Lawson for Congress

If Congressional University had a curriculum, Preventing Economic Growth 101 would be a required class. If we assume that our government is filled with educated people, it would seem that they have been taught hostility to entrepreneurship and job creation.

I serve on the board of a young company that specializes in job creation, and at yesterday’s board meeting, we spent an inordinate amount of time discussing the impact of the IRS’s Section 409A regulations. Basically, companies can grant stock options as a form of noncash compensation to give employees a meaningful stake in the company’s growth. Tax laws encourage granting options at “fair market value”, meaning that the option’s strike price at the date of grant equals the stock price on that date.

But what is the stock price? For a publicly-traded company, the answer is easy. But private companies have no liquid market for their stock. They might be just a business plan, a prototype, or a family business that is looking to expand. The private business is worth what a new investor will pay to buy stock, but any estimate of a stock price between actual fundraising events is just that: an estimate. But thanks to the IRS, we now have specific guidelines for how private companies can value their stock. Fortunately, we have excellent attorneys who can explain these regulations. If you’d rather not read all of the guidelines, here is a sample:

There are significant negative tax consequences if a company pays deferred compensation that does not comply with the requirements of Section 409A. First, the employee is subject to regular income tax on the value of vested deferred compensation even before the compensation is paid. This obviously can create significant economic hardship for an affected employee… The employee is also subject to tax every year thereafter on any increase in value… Second, the tax imposed on this compensation is increased by an excise (penalty) tax that is equal to 20% of the amount of the deferred compensation. Finally, employees are potentially subject to interest on these taxes. While the taxes are imposed on the employee, they also affect the employer because the employer may have an obligation to withhold the taxes from the employee’s cash compensation and is subject to penalties if this is not done. The employer also has an obligation to correctly report the income on the employee’s W-2 and may be subject to penalties if this is not done. (Courtesy of Hutchison Law Group’s Section 409a Valuation Handout)

Lots of ominous words in there: comply, hardship, penalty, obligation, withhold… wait a minute, we’re just trying to create jobs here! So not only did our Board spend an hour reviewing the implications of these regulations, we will convene a subsequent conference call to determine which way to proceed. Perhaps restricted stock grants will be preferable, and avoid some of these headaches, but that will take some additional conversation to explore.

Why does this matter for our economy? Every board meeting involves some element of discussing “compliance” issues. Whether it’s GAAP, IRS, SEC, SOX, or some other acronym, the cost of dealing with regulations is significant. Imagine if the time were instead invested in assessing the company’s operations, opportunities, threats, or strategic plan? What if we were less concerned with protecting ourselves as a board and a company, and more concerned with creating value for our customers and being successful in the marketplace?

Would there be more or fewer companies in that scenario? Would we create more or fewer jobs? Even our attorneys (who are truly excellent, by the way, there’s no sarcasm intended there) would prefer helping more companies start and working on advancing their success then trying to clean up behind this growing regulatory burden at a tremendous expense to their clients.

At the macro level, we’re seeing more public money being raised outside the United States’ equity markets than ever before. At the micro level, we’re seeing companies all over the country defend themselves from regulatory quicksand instead of serving the customer and attacking the market. Never before have the interests of large multinational corporations been so favored over small companies and new startup opportunities. A multinational can afford an army of attorneys and accountants, and can restructure operations to take advantage of tax havens overseas. When will our government stop strangling the goose that lays the golden eggs of domestic entrepreneurship and job creation?

This entry was posted on Thursday, August 16th, 2007 at 3:21 pm and is filed under educational freedom, free market. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.