware of independent contractors acting as sole proprietors and using a business name that may or may not be properly registered as a fictitious business name. Sole proprietors are required to pay self-employment taxes and must do so in a timely manner which is generally through quarterly estimated tax payments.

If you pay a sole proprietor more than $650 in a calendar year you are required to issue a 1099-MISC to them by January 31 of the following year. But that is not enough to get you off the hook. If that sole proprietor does not make timely payments to the IRS or takes business deductions on Schedule C of their annual 1040 tax return that are “audit flags” to the IRS, they may be audited at any time up to three years after they file their return. Once audited, the IRS may determine that the sole proprietor was not an independent contractor but, in fact, an employee of your company and that’s when you will be swept up into an expensive and time consuming tax action.

Be especially aware of a sole proprietors who have “employees” or “partners” who may also be sole proprietors. If the partner or “employee” is providing services to your firm and the sole proprietor is paying these other persons without withholding taxes, they too could be construed as employees of your company during an IRS audit.

The advent of online freelance or guru websites where you can post contract requisitions, engage independent contractors and pay a fixed rate or fee through the site’s escrow services does not exempt you from exposure to the contractor/client relationship being construed as an employee/employer relationship if you are engaging U.S. based contractors. Be sure to read the fine print of the terms of agreement section of the site because you will likely find that the site makes you specifically liable for the relationship. They are specifically exempting themselves as responsible for determining if the contractor is properly organized and/or paying taxes in a timely manner.

What You Need to Do In Order to Properly Hire Independent Contractors
1. Become familiar with Section 1706 and the 20 Questions
2. Whenever you hire an independent contractor, be sure your legal agreement incorporates language consistent with the 20 questions that will stand up in a tax court three or four years from now.
3. If two independent contractors are available to you for a particular engagement, favor the one who is incorporated over the sole proprietor if the sole proprietor cannot answer the preponderance of the 20 questions affirmatively.
4. If you hire an independent contractor who is a sole proprietor, be sure to have them fill out an IRS form W-9, before you issue any payments to them.
5. Don’t treat independent contractors like employees. i.e. don’t give them business cards; don’t introduce them to partners, customers or investors as employees; don’t invite them to company functions such as holiday parties and all-hands meetings; don’t give them a company email address or publish their name in your company directory.
6. Make sure that you are not the independent contractor’s only client and/or don’t let them work solely for your company for more than eleven months.
7. If you hire U.S. contractors through an online site, be sure that you can have the contractor sign some agreement directly with your company that makes it clear that they are not an employee. Also make sure the online site provides your company with a copy of the 1099-MISC issued to the contractor at the end of the year for your records.

In Closing
Independent contractors can be a great resource for your startup allowing you to hire the senior talent that you need and who you otherwise could not afford to hire on a fulltime basis due to their high salary, total compensation needs or geographical proximity. Independent contractors don’t require stock options, HR and payroll hassles, but can be as productive and trusted as your best employees. Contractors tend to stay out of office politics and are generally focused on the specific task at hand. Therefore, they can often provide unbiased and objective advice which, as a manager, you should always be seeking.

Just be sure that the contractor you engage with is a real “professional” and understands that a proper arm’s length relationship is important for your company and his or her practice. If the contractor is a sole proprietor, make sure you take steps to protect yourself and your company from exposure to violation of section 1706 of the Tax Reform Act of 1986.

In Part 2 of this series I’ll discuss how to draw up proper independent contractor agreements that will minimize your risk of exposure to independent contractors being construed as employees. In Part 3 of this series I’ll discuss the 20 Questions and provide some examples of questions I’ve received from my employees and contractors when they are in the process of preparing and signing independent contractor agreements.

In a period of high unemployment, outsourcing, cost-cutting and general economic uncertainty every employee needs to be keenly aware of their value to their organization. They should also be able to easily point to solid data that proves their worth. The ability to do this well, could make the difference between you being someone who is indispensable or someone holding a pink slip. If you are not your own best advocate, you should be.

If you’re a sales professional or product manager, it’s usually easy to calculate the revenue and gross profits attributable to your efforts. However, a COO and personnel in other operational positions need to maintain their own metrics such as productivity gains, cost savings, upsell revenue, or effective hourly rate. I figured this out on my first job out of college and I’ve carried this skill with me to this day (see some examples at the end of this post).

The COO is responsible for all internal operations including HR. Therefore, he or she is in a unique position to make sure that all managers and employees have clearly defined objectives along with appropriate metrics to measure their success and contribution towards fulfilling the company’s vision. At least one of those metrics should reveal an employee’s return on investment or their effective hourly rate.

