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Growth

Liz Melton / about 11 hours

Deep Dive

Daniel Jakaitis / 2 days

Why I chose freemium I recently bought a tiny SaaS business [https://tryhexadecimal.com/]. When I took over, the original owner had built in a usage-based pricing model that started around $15 per month. As all aspiring private equity investors know, the first thing you should do when evaluating a business for purchase is to figure out how to raise prices. Counterintuitively, right after closing in early February, the first thing I did was set up a freemium pricing model [https://tryhexadecimal.com/pricing]. Hexadecimal operates in a crowded space and competes directly with products offered by large public companies. Some entrepreneurs reject the idea of competition, [https://www.youtube.com/watch?v=3Fx5Q8xGU8k] but in reality, plenty of great businesses take this approach. Standing out in a crowded space is an exercise in market positioning, features, and pricing. Because the uptime monitoring business is essentially commodified, differentiated only by marketing spend and relatively minor features, Hexadecimal had to get a foothold with potential customers. Sometimes the quickest and dirtiest way to do this is going freemium. When to (not) go freemium Unique, premium enterprise products shouldn't go freemium. A product with high COGs should never go freemium (you don't want to lose money on the product you are selling). Most enterprise B2B products should not be freemium. Service businesses should not be freemium. Freemium works given the following conditions: * Your product has an entry point in the B2C space and can eventually go upmarket to B2B or B2C power-users (think Notion, Asana, Github). * Your product has a huge TAM. * Your product has very low fixed costs and sub-linear marginal costs for each new user. * A clear conversion path from free to paid usage (e.g. metered billing, feature gating, service agreements or SLAs). * No (or extremely low) manual onboarding effort. * An LTV that can remain greater than CAC at increasingly large ratios of free-to-paid accounts. On the surface, Hexadecimal checks these boxes. Let's dive in. How big is the TAM? To say that the market for uptime monitoring is large is an understatement. Estimates place the total number of websites indexed by Google at north of 30 trillion. While not every website needs uptime monitoring, most APIs and web services rely on tools such as Hexadecimal to alert users on downtime. There are estimated to be around 50,000+ [https://nordicapis.com/tracking-the-growth-of-the-api-economy] consumable, public APIs. This doesn’t include the hundreds of thousands — if not millions — of private and paid APIs on the internet, and the API economy is only growing. Needless to say, a lot of prospective customers are out there and the market has room for many players. How good are the margins? All in monthly operating costs for Hexadecimal run around ~$150. The costs grow sub-linearly for each incremental user. With only 10 paid users (and around 50 free users), the gross margins come in around 80-90%. At the end of the day the software allows us to effectively re-sell compute time from our cloud provider (AWS) given that we have no COGs. What is the LTV? Huge TAM, great margins, but what about the actual lifetime value of a Hexadecimal customer? This gets tricky, and potentially where the Hexadecimal freemium model begins to run into snags. Courtesy of Profitwell.com [http://profitwell.com/] Thanks to Stripe’s dashboard, we can easily find our current ARPU (Average Revenue per User) of ~$18 per month. As of today, Hexadecimal has churned no paying customers (!!). Using our formula above, our LTV = ($18 * months on the platform). The product has been around for 18 months, so the best I can estimate for customer lifetime is 18 months before churning (in reality, this will hopefully be longer). This gives us an LTV of ~$324. Pretty good. However, by using a freemium model, ARPU will likely begin to decline. The current ratio of free-to-paid users is 5-to-1 (50 free accounts /10 paying accounts). The goal is to keep the ratio of free to paid users below 20-to-1. At a 20-to-1 free-to-paid account ratio, LTV drops to about ~$81 per customer (this is because our LTV calculation is inclusive of customers that pay us $0 per month). This gives us substantially less wiggle room for our CAC. Estimating CAC In a bootstrapped business, with no sales team and no paid marketing, calculating CAC (Customer Acquisition Costs) comes down to pricing my own labor invested. With our current LTV of $324, and assuming I pay myself (hypothetically) around $100 per hour, I should convert at least 1 prospect or, upgrade 1 free customer, per 3 hours of effort. In other words, if I spend 3 hours writing this article, I should walk away with at least 1 paying customer to show for it (hint, hint [https://tryhexadecimal.com/]). What makes CAC calculations even trickier is the fact that it doesn't matter when I convert that person to a paying customer. Retroactively evaluating marketing impact can be a bit imprecise. Given the challenges with estimating CAC, it's best to keep track of the total labor (sales and marketing effort) for a given time period. For example, in a given month if I spend 10 hours ($1000) marketing and selling my product, I should see 2-3 paid conversions. If I don’t, then I need to re-evaluate the effectiveness of my marketing effort and iterate. In practice, this is probably best to do over 1-3 month periods to give your marketing and sales efforts time to gain traction (e.g. SEO, viral marketing, or paid marketing) before running your calculations. You can already see why keeping the free-to-paid ratio as low as possible is critical. The lower the ratio, the cheaper it is to gain new paying users. If this ratio rises to 20-to-1, we suddenly end up with less than 1 hour of marketing and sales effort per paying customer before our CAC becomes greater than LTV. Bad news bears. A note on operating costs CAC and LTV do not take into consideration development hours or operating costs (e.g. servers in this case). These are purely marketing and sales metrics that analyze the trade off of effort bringing a new customer on-board (paying) vs. the lifetime revenue from that customer. For Hexadecimal, the addition of each account adds vanishingly smaller costs to the operating expense of the platform (in the order of cents per month). New feature development, while it has some associated costs to maintain, requires only up-front capital investment that gets amortized over the life of the product (hopefully years or decades). With total development costs for a product like Hexadecimal, the amortization approaches near zero as more users onboard and the platform continues to produce revenue. This is just a complex way of saying this software has high upfront costs, with minimal incremental costs and therefore scales well. Do things that scale Sorry Paul Graham [http://paulgraham.com/ds.html], but if you are going freemium and you don't have VC money to throw around, you need to do things that scale. My labor is expensive (it is actually more than $100 per hour if you are curious). With an LTV somewhere between $80 and $325, the objective should be to create as wide of a prospect funnel as possible and consistently convert free to paid users. Initial strategies for Hexadecimal include: * SEO * Product lead growth * Partnerships * Viral marketing I won’t even try to unpack these here as they all warrant a deep dive of their own. The point here is that with limited resources, and a wide initial pipeline of users, we need to look for things that don’t require increasingly more inputs as the number of users increases. A little bit of psychology A common refrain from entrepreneurs when it comes to free tiers is that it doesn’t force the user to invest into using the platform. Even Freud was famous for always charging [https://onlinelibrary.wiley.com/doi/abs/10.1002/j.2167-4086.2009.tb00426.x] for psychoanalysis sessions as a way to force the participants to anchor themselves to the practice by way of financial investment into the process. Curiously though, by not charging up front, and allowing Hexadecimal users to begin entering data in the platform, we have created a new type of anchor. If we can get the user to simply enter a single website (or endpoint) into Hexadecimal and test the platform, we have created a synthetic form of remuneration. The user is now paying us with their data. As the owner, we can now use this information to turn this free user into a prospect for a paid plan, in effect generating the warmest sales lead you could possibly ask for. Freemium isn’t for everyone Freemium requires conviction and a clear path to conversion. In a commodity-like space such as uptime monitoring, freemium will allow me a shot at prospective customers that otherwise might balk at Hexadecimal in favor of older players. As Hexadecimal’s user base grows, monitoring LTV, CAC, and free-to-paid ratio will be critical. If you are considering a free tier in your app, be sure to have your costs in check and a clear way to trigger a free to paid conversion. Otherwise, forgo the freemium model and stay as a 100% paid solution. Freemium isn’t for everyone.

