Convertible Debt or Convertible Equity for Early Stage Companies

An article by Leena Rao – a senior editor at TechCrunch.com – suggests that while convertible debt may be getting popular with early stage investors, it can cause a lot of problems. This is especially true where Series A funding doesn’t come along before the notes become due – putting start ups in default.

This is an interesting read – Convertible Debt or Equity – but I’ll let you read it for yourself.

In BC there is a different problem for which convertible equity may also be a solution. With this province’s VCC incentives, angels are in certain circumstances (EBC investments)  encouraged to hang on for 5 years in exchange for an immediate 30% return to investors. While this lowers the risk, it may also extend the amount of time that the money is at risk. Regardless of which investment model is used, it is often difficult for investors to achieve an exit.

As I mentioned in an earlier post – convertible equity may be used by VCC or EBC investors as a means of ‘encouraging’ a management buyout, thereby securing an exit, where funds may be stranded in a ‘lifestyle business’.

Evaluating BC’s Venture Capital Programs

In June of 2010 Thomas Hellman (Sauder School of Business – UBC) and Paul Schure (Department of Economics – Uvic) prepared a report evaluating BC’s Venture Capital Program for the BC Ministry of Small Business, Technology and Economic Development.

Executive Summary

The objective of this study is to evaluate the economic impact of the venture capital program (VCP) in the province of British Columbia. The study focuses on the economic and financial performance of the companies in the program, including a comparison of the tax credits received versus the taxes paid by these companies.
The VCP provides a 30% tax credit to investors making eligible investments. Formally it includes three distinct programs, one for Labour-sponsored Venture Capital Corporations, also called Employee Venture Capital Corporations (EVCCs), one for Venture Capital Corporations (VCCs) and one for Eligible Business Corporations (EBCs).
Over the period 2001-2008, investments made in 517 companies received a total of $191M provincial and $65M federal tax credits. These companies generated an estimated $379M in provincial and $368M in federal taxes. The estimates suggest that for every $1 of provincial tax credits issued, recipient companies generated $1.98 in provincial taxes; and for every $1 of Canadian (i.e., combined provincial and federal) tax credits issued, they generated $2.92 in Canadian taxes. In short, the BC tax multiplier was 1.98 and the Canadian tax multiplier was 2.92.
The analysis distinguishes between retail funds (professional venture capitalist who invest and manage capital on behalf of qualified investors through prospectus offerings) and nonretail investors who essentially invest their own capital directly (nonretail investors are sometimes referred to as “angel investors”). Retail investors invest through either the EVCC or VCC programs, and nonretail investors through either the VCC or EBC programs. The study finds that retail investors claimed approximately 55% of the BC and 66% of the Canadian tax credits. The Canadian tax multiplier was very similar for the retail and nonretail portions of the program. However, the BC tax multiplier was lower for the nonretail portion: every $1 of BC tax credits generated $2.45 of BC taxes in the retail segment, and $1.41 in the nonretail segment. The difference arises from the fact that the federal government carries some of the costs for the retail segment (namely half of the EVCC tax credits), but does not carry any of the tax credit costs for the nonretail segment.
The tax estimates focus on sales taxes (PST & GST), income taxes and corporate taxes, both at the provincial and federal level. The two largest items were PST, which accounted for 35% of all tax revenues, and federal income taxes paid by employees, which account for 31%. Combined provincial and federal corporate taxes accounted for less than 3%.
Companies in the program generated an average of 2.43 new jobs every year. This compares favorably with a broad control sample of BC companies that generated almost no new jobs at all during the sample period. Net job creation remained positive even in the recession years of 2002 and 2008. The vast majority of new jobs were full-time positions.
For the average company, revenues grew by $572K, based on average revenues of $2.27M. Revenue growth remained positive every year after 2002. Companies financed by retail funds had significantly larger revenues ($5.18M, increasing by $1.18M per year) than nonretail investors ($703K, increasing by $235K), reflecting the fact that retail funds focus more on later stage growth companies that are more mature, while nonretail investors focus more on early stage start-ups, some of which become large established corporations.
In aggregate, we estimate that tax credits of $256M were leveraged into at least $2.3B of equity investments. On average, companies raised a total of $2.14M of equity within the program. Retail-backed companies raised considerably larger amounts ($4.61M) than nonretail backed companies ($810K). We find that for every $1 of equity raised within the program, companies raised on average an additional $3.76 of equity and $1.15 of debt outside the program, demonstrating the program’s capital leverage.
Access to capital appears to be significantly better in the two main urban areas of Vancouver (Greater Vancouver Regional District) and Victoria (Capital Regional District) than in the rest of BC, where the average company only raised $952K of program equity, and where every $1 in the program generated only $0.84 of additional equity and $1.19 of debt. These differences seem to be driven in part by companies pursuing more conservative business models, although there also appears to be lower investor appetite in the rest of BC.
2% of companies in the program went public; 7% were acquired. These exit rates appear relatively low compared to other venture capital markets both in Canada and worldwide. Part of this can be explained by the fact that many companies in the program received seed investments that precede venture capital investing. Only 16% of companies ceased operations, suggesting that the majority of companies remained in operation at the end of the observation period, providing benefit to the BC economy for an extended period.
Total amount of funds’ raised by retail funds declined from a high of $83M in 2004 to a low of $30M in 2009. Total investments increased from $50M in 2004 to $68M in 2008, but fell to $47M in 2009. Total investments trends follow fundraising trends with a lag of approximately two years. This, combined with the fact that returns have been relatively low and that financial markets are currently experiencing considerable turmoil, suggests that investments by retail funds are likely to stay low and possibly decline even further over the near horizon.
The retail fund’s returns have been negative over medium and long-term horizons if we do not take into account the tax credit. From an individual investor’s perspective, taking into account tax credits and broker fees, investment returns under- or outperform stock market returns depending on the choice of index and holding period. However, program-supported investments in the retail funds made at the inception date of these funds paid off less than unsupported investments in public equities as represented by either the S&P-TSX Composite Index or the S&P-TSX Venture Composite Index.
While this program evaluation focuses on the companies in the program, it should be mentioned that the benefits of the program are likely to extend to the BC economy more broadly. One important benefit is the legacy created by successful companies in the program. Companies that are acquired typically retain some local presence, their managers frequently move on to play leading roles in new start-ups, and their investors may reinvest part of their gains into the next generation of start-ups. Our report features short case studies, including one of Aspreva Pharmaceuticals Corporation, which demonstrates the legacy benefits of the successful companies in the program.