For example, it is not uncommon for software developers to put in very long hours during the coding phase of their projects. If a top developer is earning $120,000 per year, a traditional analysis based on a 261 day work year (including paid holiday and PTO days) would show them as earning $57.50/hour. However, if they are typically putting in 10 hour days and, when deep into a development phase, up to 16 or 18 hour days, their effective hourly rate might be more like $38/hour.

Would knowing this allow you to hire a more expensive developer than you had budgeted for? When faced with a cost cutting decision, would it be cost effective to let go of a senior developer with longevity, simply because her salary is higher than other senior developers? Are you measuring how much effort your knowledge workers are actually expending? If one of your key developers was threatening to leave because he felt he could earn more someplace else and came to you with a similar analysis, would you simply say that $120,000 is the best we can do?

If you’re a COO you should be aware of your contribution to the bottom line as well. If you save the company $150,000 on advertising fees, purchase used furniture at $100 per workstation vs. new furniture for $2,000 per workstation, hire a PEO organization at $150 per employee per month vs. an HR manager, payroll specialist and support personnel at $400,000 per year* how would that affect your company’s cash flow and operating income? If your efficiency expertise adds 3% to 10% to net income, you should be able to document that for the CEO and the Board of Directors. You should also impress upon your direct reports and their employees to track similar metrics, because those also roll up into your net contribution.

A lot of Boards, investors, CEO’s and financial analysts put the bulk of their emphasis on revenues and gross margin when looking for the main contributors to a company’s success. That explains why sales professionals are often the most highly paid people in an organization. But some of the most successful companies take a more holistic approach and value the contribution of each person and function to the whole of the organization. Companies like Southwest Airline, GE and 3M look for efficiencies and cost saving measures throughout their operations. They measure and reward the top contributors wherever they may be. Your company should, too.

As the COO you should be leading the awareness of placing a monetary value on everyone’s efforts. You should be touting your own contributions, as well. Doing so is leading by example, and what better way to lead is there?

Justifying Your Annual Salary by January 31 Every Year
Plant managers of large manufacturing firms are justifiably skeptical of corporate engineers and managers descending on their factories from the company’s headquarters. Plant managers have P&L responsibility for their facility and don’t like engineers mucking around with processes, or managers imposing system-wide policy changes.

As a young engineer fresh out of college more than one plant manager rolled his eyes at me when I first walked in the door. My specialty was industrial noise control and I knew that the PM didn’t want some green kid telling him to put a box around his equipment or slowing down production. But I had a job to do, so I needed to show the PM that I was not just a corporate hack but someone who was there to help him.

Fortunately, I knew something that most plant managers didn’t. Noise is a by-product, and getting rid of it can sometimes lead to huge savings. When I’d first meet the PM, I always asked for a plan diagram of his factory and for permission to let me take a quick survey of the entire plant before I focused in on any specific problems. Using a sound level meter, I’d produce a color coded noise contour map which easily showed the worst problems as red colored contours. In addition to large problems like punch presses, saws, and furnaces, my initial maps always had a dozen or so small red circles which I knew were an indication of sound levels in excess of 105 decibels around a leak in a high pressure air hose (all manufacturing facilities use compressed air for material movement, production or cleanup). Leaking hoses and fittings cause air compressors to run more frequently in order to maintain pressure, and the excess compressor time costs $5,000 per year, per leak in energy consumption not to mention excess wear on the compressor itself. Replacing a leaking hose or fitting costs less than $100 in time and material. So, typically within 24 hours, I could show a PM how to save $60,000 or more per year and eliminate some of the worst noise sources in his or her factory. This one action would more than justify my trip to the factory and gained me instant credibility as an ally, not an expense.

Carrying this further, by January 31 of each year, after two or three plant trips, I could show my manager at the home office that I’d already saved the company hundreds of thousands of dollars, more than justifying my salary for the entire year!

Helping a Client Maintain a Partnership
My IT consulting company was engaged by a multinational freight forwarding company to develop a fully integrated online move management system. The company was well established and had recently acquired one of its large competitors. The new system was going to take two or more years to develop and fully deploy world-wide. We’d be consolidating various manual and automated systems, replacing the newly acquired company’s entire infrastructure and deploying a modernized IT backbone world-wide. The CEO and COO of the company were young executives representing the next generation to run this family owned private company. Our project was seen as a bold strategic exercise by the prior generation with a high price tag that would take several years to achieve payback.

