Dave Naffziger's Blog

Startups rarely launch the way they are intended. Jeff and Todd had spent the better part of a year working on the groundwork for their apparel company, Out of Print Clothing.

They had spent months obtaining license rights for the original cover art from a number of cult classics such as Atlas Shrugged, Brave New World and On the Road. Tracking down the artists that had created artwork 80 years ago took a bit of work. In one instance they traveled to an old mansion in Brooklyn to meet with the widow of one of the artists.

Both Jeff and Todd were pursuing a certain look in their shirts. The quality of the shirt and silk screening was essential - they tried lots of shirt/printing variants until they were satisfied.

More importantly they struck a relationship with Books for Africa to donate one book for every shirt purchased.

They had a launch date planned for several weeks down the road. Everything was coming together nicely. They were lining up influencers to wear their shirts and had developed a media list to reach out to.

Then JD Salinger died.

And they had license rights to the original cover art from Catcher in the Rye:

They had a few more weeks of solid work before launch, but knew they couldn’t miss the opportunity. They worked through the night, polishing as much as they could, cutting requirements where they could and launched the day after the news broke about Salinger.

The result is pretty awesome. Check out their line-up of shirts. In addition to the JD Salinger shirt, these two are probably among my favorites:

Oh and of course, they have the cover art to this post’s namesake:

Amazon announced today Spot prices for EC2 instances - market-driven pricing for unused Amazon EC2 capacity.

You bid an amount per hour of usage, and if the spot price is equal to or lower than the amount, you then get the instance for that hour. This would be a great way to do things such as process time-insensitive data (maybe log files, updates of denormalized data, etc.)

A quick look at the historic graph, shows spot pricing for a Linux m1.small running between $0.025 and $0.35 per hour, averaging $0.030 per hour. Normal instances cost $0.085 per hour. Reserved instances cost $0.030 per hour.

The question that I’m most intrigued with currently is whether we should just move all of our normal instances to Spot instances. We would then set bids equal to the regular pricing. In theory, our pricing should never be worse than what we pay currently and would most likely be much better.

The long-term outcome is likely to be that all of EC2 pricing (except for the Reserved instances) moves to Spot Pricing.

The only risk I can think of is other companies doing the same thing but bidding more than the regular instance price. Then we’d get screwed as all of our instances are turned off. But of course, any company that switches from a regular instance to Spot instances, should free up an equal amount of capacity as they are currently using.

What am I missing? Are there other risks to this strategy?

I shop on Amazon a lot - especially since Amazon Fresh was launched. In fact, I pretty much use it as my first stop for the purchase of most everything.

I don’t own a Kindle and don’t really plan on getting one soon. However, that doesn’t stop Amazon from trying to sell me one. I’ve greyed out the non-kindle above the fold real estate on Amazon’s homepage.

Naturally, I was curious how Barnes and Noble was promoting the Nook. See below:

Amazon is dedicating more space to promoting Crest WhiteStrips than BN is dedicating to promoting the Nook. Does the Nook really have a chance?

My first job out of MIT was as a consultant for Bain & Company. Bain, like other strategy consulting firms was fueled almost exclusively by MBAs and recent college grads.

Excel was used extensively for casework. New consultants received several levels of Excel training and nearly everyone developed Excel expertise. SPSS made an occasional appearance in casework, but Excel was the tool of choice when the data set could be manipulated in Excel.

Super Models
The models and analysis conducted using Excel ranged from simple cash flow analysis through to analysis of data exported from ERP systems and models of thousands of chain store financial statements. Consultants that were unable to pick up Excel rarely went far in the company.

In many ways, skilled consultants used Excel as a basic programming tool.

1,048,576 >> 65,536
I rapidly became an Excel-geek, and I’ve carried my Excel-fu with me throughout my career and have used it to solve numerous problems. I elected to upgrade to Office 2007 solely because of the 1M row limit. I still find Excel quicker than MySQL and/or Python for a number of one-off analysis tasks. Data is far easier to explore, reformat and summarize in Excel.

Now add clusters
Even today, I regularly run tasks that max both of my CPUs in Excel. I have a good sense where the limits lie and avoid them. Microsoft has been testing Excel 2010 running on a cluster of machines. Nearly all the analysis that I do with Excel is exploratory in nature, and Excel provides an excellent solution for the vast majority of these problems. Microsoft is definitely mapping out a path towards the next step which truly excites me:

And then the cloud
Doing all of this in the cloud would truly be interesting. I and nearly all MBAs have no interest in running local HPC clusters. It gets really interesting when you can run a version of Excel that has access to the computational resources in the cloud. I’d happily pay computational fees to use Excel to process vastly larger amounts of data.

I’d also expect that much of the analysis conducted in the financial community that uses MBAs (and some PhDs) for algorithm development will likely remain in Excel rather than going through an implementation stage with a development team.

Google is of course on the way to doing something similar. For now they have targeted the casual user, but I’m sure that will change as Apps develops.