Operations

Daniel Jakaitis / 2 days

How to

Daniel Jakaitis / 2 days

Finish the Year Strong

The End-of-Year Checklist I like starting the year with an empty to-do list and a fresh perspective. As an obsessive list maker, this process naturally starts with another list. Some of the questions can be treated as action items, but many require deeper reflection (perfect for the quiet week at the end of the year). I hope that you find it useful as you close out 2020! As a Company * What actions most moved the company forward and how can we double down on them? What should we have spent less time doing? * Using the Pareto Principle [https://www.forbes.com/sites/kevinkruse/2016/03/07/80-20-rule/?sh=15a5959d3814] , the return on certain actions will significantly outweigh others. * Did our actions reflect our values? Did we call out times that employees personified our values? Do we need to add or subtract values? * Which relationships are most important to our success (e.g. customers, investors, partners) and what can we be doing to provide them with more value? As a Manager * Do we have the right people on the bus [https://www.jimcollins.com/concepts/first-who-then-what.html]? * Are the right people owning the right things or are there better ways that we can be distributing the work? I keep a Trello board to manage this; steal my template here [https://trello.com/b/v6lu8Xpc]. * How were my 1:1s? Did my reports walk away feeling that I had removed blockers, clarified vagueness, and given clear instructions? * Do my reports know their metrics for success? * How connected is the team overall? Meetings * Is every meeting on my calendar still relevant and useful? * Have I invited the right people to each one? * Are the major meetings for the upcoming year already scheduled? Mine are: * Off-sites * Customers business reviews * Employee reviews * Team town halls * Quarterly kickoffs * Annual trainings * Do I like the cadence and timing of my recurring meetings? * Can I schedule any back-to-back to minimize distractions? * Are meetings optimized to my energy peaks? * I’m fresh and driven in the mornings, so I schedule mentally challenging meetings during this window. * My mind is more relaxed and able to freely relate in the afternoon; I shift most brainstorming meetings to this time. Tools * Are we using the right tools (software, banking, equipment, etc.) to accomplish our goals? Can we eliminate any? I manage our tools in a Google Sheet; copy it here [https://docs.google.com/spreadsheets/d/1cvS-DarVIlliNjEsA90UVLZTOmtBH-4Vm-5N3HihmTM/edit?usp=sharing] . * Do the right people have access to each tool? Has admin access been given to the logical person? * Do we have the right tier of service for our size? * Are there more effective tools available that could reduce or combine the efforts of others? Finance * Are our finances generally in order? This can include: * Outstanding invoices * Unpaid bills * Sales commissions * Expense reconciliation * Credit card charges * Are there areas where we could cut costs next year? * Is billing set to preferred person and method? (I like to see every charge come through and to optimize points based on spend.) Operations * Where can we automate tasks? * Are the company files clean and organized? What about mine? * If a company file no longer seems relevant, I dump it into an archive folder rather than delete anything. * I run an inbox-zero on my file downloads and desktop, forcing myself to put any important files somewhere safe in case something happens to my computer. * Are our templated documents up to date? * Check company address, point of contact, and legalese on contracts, mNDAs, etc. * How are our processes? Which ones are sloppy, overly prescriptive, or begging to be eliminated entirely? Performance * How did I perform against my job description? * I keep my job description as a living document to capture what I take on and hand off over time. When I think my time could be better spent, I discuss this document with my boss and adjust accordingly. * How were my 1:1s with my boss? Did I come to the meeting with thoughtful questions and specific to-dos? * Did I listen to and incorporate feedback effectively? * Did I step up when I needed to? Did I delegate my areas of weakness? Role * How do I want my job description to change in the next year based on what the company needs and on my own strengths and weaknesses? * Which relationships within the company are most important to my efficacy? Can I do anything to improve upon those relationships? * Which tasks I should be taking on or offloading? Time * Am I spending time on the most valuable things [https://www.nfx.com/post/time-management-for-founders/] and letting the unimportant things fall through the cracks? * What have I been putting off? * Can I eliminate it or delegate it? * Can I give it more clarity? * I tend to dread tasks that either feel pointless or excessively vague, so I ask: * What can I stop doing altogether? Personal * Do I like my personal systems for keeping track of to-dos? * Do I know what I bring to the table when I join a meeting? * Am I maintaining a network of people I can turn to for advice? * Am I making time outside of work for activities that keep me healthy and happy?