About two months into the project the CEO and COO asked to meet with me about an important matter. One of their lines of business was providing logistical support and storage yards for the shipment of vehicles around the world under contract from a large multinational shipping company. My client was the largest of four subcontractors providing this service to the shipping company, responsible for over 70% of the vehicles moved and 100% of the information management. The information management was running on a PC based flat-file database program developed by an employee of my client who had little computer or programming experience. It had been refined over many years and was, in fact, doing the job. However, at the prodding of the other three logistical partners, the shipping company decided to have its IT department develop a modern supply chain management system with a relational database and internet backbone. This decision was made without my client’s knowledge and represented a significant threat to their business. At best, it would mean total loss of the information management revenue part of the business and, at worse, loss of part or all of the move management work. My client estimated the total loss would amount to multiple eight figures annually. They were very worried, hurt by what they felt was a betrayal of their partnership, and concerned at how such a loss might be perceived by their elders who had recently turned over operations of the business to this generation.

My client asked if I would conduct an assessment of their technology and present a report to the CEO of the shipping company to impress upon him that it was sound and that an upgrade was unnecessary. They felt that the CEO of the shipping company, who had been a long time partner and friend of their parents, was simply being misled by his IT managers.

Upon review of my client’s technology, I found that it was indeed outdated and I could not honestly report that an upgrade was not warranted. I proposed taking a different tact. I told my client to accept that the “ship had left the dock” and that they could not stop the shipping company from developing a new system. However, perhaps we could convince the CEO that his IT department was making a mistake by failing to include my client in the process. I said if we could get the CEO to understand that my client’s intellectual property was the enabler of this partnership, we might be able extract a licensing fee and/or an agreement that would lock in my client’s participation as their preferred partner in perpetuity.

I asked my client’s developer to give me a count of all the functions he’d programmed into his system. I didn’t care how complex or simple a function was, I simply wanted a count. The number was nearly 5,000. Then, I asked my client to arrange a meeting with the CEO of the shipping company and his IT staff. I prepped my client for the meeting telling them not to let their emotions get the best of them. They could not get angry with the CEO, because he was not a technologist and was likely just following the recommendation of his CIO and the other partners, who were in fact, competitors.

The meeting took place the following week, with the CEO and five of his direct reports flying in from the east coast or Sweden. Within minutes, the meeting got out of control when my client’s COO lashed out at the shipping company’s CEO for betraying them. The shipping company’s CIO escalated the anger and tension when he sharply criticized my client’s system as being “Mickey Mouse”. I called for a time out and everybody stood up and huddled into their own corners.

I walked up to the shipping company’s CEO and asked if he’d step out on the balcony with me to chat for a few minutes. Once we were outside, overlooking the San Francisco bay on a sunny California day, I asked him to excuse my client’s behavior as they were simply hurt by the situation. Next, I asked him what sort of estimate his CIO had given him for creating the new supply chain system. He said they estimated six months.

Then I told him how I became involved with the matter and how I agreed with his technical team that my client’s system was antiquated. I told him that I had already convinced my client that it was in everyone’s best interest to move to a new system, and that the transition be smooth and successful. However, I asked to arrange this meeting because we felt that he needed to know that making the unilateral decision to replace the system, leaving my client out of the process, would be a financial and operational mistake. I reminded him that my client had developed the existing system at their own expense for the benefit of the partnership. It had evolved over more than a decade and codified 5,000 unique business processes necessary to fulfill his contract to his auto suppliers. To think that his CIO’s team would be able to learn all that operational knowledge and reprogram all 5,000 functions in six months without my client’s help would be highly risky and likely to disrupt his ability to service his clients. I said that my client would be willing to license their intellectual property to his company in exchange for an annual fee and a guarantee that they would be a perpetual partner in this operation.

He thanked me, walked back into the conference room and asked everyone to sit down. He asked his CIO if he was aware of how many functions were needed to facilitate the supply chain system. The CIO said he did not have a count, but they were starting to gather requirements. That was all he had to hear. He commanded his team to draw up a licensing agreement to transfer my client’s technology and assured my client that their partnership would stand for as long as his company had the contracts with their customers. The meeting was over within one hour.

I saved my client tens of millions of dollars annually, essentially giving them an immediate payback on the internal move management system that we had been contracted for, as well as for any fees that we would ever be charging on any other project. Over the next few years we completed the move management system, identified ways to save over $2 million per year on communications costs and provided other benefits in operational costs and head count reduction.