THE IMPACT ON STAKEHOLDERS
Evaluating the effectiveness of the program means looking at it from the perspective of each of the major stakeholders:
– The government on behalf of taxpayers must ensure that the cost of the program is justified in terms of tax recoveries and broad-based economic benefits
– Investors should ensure that returns warrant the level of risk
– Companies must look at the cost of capital in comparison to alternatives
PUBLIC POLICY
Clearly the program appears effective from a public policy perspective in terms of increased economic activity – as evidenced by job creation – and increased tax revenue in relation to tax expenditures. This is particularly true for the federal government who benefit from much higher provincial tax expenditures, yet still share in the economic benefits.

INVESTORS

RETAIL VCCs

Investments in retail VCCs under-perform the public markets generally. The study alludes to the fact that brokers and fund managers may be compensated excessively for their services – and then diplomatically fails to reach a conclusion.
This under performance has led to declining interest in retail VCCs.

NON-RETAIL VCCs

EXIT RATES

The study discusses exits as indicators of success when evaluating investment success. During the period of the study, only about 1 in 30 companies actually achieved an exit for investors. This compares to a rate of 1 in 7 worldwide and 1 in 5 for Canada as a whole. Of these exits about 85% are by acquisition, suggesting that IPOs are not a realistic goal for most startups.