Deep Dive

Daniel Jakaitis / 2 days

Money In the Bank

Despite the uncertainty of the past year, new business applications are up [https://knowledge.wharton.upenn.edu/article/mollick-pandemic-startups/] 38.5% year/year [https://www.census.gov/econ/bfs/index.html]. For new entrepreneurs it can be hard to know what steps to take when it comes handling your new businesses finances. With the explosion of neobanks in the last few years, there are more options than ever to pick from for your business banking needs. Here’s our scoop when it comes to opening accounts and optimizing your existing banking stack. When is the right time to open your first business bank account? According to the US Small Business Administration [https://www.sba.gov/business-guide/launch-your-business/open-business-bank-account] , “as soon as you start accepting or spending money as your business.” However, that can be a tricky in practice, so let’s look at a few scenarios: Long story short: If you plan to make more than a few bucks, and hope to grow your business, separate the business finances from your personal account. What banking and corporate card features are right for you? So you are taking the leap. You are gonna need a business checking account and a business card (charge or credit). Lucky for you, nearly all banks offering business checking will have cards available to get you started. However, to get the most bang for your buck you may want to mix it up. Decisions around checking accounts are straight forward. You will want some combination of the following: * Lowest minimum account balance * Lowest cost (or free) wire transfers * Low or no monthly fee * Simple digital experience When it comes to corporate cards (charge or credit) it is a little more nuanced and highly dependent on use cases. Here are a few questions to think through: * Will you need to issue invoices for your business? * Azlo offers invoicing as part of its suite. [https://www.azlo.com/online-invoicing/]For more traditional bank card offerings you will need a separate piece of invoicing software. * Will you need a line of credit? * It is generally easier to maintain credit accounts or other types of debt with the same bank that handles your primary business checking accounts. Often, by using the same bank, you will get reduced interest rates on loans or lines of credit. * Which products or vendors will your company be using? * Many startup focused issuers, such as Brex, offer deep discounts for tons of the tooling you are likely already using (who doesn’t want up to $100,000 in AWS Activate credits? [https://www.brex.com/rewards/]). * How much will you be spending? * Premium cards like the AMEX Platinum reward big spending with up to 85,000 points after 15k of spending. [https://creditcard.americanexpress.com/d/business-platinum-drawer/?utm_mcid=3541058&utm_source=google&utm_medium=cpc&utm_term=%2Bamex+%2Bbusiness+%2Bplatinum&utm_cmpid=620018049&utm_adgid=30989218992&utm_tgtid=kwd-41365011624&utm_mt=b&utm_adid=469737613399&utm_dvc=c&utm_ntwk=g&utm_adpos=&utm_plcmnt=&utm_locphysid=9004564&utm_locintid=&utm_feeditemid=&utm_devicemdl=&utm_plcmnttgt=&utm_programname=brandproductspecific&gclid=Cj0KCQiA7qP9BRCLARIsABDaZzgWO3ZCWgs7VS1-oh6Vgpr1ljWoVEH0JuPWpIVyk7n_DXiexEy0iQYaAsxOEALw_wcB] Big spending can come with big rewards, so shop around. * Do you have plans for employee expense management? * Certain issuers, like Ramp [https://ramp.com/capabilities], have issuing built right into their platform. Incumbent issuers like Chase or AMEX will require you to explicitly request new cards for each employee expense account. OK, so what are your options? It never hurts to explore options. No choice is permanent. Banking needs can change as headcount grows and vendor relationships change. Having multiple accounts for specific needs can be a viable