How 2% Can Pay For Your Entire Existence
My most recent role was as COO of an Internet based consumer services company. The company was started by two young brothers who were 19 and 23 years old at the time, the youngest being a sophomore at Harvard when he launched the initial website. I was the second person hired after a person who was answering customer emails.

The company was self-funded and generating money by selling information to consumers. To drive consumers to our web site we relied on various marketing techniques including search engine marketing or SEM (some call this PPC or pay per click). SEM was our largest expense at first and all of the search engine companies were making daily charges to one of the brother’s credit card. Because the brothers had no credit history, we were hitting the card’s limit every couple days, which was becoming a cash flow problem as our spending increased. It also required a lot of my time because I was checking our credit card balance several times during the day and night, seven days a week and paying down the balance several times a week so that our SEM campaigns wouldn’t be halted.

We explained our dilemma to our largest search engine provider and convinced them to switch from billing our credit card to sending us a monthly invoice. Since our credit card merchant provider was wiring our revenue payments to us semi-monthly, paying the SEM charges once per month provided immediate relief to our cash-flow situation.

Our company was profitable from the get-go, growing 15% to 25% month to month during the first couple years and, after a few months, was starting to build a cash reserve. After a while, we had been proving to the search engine company that we were able to make our monthly payments, so I asked our representative if they would offer us 2% 10/net 30 terms. They refused to do so.

I knew that as we grew, our SEM expenditures were going to exceed seven figures and finding a way to reduce that expense would directly affect our profitability. Fortunately, cash back credit cards were starting to emerge and since the search engine companies accept credit cards, I figured let’s find a cash-back card and switch back to paying for SEM with it. Most card issuers offered 0.5% to 2% cash back, but limited the total eligible spend. I needed to find an issuing bank that would offer 2% cash-back, not cap our eligible spend, give us a high enough monthly limit to accommodate our current spend, and be willing to review our financial statements each quarter to increase our limits as we grew.

It took over a month of concerted effort, production of lots of financial information, a personal guarantee from the founders and staking my more than twenty-year squeaky-clean business reputation for never missing a payment to convince one issuer that our company was an acceptable risk. The card was issued and we switched all of our SEM spend to the new credit card. In addition, we started paying virtually anything that we can with this card including insurance premiums (GL and E&O), vendor purchases, rent, utilities, software, co-location fees, etc.

Fast forward, three years later, and our annual savings are approaching $200,000 per year and growing. The credit card company is delighted to have us as a client and being able to consolidate the bulk of our expense processing into one source has greatly simplified our accounting.

This one action, by itself, more than justifies any salary that I’ve taken out of the company. And it is just one of many examples that I can point to.

* including benefits, annual training, facilities

One of the first questions a startup venture needs to address – at least as soon as the founders hire their first employee or contractor – is who will be responsible for the HR function. Getting this right is critical to the success of a venture, as it is the first five to ten people in an organization that will establish the company’s culture for years to come. If your company has a COO, then HR will clearly fall under his or her domain.

There are two main aspects to HR. First, there is the impression of the company as an entity and an environment that new hires and contractors will perceive and ultimately retain, based on their interactions with existing personnel. Next, there are the activities performed by HR personnel including generation and maintenance of paperwork, recruiting, planning and execution of HR functions (benefits, company events, performance reviews, on-boarding, etc.), to name a few.

A third aspect, of overarching importance, is the legal ramifications of virtually every component of HR. When HR matters turn into a legal problem, it becomes an expensive and time-robbing experience. Therefore, the HR function should not be taken lightly or for granted by startup entrepreneurs.

So, where should an entrepreneur start with HR? What are the top five or so things to devote time and energy to without diverting too much mindshare from the company’s vision? Here is a proposed list:

- New Hire Package
- Contactor’s Engagement Package
- Plan for regular reviews
- Template for job requisitions
- On-Boarding procedures

Each of these will be covered in greater detail in subsequent posts, but here is a brief summary of each:

New Hire Package: Job Requisition or description, resume of the candidate, job application for the candidate, EEO forms, background check authorization, welcome letter, offer letter, inventions and proprietary information agreement, arbitration agreement, reference check information, other pre-hire communications, candidate submitted papers, W-4 and I-9 forms, emergency medical form, property pass.

Contractors Engagement Package: Project description, resume or brochure of candidate or contractor firm, background check authorization, non-disclosure agreement, contractor agreement with inventions and proprietary information agreement, W-9 or W-8 form, reference check information, certificate of general liability and or workers compensation insurance.