SURVIVAL

If we consider that more than 50% of startups don’t survive more than 3 years, the survival rate of about 83% may seem like a success story. From a public policy perspective, and from the point of view of companies this is a good result. However investors need to do much better.
It is also likely this result is not be quite as impressive as it may seems at first glance. In fact the study mentions ‘informal discussions’ suggesting that some companies are effectively out of business but retain their corporate shell for other reasons. Certainly a large number of surviving companies are not candidates for acquisition. This poses a couple of problems for investors:

  • How to recognize a loss and claim resulting tax benefits
  • How to exercise some management control where founders lack the skills and cannot be held to account because of the corporate structure imposed by the VCP regulations

It may be that founders may in fact be comfortable building ‘lifestyle’ companies that produce a good living for founders with little or no return to investors. In my view the lack of exit opportunities for investors is the biggest weakness of the VCP.

OTHER MOTIVATIONS FOR INVESTORS

In spite of this there are other motivations for investors that may help explain why investors continue to invest in non-retail VCCs:

  • Friends and family may be investing in early stage companies for considerations that aren’t entirely economic
  • Arm’s-length investors may be benefitting from consulting and advisory opportunities that arise because of their investments

COMPANIES

As with the public at large, the benefits to companies are demonstrable:

  • Much higher survival rates
  • Significantly better exit opportunities
  • Faster growth

MEDIA 2o PRODUCTIONS INC NOMINATED FOR THE CANADIAN SCREEN AWARDS

Media 2o – an exciting new digital marketing agency working out Vancouver’s edgy rail town district – received a Canadian Screen Awards nomination for its work on their GROW INC video for Telus Optic Local. Using a lot of creativity, leading edge skills in digital editing techniques, along with proprietary tools for ‘filming’ on location, the company was able to create an award-winning documentary at a fraction of the cost required to use conventional technologies.

A week earlier the Kamloops Daily News announced that it was ceasing publication, after serving the local community for more some 83 years.

The juxtaposition of these 2 events, seems to point to the fact that we are near the beginning of a seismic shift in the economics of content.

For the media, publishing and entertainment industries, the landscape is shifting quickly. What’s more the pace of change is accelerating. The major newspapers are restructuring. A week ago both the Globe and Mail and the National Post – Canada’s 2 leading national newspapers – announced staffing cutbacks. And yesterday we learned that Rogers Communications – one of the country’s largest cable TV providers has invested about $100 million in accumulating content in a bid to compete with Netflix.

Rogers has stated publicly in the past that it takes so-called “cord cutting” seriously. Cord cutting is when consumers stop paying for a traditional television plan and instead make do with streamed content, get into free over-the-air signals, or watch DVDs and Blu-rays.
“We’re kind of in the beginning of what we think is a major transformational stage in the TV world,” said David Purdy, senior vice president of content for Rogers Communications, in an interview with The Canadian Press last June, “so we have a ton of questions and we’re doing a lot of research these days.”
In November, the Convergence Consulting Group estimated about 400,000 Canadian TV subscribers out of 11.8 million have cut the cord since 2011, which is about 3.5 per cent of the market.
Other industry buzzwords are “cord shavers,” referring to consumers who have cut back on their TV packages because they’re spending a lot of time streaming digital content, and “cord nevers,” who are typically younger consumers who have never paid for a TV plan and perhaps never will.

The big cable companies are starting to lose out to content aggregators and individual producers that deliver content to subscribers for a fee, in exchange for advertising or as a labour of love with funding from crowdfunding sites like Kickstarter™ or Indiegogo™. Exactly how content should be packaged and how providers should monetize their work isn’t clear, but that doesn’t stop brash new startups from contInuing to innovate.
Not only legacy industries that are forced to adapt though. Even Apple’s iTunes is being forced to reassess after its first ever year-over-year decline in revenues. They are beginning to look oh so 20th century in the face of all this turmoil.