solution. Below is a list of our favorite options to kickstart your search. Silicon Valley Bank [https://www.svb.com/startup-banking] Arguably the most popular banking option for startups, SVB has cornered the market for a reason. They offer a 1.00% APY for balances under $1MM for pre-Series A companies, plus a line of business credit cards [https://www.svb.com/business-banking/business-credit-card]. Though their checking account is only free for the first 3 years, they boast a slew of events and other resources for founders. Novo [https://banknovo.com/] This Techstars-backed startup claims no hidden fees [https://banknovo.com/assets/documents/novo-fee-schedule-july-18.pdf] plus a superb online and mobile experience. Focused on excellent customer service, you can chat with their team right through the app. Novo also offers a business debit card and decent perks package [https://banknovo.com/perks]. Mercury [https://mercury.com/] This no-frills solution offers analytics, integrations, and API access as their differentiating points, plus a product line specifically tailored to ecommerce [https://mercury.com/ecommerce]. The rewards side [https://mercury.com/pricing] is fairly scant until you hit $250k, but even the promised partner rewards for the Tea Room are not described in detail. BlueVine [https://www.bluevine.com/] With no fees, no minimums, and a lofty 1.00% APY on amounts under $100k, BlueVine is an incredibly solid option. Their main differentiators include invoice factoring [https://www.bluevine.com/invoice-factoring/] and super fast lines of credit [https://www.bluevine.com/line-of-credit/], making this a good choice for companies heavily reliant upon large invoice payment. They offer a debit card to boot. Azlo [https://www.azlo.com/] Beyond the standard set of banking options, Azlo lets customers issue and track invoices plus set up payment options. Though they offers a free tier, the real magic seems to lie within the Azlo Pro [https://www.azlo.com/azlo-pro/] feature set, which enables further automation and advanced invoicing capabilities. Each checking account automatically includes a debit card as well. Brex [https://www.brex.com/] Previously branded as the credit card for startups, Brex has recently worked to encompass businesses of all stages. Their new Cash product [https://www.brex.com/product/cash-management-account/] means that banking and expenses can be handled in one place. Flush with tech credits, sign-up bonuses, and point multipliers, Brex knows that its clients love to get the most out of their spending. And don’t forget their member-only lounge in SF [https://www.businessinsider.com/brex-san-francisco-members-only-lounge-2019-3]. Ramp [https://ramp.com/] This charge card angling to take on Brex [https://techcrunch.com/2020/02/12/ramp-is-a-corporate-card-focused-on-helping-you-spend-less/] offers an impressive 1.5% back on everything [https://ramp.com/savings], plus a whole lot of startup-focused savings. Pricing is free for companies with fewer than 50 employees, with fixed rate and custom tiers beyond that. They even have a new vendor management system [https://www.producthunt.com/posts/ramp-vendor-management] that brings visibility to recurring vendor payments and consolidating their overhead. Hatch [https://www.hatchcard.com/] Designed for “underestimated small business owners,” the Hatch card is a great fit for founders just starting to hustle. With no fees, a set of perks [https://www.hatchcard.com/perks] tailored more toward brick and mortar owners, and an available line of credit [https://help.hatchcard.com/hc/en-us/articles/360052221053-Credit-and-the-Hatch-Card] , Hatch seems to be targeting the companies that more tech-focused banks may be leaving out. Look out for their mobile app and robust merchant rewards program to launch in the coming months.