The media[WSJ] really[Independent] has this wrong.

The news in question was ICANN’s announcement (PDF) of internationalized top level domains.

Consider this quote from the AP:

Since their creation in the 1980s, domain names have been limited to the 26 characters in the Latin alphabet used in English - A-Z - as well as 10 numerals and the hyphen.

or this breathless prediction from Wired:

Domain-name speculators will race to buy as many names as they can in languages they don’t understand in order to create more contentless “landing” pages to make money from people who accidentally type that URL into a browser address bar.

Except that ICANN hasn’t done anything to allow new registrations. They are just allowing existing top level domain endings (.com, .net, .org) to be typed differently. Anyone could register internationalized domain names (IDNs) on the .com TLD since 2000. However, for a long-time no major browsers supported IDNs. The real land-rush happened around 2007 when IE7 became the first major browser to support IDNs by default and domainers rushed to purchase IDNs.

The announcement from ICANN only pertains to the bit after the dot. Imagine how awkward it is for a user in Japan to type their intended domain in katakana and then switch to an ascii script to add “.com” to the end. All that ICANN is saying is that it will allow the creation of equivalent TLDs in scripts other than ascii. However, these TLDs will simply be aliases of existing TLDs.

Amazon announced their first EC2 price reduction since EC2 was launched in August 2006.

Amazon’s price reductions take the form of EC2 ‘Reserved’ Instances. Users can opt to ‘reserve’ an instance for an up front cost. Reserved Instances then have a lower rate for each instance-hour use afterwards. For example, a Small instance normally costs $.10 /hour. A 1-yr Reserved Small Instance costs $325 up front and then $.03/hour. That works out to a 33% discount if you use it for a full year. A 3-yr Reserved Instance ($500 up front), results in a 50% discount over the 3 years.

The discounts are the same across the spectrum of EC2 Instance types. If you use your servers full-time, the 3-yr Reserved Instance is the better deal compared to the 1-yr instance if you use the instance for longer than 12 months:

What’s wrong with discounts?

Don’t get me wrong, the Reserved Instances will save BrandVerity a lot of money. I completely understand why these long-termish commitments make sense for Amazon, but some of the magic of EC2 just disappeared:

• Moore’s Law Violations: EC2 is nearing 3yrs old and Amazon hasn’t lowered prices (or increased capabilities) of its basic compute unit. They’ve introduced a ton of different configurations, but core prices haven’t budged. Committing to 3-yr usage and prices gives me the feeling that we aren’t on a pricing slope that parallels Moore’s Law.
• Oh, The Democracy!: Capital suddenly matters. Nothing costs more for the boot-strapped startup, but the company with capital can build a significantly lower cost-basis.
• Scale Flexibility: Committing to specific instance types increases the cost of moving between different EC2 types. UnReserved Surge capacity is now much more expensive vis-a-vis Reserved every-day servers.

Of course, Amazon isn’t bound by many of the assumptions I made above. Their next pricing update could address some of those issues - even for customers that have already purchased a reserved instance.

While there are tons of measures of a startup’s success, one of the more amusing ones is the degree to which your competitors take notice.

We have been fairly quiet in public about BrandVerity and our growth, so I always take a special interest in how new prospects find us (good practice at any stage of a company). We make trials incredibly easy to start, so we often know very little about the party on the other end that creates the account. Occasionally, someone will create an account that just doesn’t seem to fit with what we do.

So far we’ve had at least two accounts that I can directly trace back to a competitor. In one case, the CEO of a peer opened an account using an email address from her husband’s company. She never contacted us directly, but looking at her usage patterns in the site it was pretty clear that she was conducting a feature comparison.

The more recent one was particularly brazen though. An employee of a larger competitor created an account (using a hotmail address), and then sent a note asking to speak. The employee represented themselves as a marketing consultant that managed campaigns for several brands, but over the course of the conversation it became pretty clear that she wasn’t a typical customer. Questions about unrelated aspects of the service, size of company, and customer counts just didn’t fit with a typical customer’s behavior. I declined to answer the more sensitive questions, and after the call I created an excuse to call her back to clarify something. The response at the other end of the call was ‘Hello, ’.

Competitive research is an imperative in business and I certainly expect competitors to try and learn as much as they can about us. I actually think that more direct approaches yield better success (eg just reach out and introduce yourself), but as a startup you should just be aware that anything you say to customers and prospects becomes generally available information.

Oh, and it is great if your competitors accept your Terms of Service!

While speaking to a friend that is starting a company I realized that I haven’t written about filing an 83b Election. The election is a very important step in new company formation and if forgotten can have painful tax consequences.

I use stock vesting to refer to both traditional options vesting agreements and the buy-back restrictions on granted stock. In practice the two approaches generally serve the same purpose: to grant stock rights to an employee over time.

What is an IRS Section 83B Election?