Equity Share Structures in BC VCCs – Improving Investor’s Chances of an Exit

British Columbia’s Small Business Venture Capital Act (“the Act”) provides for a 30% tax credit to investors (refundable in cash) who buy eligible investments through a provincially-registered venture capital corporation (“VCC”). The small business must meet eligibility requirements –

What are the 6 qualifying activities?

the following types of business are NOT eligible:

  • primary resource exploration or extraction,
  • financial services, such as providing loans, selling insurance or real estate, or trading in securities,
  • property management or the rental or leasing of land or improvements,
  • the development of or improvement of land,
  • traditional agricultural activities,
  • retail and commercial services (other than services that are (i) exported outside British Columbia or replace imported services, or (ii) provided by a business which derives more than 50% of its revenues from the provision of services to tourists, or (iii) provided by a regional business and promote community diversification within the region.)
  • restaurant or food services,
  • the sale or lease of tangible or intangible personal property for a person’s personal consumption or use

The legislation was enacted to help small business attract equity by offering investors 30% of their investment back in cash, to compensate them for risk and a lack of liquidity. Of course it’s one thing to invest in small private companies – but quite another to get your money out again. Angels are invariably concerned that too much of their capital gets stranded in under-performing companies. Angel investors – unless the gods are smiling on them – can only expect to be successful between 10% and 20% of the time. They need a couple of high-performing investments to make it all worthwhile.

For the most part share structures tend to be quite simple and straightforward. There is some concern that complex corporate structures will frighten off venture capital in later rounds, if a company is poised to grow. In addition the Act does not allow shares to

“carry prescribed rights and restrictions. This requirement recognizes that VCCs or EBC investors (herein referred to as “investors”) may invest in voting preferred, as well as common, shares or in unit offerings of a small business. However, some limitations are necessary to ensure that the investors hold a true equity investment that is at risk both as to return of capital and return on capital.”

In other words the Act requires that companies can’t structure the features of a class of shares with things like retraction rights or excessive, cumulative dividends on preferred shares. If they could, shares could look more like debt than equity – defeating the policy objectives of the program. In spite of this the BC Government has published a policy document that seems to allow a fair amount of flexibility.

“Retraction Rights and Puts
A retraction right or put which is exercised at the option of the investors may, depending on wording of the right or put, impair the ability of a small business to carry on an ongoing business with a reasonable expectation of profit or entitle the investors to reduce the impact of any loss in holding the shares in violation of section 3(1) of the regulations.

As a result, retraction rights or puts will be permitted only where the price paid to the investors under the retraction right or put does not exceed the fair market value of the shares. If the parties are unable to agree as to the fair market value of the shares at the time the retraction right or put is exercised, the parties may agree to appoint an independent third person (e.g. a chartered business valuator) to determine fair market value.

A retraction right or put at a fixed price in excess of fair market value will not be permitted because the fixed price downsizes the risk to the investors of holding the small business shares.

The terms of any retraction right or put must provide that the retraction or put can only be exercised where its operation would not threaten the existence of the small business. Generally, this means that retraction rights or puts which would create a working capital deficiency, or cause a small business to be in default of an arms’ length loan will not be allowed.

The terms of any retraction right or put must also provide that the retraction or put is not exercisable until at least five years have passed since the issuance of the equity shares. This five-year period is required to comply with regulation section 8(2) which would otherwise deem the value of the investment to be zero.”

In private companies where founders remain in control, founders can effectively strip all of the value by paying uneconomic wages and investors will have little recourse. – at least if they don’t have retraction rights or other protections built in.

Prospective investors might be in a position to request retraction rights – or potentially cumulative preferred shares with fairly high dividend rates. That might make it more difficult for founder shareholders to ignore the  concerns of preferred shareholders. For shareholders looking to “exit early and often” – this might provide a little downside insurance for investments that turn out to be “lifestyle” businesses.

 

As a last resort shareholders can refuse to waive the audit requirement…and at least make their presence felt by management.