Finance

Daniel Jakaitis / 2 days

R&D Tax Credits to the Rescue

Are You Leaving Money on the Table? This week, we spoke with Brian Goodwin [https://www.linkedin.com/in/bgincentax/] about R&D tax credits and what they mean for startups. Goodwin is the Director of Sales and Partnerships at Incentax [https://incentaxllc.com/], a tax credit consulting firm focused on these tax credits for businesses. Quibi has pulled the plugged [https://www.wsj.com/articles/quibi-weighs-shutting-down-as-problems-mount-11603301946] What is the R&D tax credit and how does it apply to my company? The Research and Experimentation (R&D) Tax Credit has been around for over 30 years and aims to promote innovation and jobs within the United States. Traditionally, this credit has been used by larger profitable companies looking to eliminate their overall tax burden, since it is applied dollar for dollar against income tax liabilities. A great example of this is Amazon, who reduced their federal tax bill to nearly zero [https://itep.org/between-the-lines-amazon-q2-reports-hints-it-will-avoid-taxes-on-this-years-record-profit-haul/] . Startups innovate at a very high level, but until the recent PATH Act [https://www.investopedia.com/terms/p/path-act.asp], they were unable to take advantage of the program. Now early-stage businesses with qualifying expenses can put the credits toward the employer share of Social Security payroll taxes, thereby freeing up cash flow. What makes a startup eligible for the early-stage R&D tax credit? Companies just need qualifying R&D activities and expenses. These can differ by industry, but here are a few quick items we look for at a high level: * Does the company create or improve a new product process or technology? * Do employees have scientific-based roles (e.g. engineer, mathematician, developer, etc.)? * Was there a level of uncertainty in the process? Startups are eligible for up to $250k per year in credits on R&D-related payroll taxes (~6.2% of wages) if they: * Have a total of less than 5 years total of revenue (or gross receipts) * Have less than $5 million in revenue in the current open year (greater revenue in prior years is allowed) One thing to note: income tax credits (if available) must be applied before payroll tax credits. For instance, if a company gets $100k in R&D credits while having an income tax liability of $25k, the credit would be applied to eliminate that first. The remaining $75k would be applied to payroll taxes in the early-stage provision. Why don’t more companies know about this? Is this different from other typical business deductions? Companies often focus on deductions rather than credits in order to reduce the amount paid on taxes. With a deduction, you are reducing taxable income, which decreases the amount owed in taxes, whereas a credit is a dollar-for-dollar cancellation of tax liability. Credits tend to provide more bang for the buck. Example: A person with an income of $200,000 is taxed at 32% and pays $64,000 in taxes. * DEDUCTION: A deduction of $60,000 leaves $140,000 of income. Potentially taxed at a lower rate of 24%, the tax bill would be $33,600. * TAX CREDIT: If instead the person received a tax credit of $60,000, they still have a tax bill of $64,000 on the $200,000 of income. With the dollar for dollar tax credit, the final tax bill would be $4,000. The R&D tax credit is mainly underutilized because businesses, particularly early-stage ones, think they won’t qualify for it. Unfortunately, very few conversations are being had to change that, because tax firms tend to focus on larger business. That leaves a big knowledge gap in which early-stage companies and their advisors aren’t given enough resources to understand the potential of this credit. They are missing out on cash flow that can be reinvested in the business, all generated from expenses they’ve already incurred. What are some examples of companies using the credits? On the early-stage side, we’re working with a biotech company with 25 employees (including 5 engineers involved in R&D) and roughly $125K in annual revenue. They qualified for $105K in Social Security tax credits. Another small startup developing a mental health app just did the same, freeing up additional capital to reinvest into clinical trials key to their development. On the income tax credit side, we currently are working with a 45-employee company that manufacturers packaging equipment. They’ve been in business for over 20 years but have never taken the credit. With a multi-year study, they’re eligible to apply over $600K in credits towards current and future tax liabilities. Can these credits ever be applied retroactively? The payroll tax application of the R&D credit is only good for the open year/current year. However, the income tax application of the credit can be claimed retroactively, up to three years back for the federal credit. Most states also have a state R&D tax credit, with the rules and lookback periods varying by state. (California, for example, has a lookback of four years.) Outside of that window, income tax credits can be carried forward up to 20 years and applied to income taxes at a future date, as seen in the manufacturing company example earlier. Are there any risks in using R&D tax credits? The main risk is working with someone who either doesn’t have your best interest in mind (they may over-inflate the credit) or doesn’t specialize in the R&D tax credit (they may not get the calculations correct). If I think my company may qualify, what do I do next? Speak with either a CPA or a tax credit consulting firm, like Incentax, and learn more about your individual situation. Any recommendations for finding a qualified CPA with R&D tax credit experience? Smaller CPA firms are not likely to offer R&D tax credit services because it is very specialized. Ask your firm if they offer it all, and then whether it’s in-house or through a third party. Incentax works with CPA firms in these exact cases, providing expertise and advice on an as-needed basis. -------------------------------------------------------------------------------- What startup do you find most interesting at the moment? StartEngine [https://www.startengine.com/?utm_source=boringstartupstuff] - their platform helps startups with crowdfunding, and they are creating a secondary market for startup investors to trade their shares. What have you been reading lately? Talking to Strangers [https://www.amazon.com/Talking-Strangers-Should-about-People-ebook/dp/B07NDKVWZW] by Malcolm Gladwell; another thought-provoking book on the way we perceive and interact with others. What’s a great piece of advice you've received? One from Ryan Holiday’s The Obstacle Is the Way [https://www.amazon.com/Obstacle-Way-Timeless-Turning-Triumph/dp/1591846358] stands out. A challenge that looks insurmountable is, in fact, the way through. Obstacles are only obstacles because we perceive them to be. See it in a different way and you can, and will, overcome it. To connect with Brian about tax credits and more, email him here [bg@incentaxllc.com].

