Redesigning the U.S. Business Workforce by Obama Fiat

If you thought Obama’s recent fiat on immigration only on focuses on Hispanic families and other illegal aliens, you are wrong. It targets business growth across the size, maturity and territorial footprint of a wide array of US businesses.

On November 20, 2014, President Barack Obama announced an Executive Order changing the legality of current illegal residents, creating  a path to regularization and amnesty for some 4 million to 5 million illegal aliens who have been in the United States for over 5 years, are not felons and will pay taxes.  But the real economic impact of his governing by “national interest waiver” and “parole” of foreigners into the U.S. will be felt more broadly, in startups, technology-based businesses and outsourcing services.

His proposal is to govern not by enforcing law, but by waiving enforcement and announcing it as an executive fiat rather than by legislative reform.  For politicians, this will potentially expose his waiver policy to judicial scrutiny and political contests in Congress, so much so that I believe that true legislative reform is highly unlikely in the next two years.

The political impetus was humanitarian aid to foreign parents of U.S. citizen children.   The economic impact will be felt broadly, not only in industries (such as restaurants, food processing, farming, landscaping and small business) that have traditionally employed illegal foreign workers.  Indeed, the greater impact will be felt across broad sectors involving STEM technology, startups, venture capital, outsourcing, global consulting and multinational companies.

• Domestic business owners will face increased costs of compliance with new administrative regulations. Those businesses that have relied upon illegal foreign workers will likely have to increase wages because the newly protected illegal foreign workers will have new portability of their work at one employer as a basis for adjustment of status to lawful permanent resident.  The new rules for the “Deferred Action for Childhood Arrivals” (DACA) program will impact every U.S. employer who will need to adopt new employment eligibility reviews, on terms to be defined under future regulations.

• Startup Mania.

• Foreign-owned startups won’t need to worry about H1-B’s.  They will benefit either by “national interest waivers” or (on a case-by-case basis for “urgent humanitarian reasons or significant public benefit”) by “parole.”  For foreign inventors, researchers and founders of start-up enterprises, the Obama administration has set an agenda to “clarify the standard by which a national interest waiver may be granted to benefit the U.S economy.”  Under individual decisions on to “parole” a foreigner, the USCIS will evaluate and grant individual requests for admission from abroad or even extend the right to “stay in place” in the United States.  According to USCIS, waivers and paroles will be granted to “eligible inventors, researchers and founders of start-up enterprises who might not yet qualify for a national interest waiver,” but who (i) have been awarded “substantial U.S. investor financing”; or (ii) “otherwise hold the promise of innovation and job creation through the development of new technologies or the pursuit of cutting-edge research.”  http://www.uscis.gov/immigrationaction/. 
• Startup Investors.  The US government estimates that this will benefit about 400,000 highly skilled foreign workers.  U.S. angel investors, venture capitalists, startup incubators and their operational supporters will be overjoyed, though the details remain to be seen. 
• Domestic startups will probably have greater access to foreign inventors, researchers and co-founders.

• Foreign investors in US companies, global consulting companies and foreign outsourcing companies dodged a bullet.  Foreign outsourcers will probably be able to continue to send large numbers of skilled foreign workers to fill gaps in the US workforce.    However, I suspect that new regulations will be drafted to adopt (tacitly or explicitly) the restrictions and additional governmental scrutiny under the draft Border Security, Economic Opportunity and Immigration Modernization Act, see S. Rept. 113-40 (113th Cong., 1st Sess.), as passed by the Senate in mid-2013.  Thus, H1-B skilled worker dependent employers would likely need to take good faith steps to recruit U.S. workers first, advertise H1-B jobs on a U.S. Department of Labor website and offer the job to a any U.S. worker who applies and is equally if not better qualified than a potential H1-B skilled worker.

• Foreign spouses of H1-B skilled foreign workers will get the right to work. This will bring additional foreign skills and competition to the American labor market.  But Indian and other foreign outsourcing companies were disappointed not to get an increase in the current 65,000 ceiling on H1-B visas, though they must accept that such an increase would take a new law, not a new “waiver” or “parole.”

• Foreign students will likely get increased access to work in the U.S. after U.S. university training under an expanded and extended definition of “optional practical training.”