 

Enterprise + Risk

Small business is not easy and it’s not for everyone. Successful companies and professionals understand the degree of risk and have strategies to protect themselves. These strategies are referred to as risk management strategies or simply:

Risk Management

In the slides below we discuss measures that successful companies and business professionals put in place to manage risk. Consider how these various strategies protect the lender, investor or supplier – and how (and why) these people want to take the risk of dealing with small business.

Risk Management

Public Accounting Pyramid

PyramidThe accounting industry in some ways resembles a giant pyramid scheme. At the ‘pointy end’ (aka ‘the zenith’) are the partners of the Big 4 international accounting firms. These are very prestigious and highly paid positions. Predictably there a great many people vying to be made partner – and the competition is fierce. At the base of the pyramid are the bookkeepers who ‘don’t get no respect’ and are paid very little. Consequently skilled bookkeepers are in short supply.

Consumers of public accounting services – which means virtually every business in the western world – need to understand what services public accountants provide, and how best to use these services.

Fundamentally public accountants only provide 2 kinds of service:

  1. assurance
  2. tax advice

…and the lion’s share of public accounting revenue is derived from assurance services.

About Assurance Services

Generally this refers to the involvement of a professional accountant in the preparation of financial statements. Independent readers of financial statements take comfort – or assurance – from the involvement of a professional accountant in the preparation of the financial statements.

Depending on the extent of their involvement (and the size of the fee), public accountants in Canada provide more or less assurance which they describe in a notice appended to the front of the financial statements. There are 3 types of assurance engagement, each corresponding to a different level of assurance. These are:

  1. Compilation – the accountant ‘compiles’ the financial statements based on information provided by the business and does not perform any kind of  review except to determine that the financial statements are plausible. A ‘Notice To Reader’ is attached by the public accountant to explain the limited nature of the accountant’s involvement.
  2. Review – the accountant reviews financial statements in accordance with professional standards for review engagements and attaches a ‘Review Engagement Report’.
  3. Audit – the accountant audits the financial statements in accordance with generally accepted auditing standards and attaches an ‘Independent Auditor’s Report’.

Compilations (or ‘Notice To Readers’) are the most common type of assurance services purchased by very small businesses. Technically they aren’t ‘assurance’ services at all, since the professional accountant specifically avoids providing any assurance in his or her ‘notice’. Theoretically professional accountants should not issue compilation-type financial statements if they are aware that a 3rd party is intending to rely on them for an investment decision.

In spite of this most users take a certain amount of comfort from the public accountant’s notice. Financial statements that have been ‘compiled’ by an independent public accountant are required to be ‘plausible’ – but not much else. This is generally a quantum leap up from financial statements prepared in-house by management – or those prepared by small, bookkeeping firms.

However, if it is important for a 3rd party to have confidence in a set of financial statements, the reader should insist on financial statements that have been reviewed by an accredited public accountant[1]. If the public accountant is aware that you are relying on his review to loan or otherwise invest in the company, the public accountant is required to take that reliance into account in determining the level of ‘materiality[2]’.  You might therefore consider letting the accountant know in writing that you intend to rely on the financial statements in making your investment decision.

A review engagement is a huge step up in terms of quality from a compilation engagement. An audit provides more assurance – but at a much greater cost to the company. For that reason audits are unusual for small[3], privately-held companies.

While accounting, bookkeeping and assurance services represent the lion’s share of services provided to businesses by public accounting firms, small business owners generally value tax advice more than assurance services. This is probably because they view assurance services as a necessary cost driven by the needs of 3rd parties for reliable financial information. Good tax advice on the other hand actually saves money for the entrepreneur.

 

About Tax Advice

Unfortunately income tax is exceedingly complex.  In Canada, the Income Tax Act is probably the single most complex piece of legislation there is.

For example subsection 9(1) of that act reads as follows:

“9. (1) Income — Subject to this Part, a taxpayer’s income for a taxation year from a business or property is the taxpayer’s profit from that business or property for the year.”

It sounds straightforward doesn’t it?

However profit isn’t actually defined in the Act. Which means you must look to the concept of profit as defined by the accounting profession…..and interpreted by the courts. What’s more, these days there are alternatives emerging in the form of the new IFRS[4] to challenge our tried and true Canadian GAAP[5].