Deep Dive

Daniel Jakaitis / 2 days

Murphy's First Law

Deep Dive

Daniel Jakaitis / 2 days

Can you afford to do enterprise sales? If you focus on enterprise sales, you will at some point need to show proof that your company has some operational integrity. SOC2 is the most common auditing procedure expected among early stage software startups. The SOC2 audit comes in two flavors: * Type 1: An initial 'in place' audit that verifies security and operations practice at a specific "point in time." This is done once and will run between $10,000 and $50,000. * Type 2: An annual audit that reviews a paper trail over the preceding 12 months to ensure your company meets the audit standards. Can cost $15,000 - $50,000 annually. I encourage using an advisory firm to walk you through your first set of audits. Depending on the type of work they do this can tack on an extra $10 to 50k per audit. > All in, a SOC2 Type 1 and 2 audit will cost a small company $25,000 to $100,000. Each year of Type 2 audits will add $20,000+ in expenses. Keep in mind none of these costs account for the internal labor cost of managing these audits. -------------------------------------------------------------------------------- How to avoid getting on the hook for $179,000,000(We are not lawyers and below is not legal advice) Indemnification clauses will pop up in every contract you negotiate. Any lawyer worth their salt will zero in on these clauses like a fly to poop. What do these clauses do?Indemnity is a risk transfer from the one party to another (from buyer to seller in a purchase or service contract). Why should you care?If you get sued, and your corporate docs are not in order, there are scenarios where you can personally be on the hook. Or, in the event you decide to sell your business, customer contracts containing uncapped or excessive indemnity clauses can create acquisition hurdles. Just ask Uber about how much their indemnification of Anthony Levandowski might cost (hint: $179,000,000) [https://arstechnica.com/cars/2020/04/levandowski-says-uber-must-pay-his-179-million-judgment-to-google/] . What to watch out forIf you are the purchaser/licensee/employer you usually want some form of indemnification in the event of loss or liability that results from the use of the provided good. If you are on the other side of the table (seller/licensor/employee) you are looking for indemnification from breach of the contract terms. As an example, if the purchaser modifies software in a way to infringe on IP of another company (breaching your agreement), you the seller do not want to be on the hook for the infringement liability. A few things to keep an eye out for: * Watch out for requests for uncapped indemnity or vague language. * Any clauses holding officers or employees directly responsible * It is usually better to have explicit language on the type of losses that would be covered. It is common to cover attorney fees. * Know what circumstances would be covered. * Keep an eye out for broadly scoped clauses. Phrasing such as "any services performed under this agreement" could be a red flag. There are dozens of things to keep an eye on depending on the type of contract. I encourage consulting an attorney on a case by case basis. Some final thoughts Verify that your business's corporate docs are in order so the corporate veil cannot be pierced, get good E&O coverage, and continue on with life.

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