Plan for regular reviews: Employee hire date tracker and tickler system, documentation of each employee or contractor’s unique objectives and criteria for the tracking period, definition of key criteria for all employees or contractors, ranking system, review procedure checklist for supervisors and employees, template for presentation of review information to be used during the actual review meeting.

Template for job requisitions: Master document with fonts, logo graphics and layout of key sections. Key sections include job title, summary with work location specified, job description, requirements of the position, required experience of candidate, educational requirements, company description, contact information, legal and EEO footer.

On-Boarding procedures and checklist: Employee or contractor’s cube or office location, list of computer and other equipment, list of software, office supplies, business cards, phone extension, IT requirements (username, email alias, group membership, permission levels, homepage, VPN access, etc.), keys and/or access tokens, cell phone, orientation meetings, description of first day or week’s activities.

Even though one may disagree whether or not these are the correct top five, the salient point is that there are a lot of items to consider. Remember also, that I have not even listed payroll and benefits.

One might take a position that their organization is simply too small or too young to worry about getting exactly HR right, but that would be a cavalier position and will surely come back to bite an entrepreneur when it comes time for dismissing an employee, or worse, when intellectual property goes walking out the door with no recourse for stopping it.

Does this mean that every start up needs an HR manager at the outset? Absolutely not! In fact, I would argue that a startup venture should not hire an HR manager until there are at least 50 employees and perhaps as late as 100 to 150 employees. Even if a startup could afford the luxury and salary of an HR manager, it would cost an additional $50,000 to $100,000 per year to maintain that employee’s legal knowledge, or to subsidize their lack of legal expertise with outside accountants and attorneys.

Instead, a startup organization’s HR should fall under the domain of the company’s COO and he or she should outsource the HR, payroll and benefits to a professional employer organization, or PEO. Doing so, leverages the COO’s time, reduces internal headcount and greatly simplifies the logistics of growing a startup. This one decision alone could be a key enabler for rapidly ramping a young organization.

There are so many benefits to working with a PEO that it almost seems like a “no brainer” decision. For example, think of hiring a PEO as an insurance policy. It provides virtually full indemnification for all legal matters around hiring and firing as well as complying with local, state and federal requirements for tax and benefits withholdings. Just like an insurance policy allows you to pass off liability for an accident, a PEO allows you to simply refer all discharge, workman’s comp, unemployment insurance, disability and 401(k) problems to another party.

Employment and payroll tax laws change every year. There is no way that one person can keep up with it without extensive continuing education requiring a large expenditure of time and money. Even then, it’s almost impossible for one person to be a subject matter expert on both employment and payroll. Add in 401(k) retirement plans and it’s simply impossible for a startup to maintain the expertise in-house. A PEO is comprised of a team of employment, payroll and benefits professionals who each maintain their annual certification in their particular area of expertise. It is their job to keep up with current law and they can afford to stay current because each professional is leveraged across all of the PEO’s client companies.

With a good PEO, a simple email is usually all it takes to deal with the legal ramifications of a problem employee. A CEO never has to deal with the matter at all other than being kept abreast of issues when he or she holds their weekly meeting with the COO.

Additionally, the right PEO allows a startup to hire employees in any state, facilitating a virtual organization and allowing for a scale that would otherwise be impossible to achieve. In other words, with a PEO your hiring pool is no longer constrained to your local market.

Even with a PEO, it’s still up to the startup to manage the day-to-day activities of all employees and contractors. However, the CEO and managers need only to deal with real business matters that have direct impact on products and customers. The COO and his assistant can easily handle all the rest by leveraging the PEO (i.e. hiring, firing, benefits, 401(k), payroll, PTO, etc).

The PEO will not establish the company’s internal culture or environment, but it will allow a company to “feel” like a larger and more stable organization which will be a huge factor in attracting top talent to a nascent company. Employees will appreciate having access to the PEO’s online system for managing changes to their W-4s, setting up direct deposit to their bank, establishing allocations for 401(k), and managing Section 125 or Section 132 dollars.

There is no way to grow your startup without dealing with HR matters. How you deal with it will make all the difference in the quality of employees and contractors that your company can attract and retain. You can do it in-house if you have the resources and expertise, or you can outsource it to a PEO. Keep in mind that each HR function requires a checklist of activities to perform and documents to maintain. Keep those documents organized and secured in terms of filing system and access control in order to comply with state and federal requirements. Good HR is like a security blanket for employees. It not something that anyone will thank you for, but it will add to an overall sense of comfort for management and employees, and will be one more of those things that makes everyone happy to come into work every day.