So which standard do we apply when both are allowable? And exactly what are those standards anyway?

For the most part designated professional accountants who are licensed to practice as public accountants can provide competent advice for most domestic companies – except those that work internationally[6], perform eligible scientific research and experimental development (“SR&ED”), are engaged in mining or mining exploration, are looking for foreign investment, or need complex tax structures.

Where your company needs help in these areas you will need a specialist to assist your general practitioner. Practitioners with smaller firms are often reluctant to seek specialist advice on your behalf, for fear of losing your business. If you sense this consider seeking the advice of a specialist yourself.

Of course finding a tax specialist can be challenging.

As an employee of a large CA firm I call myself an ‘SR&ED Financial Specialist’ which is in fact what I am. If I were ‘registered in public practice’ as a CGA in British Columbia, I would not be allowed to refer to myself as a specialist – since the CGA Association does not recognize SR&ED as a specialty. Instead I could only indicate that SR&ED tax incentives are my ‘preferred area of practice’ – which any other CGA can do.

I don’t believe the Institute of Chartered Accountants of BC has similar restrictions, but in any case there are very few SR&ED specialists and they are seldom found working in small firms.

Theoretically if an accountant is providing some level of assurance on a set of financial statements (i.e. a review or an audit), the financial statements should have been prepared by someone else. The notion is that the accountant is reviewing or auditing someone else’s work. When an accountant compiles (i.e. ‘prepares’) financial statements himself, it is difficult for him to perform an unbiased review or audit – and he is prohibited from doing so.

So if you are looking to have your statements reviewed, you will need to prepare your own financial statements competently. At a minimum this means either working with a professionally-trained accounting staff, or hiring a firm that has more than one professional accountant on staff. Either way, better quality (more assurance) financial statements cost more.

People who start their own businesses are typically independent and self-reliant. They have to be to believe they can beat the odds and succeed in their own small business. While this may come as a surprise to you, many of them really delusional and more than a little bit arrogant — not to mention woefully ignorant of basic accounting principles.

If you are an entrepreneur yourself, clearly you aren’t either delusional or arrogant[7], the lenders and/or investors who need to rely on your financial statements have no way of knowing this however. They need to rely on an accredited public accountant to have a level of assurance that your numbers are worthy of belief. The more that an entrepreneur is asking from lenders or investors, the more those assurance services will cost.


[1] Note that about 75% of professional accountants are not registered to practice as public accountants. If you’re hoping to save money by hiring a designated professional part-time to prepare your financial statements, understand that they are not permitted to audit or review your financial statements.

Professional accounting bodies require that, if their members are engaged in public accounting, they must carry liability insurance, continually upgrade their professional knowledge and submit their files periodically to quality assurance reviews.

[2] Tolerance for risk

[3] Note that the notion of ‘small’ is relative here.

[4] International Financial Reporting Standards

[5] Generally Accepted Accounting Principles

[6] Including selling to customers in the US or abroad.

[7] After all you have enough sense to read this guide

Why Professionals Say ‘NO’

Both public accountants and  lawyers in private practice depend on new entrepreneurs defying the odds to try and establish new businesses. However they are only too aware of the risks that anyone will face as an entrepreneur. In fact a key role is to understand the nature of these risks and to help mitigate them to some extent.

Lawyers practicing commercial law will help with legal structures and contractual arrangements much of which is designed to protect the business owner from his or her partners, other shareholders, suppliers, customers and even the government in the form of the taxman.

Similarly public accountants help ensure that financial systems are properly designed, that financial information is accurate, that the appropriate, tax-efficient legal structures are put in place, that tax and regulatory compliance doesn’t become a problem. They also use their experience to understand risk and opportunity found in financial information.