• Foreign skilled workers who entered the country legally and are in limbo waiting for green cards (lawful permanent residency) will have new flexibility to change jobs without getting sent to the back of the queue for green cards.  This newfound job mobility will give them higher, more competitive salaries and thus less likelihood of being abused as “cheap labor.”

• U.S. labor unions, Obama’s core supporters, have kept their mouths shut.  They probably will be happy to see higher wages for H1-B’s due to portability and no increase in the 65,000 H1-B cap.   They can’t complain about humanitarian waivers and parole for family unification under the DACA program.

• Governing without a legislature.  In the short term, Obama’s executive order to waive the application of the law on a wholesale basis is good for business (especially high-tech, e-business and startups).  As a political gesture, it is probably bad for the incoming Republican-controlled Congress and the constitutional balance of power.  Thus, it will unlikely be overturned legislatively until a new Congress in 2016.

Not only illegal aliens, but businesses of all sizes, universities, startups, venture capital, business angels, tech-based operations can rejoice.   Of course, the devil’s in the details. 

Bringing Phoenix Value to Failed Startups

Entrepreneurship is strewn with startup corpses.  Dynamically, the world’s entrepreneurs, investors, governments, business schools (and their supporters like attorneys, accountants, incubators, consultants and advisors) have created millions of new startups in the last few years.   But startups have a high failure rate.  Yet few commentators discuss the painful process of what happens to failed startups. 

Like political questions, a “startup failure” depends on how you define it.  About three-quarters of venture-backed firms in the U.S. don't return investors' capital, according to a Wall Street Journal report on the research of Shikhar Ghosh, a Harvard Business School senior lecturer.   For him, “failure” means 0% ROI.  The same article cited more optimistic venture capitalists’ estimates that 30% to 40% of startups “fail completely” while another 30-40% return the original investment, and only 10% or 20% yield substantial returns. 

“Startup corpses” have “Phoenix Value.”   A “loser” is any project with 0% ROI.  Starting with the “Dot Bomb” bust in 2003,  some are purely domestic, like the web developers who offered new social “community” business models in 2003 for $500,000 that today would cost $5,000 to $20,000.  Others involve cross-border startups (and more mature enterprises) entering the U.S. markets seeking customers, funding, talent and sometimes a new home.  For example, this category includes “pet robots,” web analytics software and online video editing. 

A “winner” is a successful traveler from the Gulf of Nothingness to the radiant shores of Exitness.  Steps could include incorporation to “friends and family” funding, to VC rounds 1 and 2, to bridge loans where the founders mortgaged their souls (and shares), to sale of non-strategic assets, refinancing, generation of strong customer relationships and highly profitable exit sale.

However, don’t think that failed startups are always lost causes. Professionals can resuscitate, reutilize and reintroduce the lost value from startup corpses.  To help recover value from the startup crematory, an ecosystem of “Phoenix Value hunters” has arisen.   They consist of attorneys, restructuring experts, valuation advisers, investment bankers, stable businesses looking to fill tech gaps and “Phoenix Value” investors. 

Here are a few lessons learned from the trenches.

• Founders and early-stage investors in startups want to ensure the legal entity owns the intellectual property, trade secrets and, to the extent possible, the people doing the innovation. 

• VC investors want a preference in liquidation.  This means not only a preferred payment (ahead of common stockholders) but also a preferred return (the “liquidation preference” multiple of invested capital).

• VC investors need the right to fire the founder from management roles.

• Founders can leave failing startups and build anew, but the manner, timing and perceptions about their departures will impact their ability to raise capital in the future.

•  “Phoenix Value” investors can make good money by buying distress assets from a failing or failed startup.  They don’t anticipate any more “funding rounds.” “Phoenix Value” investors create Phoenix Value for transformation of “dead” or “useless” innovation into productive assets in a sustainable, well-funded business.

• Proper foresight in management and administration of intellectual property (as well as the people who create and manage it) can reduce losses, increase gains and avoid surprises that can kill or delay prospective acquisitions.

• Some bankrupt companies in one country might reappear in the markets of other countries, thanks to Phoenix-stage investors finding and generating new value from the ashes.

 So, when considering a startup or a new product development plan, keep planning for both success and failure.   Understanding how failures can be used to retrieve and revive a “sunk cost” can make a big difference in your personal and professional success.

New Tax Planning for Your Digital Business

Two recent developments in the news should get you thinking about what if….