The Section 83B election allows employees to change the tax treatment of a restricted stock grant. Normally, employees pay regular income tax when the stock vests (the restrictions lapse) and no tax when the restricted stock is granted.

The 83B election allows employees to pay income tax on the initial grant instead of paying tax when the stock vests. More specifically, they pay tax on the difference between the amount they paid and the Fair Market Value (FMV) of the stock.

Since the FMV of a brand new enterprise is generally close to zero, most founders purchase their stock at FMV. If the founders file an 83B, they end up paying no tax at purchase and no tax when the stock vests. They will only need to pay capital gains tax when the stock is sold.

The 83B election only applies to restricted stock – it only deals with the recognition of income on stock that has restrictions that lapse.

Let’s use an example to illustrate the effect of making (or not making) the election. We’ll consider a founder that is subject to a 4 year annual vesting schedule:

At formation, the company stock is determined to have a FMV of $0.001 per share and he is granted 100,000 shares. The firm grows and the FMV increases to $.10 in Y1, $1.00 in Y2, $10 in Y3, $100 in Y4 (nice growth curve). Assume a 40% regular income tax.

Initial Stock Purchase: $100
Value of stock that vests in Y1: $2,500
Value of stock that vests in Y2: $25,000
Value of stock that vests in Y3: $250,000
Value of stock that vests in Y4: $2,500,000

83b election filed
Taxes Due at Purchase: $0
Taxes Due at Vesting Intervals: $0
At the end of the 4 years, the founder owns all of his stock outright and has paid no taxes on it. Should he sell the stock, he would be subject to long-term capital gains taxes.

No election made
Taxes Due at Purchase: $0
Taxes Due at Vesting Intervals: Y1: $1000, Y2: $10,000, Y3: $100,000, Y4: $1,000,000
Total taxes paid: $1,111,000

And these taxes had to be paid before the company ever had a liquidating event (the founder never received cash for his stock).

Even worse, if the company collapses in Y5 the founder will have paid over $1M in taxes and never received any cash for his stock.

When do you need to make an 83B Election?

Within 30 days of assuming stock ownership. This rule is notoriously inflexible. The election form must be sent to the IRS within 30 days of the grant.

83B applied to startups

The 83B is typically relevant in two scenarios:

1. Restricted stock agreements for founders. The most common scenario is the restricted stock agreements of founders. Founders should usually draft and sign restricted stock agreements at the same time that they purchase their initial shares.

   A common scenario is one where founders don’t draft vesting agreements when they form the company. Some time later, the company takes investment and the investors require that the founders accept restrictions on their existing stock.
   Since the stock in question was granted more than 30-days ago, filing an 83b might not be an option.

   I’ve received distinctly opposing views from lawyers on this scenario, and a recent ruling (Revenue Ruling 2007-49) by the IRS provides some, but not necessarily full guidance.

   Creating stock vesting agreements after the 30-day 83B window is tricky and can require new stock grants that dilute the initial holdings. Altering existing vesting agreements is much more straightforward and is directly addressed by the IRS ruling mentioned above (and typically allows the original 83b filing to remain in effect).

   In my opinion, founders should always draft vesting agreements when the company is incorporated (for a multitude of reasons). This has an important benefit of giving them the opportunity to file their 83b election within the 30-day window. This significantly lowers the risk that they find themselves owing tax as shares vest if they are required to accept vesting agreements in the future.

2. Early option exercise plans. Some option plans allow employees to exercise their options prior to vesting. This provides the employees the tax advantage of starting the clock on long-term capital gains early. Once the options are exercised, they typically become subject to a stock restriction agreement and the employees would need to file an 83B after they exercise.

How to make an 83B election
The IRS doesn’t provide a form for the 83B election, but the process is straightforward. From IRS publication 525:

How to make the choice. You make the choice by filing a written statement with the Internal Revenue Service Center where you file your return. You must file this statement no later than 30 days after the date the property was transferred. A copy of the statement must be attached to your tax return for the year the property was transferred. You also must give a copy of this statement to the person for whom you performed the services and, if someone other than you received the property, to that person.

You must sign the statement and indicate on it that you are making the choice under section 83(b) of the Internal Revenue Code. The statement must contain all of the following information.

• Your name, address, and taxpayer identification number.
• A description of each property for which you are making the choice.
• The date or dates on which the property was transferred and the tax year for which you are making the choice.
• The nature of any restrictions on the property.
• The fair market value at the time of transfer (ignoring restrictions except those that will never lapse) of each property for which you are making the choice.
• Any amount that you paid for the property.
• A statement that you have provided copies to the appropriate persons.

The form we used to file our 83B elections at BrandVerity is here. Most lawyers will recommend that this notice be sent via certified mail.

Disclaimer: I am not a lawyer, tax accountant or otherwise qualified to dispense with legal and/or tax advice. You should always consult with a qualified professional before making decisions regarding Section 83b and/or your stock plans.