Since entrepreneurs depend on professionals to identify risk, they shouldn’t be surprised when lawyers and accountants seem somewhat negative. From the professional’s perspective there is almost no risk to them in recommending  against making an investment.  If you don’t make an investment, you cannot prove how it ‘would have turned out’ . If someone else succeeds with an investment there are always factors that differentiate their situation from yours.

The alternative situation – recommending an investment – is fraught with risk for the professional. The entrepreneur can expect  a large number of caveats from the professional to limit their (the professional’s) risk.

About Small Business in BC

Most of us – when we think of business, we think of large multinational corporations – and we see businessmen as the ‘captains of industry’. The truth is really quite different. Small business accounts for almost half (48%) of private sector  employment in Canada.

The situation in the US is very different. While the percentage distribution by size of firm resembles the distribution in Canada – the percentage of very small firms in the US is even larger than in Canada. The greatest difference though is in the number of very large firms – and more significantly – in the size of those firms.

In fact, large firms in the US account for about 64% of all private sector employment. Compare that with the situation in British Columbia – where small business (fewer than 50 employees) accounted for 56% of private sector employment. While small business is very important to the Canadian economy as a while, the relative importance increases as you move west from the Atlantic.

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What’s more, these ‘small’ businesses are really quite a bit smaller than we’re led to believe. Fully 90% of small businesses in Canada have fewer than 10 employees – and 80% have 4 or less.

About Small Business

When designing accounting or bookkeeping systems for a business, it should be clear that we need to match the system to the business’ needs and to the skills and capabilities of those who are going to work with the system. At best small companies hire bookkeepers to come in once a month to record batches of transactions. They are very lucky if they actually find a skilled bookkeeper, since these are a rare commodity.

So why is it that we typically saddle these poor companies with accounting systems that are meant to be operated in real-time by skilled bookkeepers?

It just plain doesn’t make sense to inflict a fairly sophisticated accounting system on an early stage business.  Anticipating what a business will look like in 5 years and creating a structure at the outset to accommodate the expected growth will almost certainly fail. That’s kind of like buying a made-to-measure suit for a 10 year old boy, and asking the tailor to measure his father to get the dimensions. There are a number of reasons why this approach will fail:

  1. Most of these businesses won’t exist in 5 years time
  2. The business may not be able to afford someone with the skills to operate a complex system
  3. A public accountant will charge at his or her professional rates to fix the system – if an inexperienced bookkeeper screws it up.
  4. The owner could spend too much time learning about – and tweaking – their bookkeeping system instead of working on the business.
  5. Simplicity encourages timely compliance (i.e. getting it done) – putting off doing the books is very typical of entrepreneurs
  6. Accounting software is cheap – but good implementations can be expensive
  7. It’s impossible to predict what the business will look like in 5 years.

The Cost of Professional Advice

The best professional advice is expensive, and you have to line up to get it. Hourly rates for highly-skilled professional accountants start at more than $300 an hour for a manager. For senior managers and partners, rates often exceed $600. Large, multinational companies are prepared to pay these rates because they know that the best advice is worth it, and they only pay for what they need.

These same multinationals ‘poach’ talent shamelessly from the ‘Big 4’ accounting firms to staff up their internal accounting and tax departments. So when the VP of tax for an international mining company calls up a tax partner at KPMG to discuss a tax issue, it’s more or less a discussion amongst equals.

Electronic Document Imaging (“EDI”)

EDI faciltates outsourcing.

It allows us to put documents in front of people instead of taking people to documents. Coupled with cloud-based technologies like GOOGLE Docs™ – it gives access to authorized users wherever they are in the world.

While the paperless office may still be a pipedream, EDI is an important step along the way to the paperless workplace. Paper is still important as evidence though. Standards for document imaging are evolving, but it still makes sense for most organizations to archive paper documents as evidence.

The Canada Revenue Agency (“CRA”) may still require paper documents as evidence that a transaction took place – unless you conform fully to the CAN/CGSB-72.34-2005 standard for Electronic Records as Documentary Evidence (available in paper format at major public libraries)

The CRA also publishes a guide to KEEPING RECORDS: (rc4409-9e)