Domestically, the U.S. Internet Tax Freedom Act (“ITFA”) will expire on December 11, 2014, unless Congress passes another extension.   ITFA, enacted in 1998 to encourage the growth of internet access and e-commerce, has already been extended three times, the last time in 2007.  It essentially prohibits any new direct taxation by state and local governments on internet access, multiple taxes on internet transactions (can’t be taxed twice by different jurisdictions) and discriminatory taxes (same tax rate must apply for both online and its physical counterpart) on online transactions.  A permanent ITFA was passed by the House in July, 2014, but has been held up in the Senate, politics being what it is.  ITFA was due to expire November 1, 2014, just prior to Election Day, but was kindly extended by Congress to December 11 for obvious reasons. 

So what if it is not extended or made permanent:

1)    Consumers and businesses alike would be hit by higher taxes in its usage and access to the internet.
2)    Higher taxes may restrict the ability of (moderate to lower income) consumers to access the internet, thereby reducing e-business sales and profits, affecting the nationwide economy.  Dissemination of information on the internet would suffer as well from lack of access.
3)    Services, such as e-mail, may be subject to taxes, taking a bigger bite of everyone’s budget.

Although it is likely to be extended, e-businesses need to be prepared for the possibility of higher taxes, going forward.

Internationally, on October 29, 2014, the OECD and G20 countries endorsed a new standard for the automatic intergovernmental exchange of financial and tax information, which will usher a new era of international financial transparency, beginning in 2017.  As one of the policies to prevent “artificial” “base erosion and profit shifting” (BEPS), the standard follows the US model of adopting information exchange treaties to identify all financial transactions of its citizens globally, where foreign governments become the willing enforcement mechanism for U.S. tax law.   See http://www.oecd.org/ctp/beps-2014-deliverables-explanatory-statement.pdf.  and recent press release by oecd.

…, [I]t is also recognised that the business models and key features of the digital economy exacerbate BEPS risks and therefore must be addressed. It is expected that the other actions will address these risks but at the same time a number of specific issues have been identified which must be taken into account when doing the work (permanent establishment issues, importance of intangibles and use of data and possible need to adapt CFC rules and transfer pricing rules to the digital economy). A number of broader direct tax challenges have also been analysed, such as the ability of a company to have a significant digital presence in the economy of another country without being liable to taxation due to the lack of nexus and further work will be carried out to evaluate their scope and urgency and potential options to address them. Finally, challenges in the area of indirect taxes in relation to business to consumer transactions have also been identified and will be addressed by 2015.  OECD, BEPS report, p. 8 (see above).

And Ireland has bowed to international pressure to eliminate the “Double Irish” corporate tax loophole, which allows an Irish-registered subsidiary to send royalty payments for intellectual property to another that resides for tax purposes in a country with no corporate income taxes (such as Bermuda).

So, what should the ordinary e-business do to simplify business and minimize compliance problems?

    First, you can’t hide.  As an “ultimate beneficial owner” (“UBO”), you should forget any hope of confidentiality of your ownership interests in any legal entity.  While American corporate laws do not require reporting of ownership to local Secretaries of State, tax laws do.  Under the OECD/G20 standard, you can’t hide behind a foreign holding company.  

    Second, develop strategies for workforce deployment and outsourcing.  Learn about “form vs. substance” and the principles of what constitutes a taxable nexus.  Anticipate that transferring intellectual property to a tax-favored holding company might not work unless it is in the same jurisdiction as your innovative employees who create the IP.  This principle will encourage smaller companies to outsource new product development since outsourcers normally assign IP rights across borders without much tax complexity. 

    Third, refocus on transfer pricing and be reasonable.  The new rules invite governments to tax more.  As governments get more active in adopting a new template for country-by-country reporting and challenging transfer pricing, businesses can consider collective action through trade associations to define standards for transfer pricing levels.  (Of course, exchanging of pricing information smells of concerted monopolism, so this would need some care to avoid crossing the line into anti-competitive conduct).

    Fourth, ask your portfolio companies what they are doing and how they are adapting.     

    Finally, rethink your game plan for tax compliance and eventual tax audit.  Maybe your internal analysis on allocation of value-creation and taxable revenue streams could be programmed into a software model that you could sell on the market.  After all, compliance costs for everyone will only increase, and you could recover your investment. 

Every pain enables someone to gain.  No pain, no gain.