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How COVID Affected the World Economy and What that Means for Business Owners

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How COVID Affected the World Economy and What that Means for Business Owners

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The COVID virus was one of the most recent viruses to sweep through the world. It has had a significant impact on both individuals and businesses, but not in ways that are all negative. In this blog post, we will discuss how the COVID virus affected the global economy and what it means for business owners.

Unemployment

Many business owners have decided not to add any new employees until they see what impact COVID will have on their bottom line profit margins – this can be seen through “hiring intentions” and the “average monthly increase in employment”.

Employment growth is slowing but this can be seen as an opportunity for job seekers to find a great new position before others do. There are currently more open jobs than unemployed people looking to take advantage of that.

Stocks

Stock prices fell at first, with business executives unsure how the new tax plan would affect them, but those concerns vanished quickly as consumer confidence rose and company profits skyrocketed. The stock market and interest rates suffered as a result of the impact of stagflation. This impacted businesses negatively because it made investments less profitable by decreasing their net worth. It also caused inflation to rise, which increased costs for business owners who had no control over how much they could charge customers for products or services. Because people were spending more money on food and other necessities due to inflation, this led them to spend less money on luxury items such as expensive cars or homes, so sales went down at car dealerships and real estate companies alike.

Tourism Industry Crumbling

The tourism industry might be feeling some pain as it will now cost more to travel outside of one’s country due to COVID and other new tariffs that have been imposed on certain goods. This may impact those who enjoy traveling abroad, but with unemployment rates decreasing at such a rapid rate, the demand for labor will also increase. Many businesses that rely on tourism as a large source of customers and revenue might take a hit but it may be short-lived if they can adapt quickly enough.

The travel industry is feeling some pain from COVID already, especially with tariffs placed on goods like electronics and other items that are commonly exported and imported. Tourism is a vital part of many economies, but it will take time to see the true impact COVID has on international travel and tourism.

Online Shopping

Online shopping has impacted stores in a big way. Many consumers prefer the convenience of buying from home rather than going out into crowded retail centers to shop for items they need or want. Online retailers have been able to adapt quickly by increasing their marketing spend on Google Adwords so that they can be more visible when people search for products online. This might be a good time to consider an online marketing strategy if you own or operate a retail store.

The rise of e-commerce has allowed many consumers – especially Millennials and younger generations – to buy things from the comfort of their homes without ever leaving. Many brick-and-mortar retailers have been able to adapt quickly by increasing their digital marketing presence so that they can compete against online retailers.

Loans

Loans are getting harder to come by as banks begin to tighten their lending standards due to fears of rising defaults rates. They have not yet raised interest rates but many experts believe it is only a matter of time before they do! Businesses that need funding for various projects might look into alternative financing options or increase spending to boost revenue and profits so that they can generate enough cash flow to cover their debt obligations.

The difficulty of obtaining loans has increased as a result of COVID and other new tariffs placed on various goods from different countries. This is especially true for those who are deemed “high risk” borrowers by lenders, but it might be time to find alternative financing options if you need them.

World Trade

The world is slightly less connected as a result of COVID and other new tariffs that have been placed on goods from certain countries. This means it will be more difficult for those who rely on international sales to sell their products, but there are still plenty of opportunities out there. Business owners should keep an eye on how this plays out over time and consider new marketing strategies if they rely on international sales.

There are still plenty of opportunities out there for those who rely on international sales. If you haven’t considered it already, now might be the time to invest in some marketing strategies that will help you reach a larger audience.

Working Abroad

The ease of working abroad may decline as the world continues to become less connected. This could impact those who enjoy traveling and want to work while they are on holiday, but it might also make sense for some people if they can save money by living in another country. It will take time before we know how COVID affects the ability of individuals or business owners to work outside their home countries long-term.

It has become slightly more difficult (and costly) to travel overseas and work there due to tariffs placed on goods like electronics that many workers bring with them when they go freelancing or contract jobs globally. However, this is still an option open for businesses that want cheap labor; something which should be considered sooner rather than later if you are looking to expand your business overseas.

With all this information at hand now comes the time when you can use it to your advantage. Remember that while COVID was a major international event, many other factors are affecting the world economy which you should also consider when making decisions about your business or investments. Understanding how they interact and affect one another will help you make better-informed decisions for yourself in this fast-moving globalized society of ours.

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Best Renewable Energy Stocks in 2021: A Survey by Paul Harmaan

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The global economy nowadays is pivoting towards renewable energy, leaving fossil fuels behind. According to Paul Haarman, the economy is evolving and finding ways to adapt to modern technology, changing the whole world and making it more efficient. The various green energy sources that it was planning to adopt vary from solar energy to geothermal energy, from wind to biomass, and many more.

For the economy to convert to clean renewable, there will be a need for a strong financial back which is possible only when we use the economic prowess of renewable energy, and this is only possible through their stocks. So let us go in-depth to understand a few of those energy stocks.

Stocks for Top Renewable Energy

According to Paul Harmaan, various energy stocks like biomass, wind, solar, geothermal, etc., are present, which could support fast-forwarding the clean energy conversion for the economy. First, however, we will look for two of the best stocks where you should invest your money to get the best returns

First Solar

First Solar is one of the top leaders responsible for developing efficient thin-film solar panels. The company produces low-cost electricity per watt compared to the traditional silicon-based panels. Their solar panels are efficient mainly because they work well in extreme hotness and humidity conditions and work efficiently in shedding snow and debris quickly. These few features make them the most ideally used solar panels for utility-scale applications.

Moreover, the panel manufacturing sector of the first solar acts like a strong balance sheet responsible for making First Solar the number one choice and making it stand out.

NextEra Energy

NextEra Energy is responsible for two businesses which it runs efficiently. One business shows the efficient use of the competitive energy segment and is responsible for generating electricity. Besides this, it also transports natural gas under fix-free agreements that are beneficial for the long run. At the same time, the other one revolves around the rate-regulated electric utilities that NextEra Energy takes responsibility for and distributes that power to various businesses and consumers.

One of the highest credit ratings with the support of the largest electric utilities makes the NextEra Energy-efficient in working its stable operations responsibly. The two efficient businesses conducted by NextEra Energy are solely credited, and why shouldn’t they? The combined powers of both businesses help produce extra units of energy from natural resources like that of the wind and the sun, which any other company in the world is incapable of, making it a unique company.

Future of the Top Renewable Energy stocks

The effective and efficient shift by the world economy from fossil fuels to renewable energy sources or clean energy sources has created a massive opportunity for a variety of investors to look into the profits. At the same time, they understand the concept of how these sources can change the world and turn it into a better place. Suppose there is a need to find the future of these top renewable energy stocks. In that case, the most important thing to look for is the balance sheet of the company and the solar energy-focused growth profile, as these two main factors are highly responsible for generating higher returns in the future both for the world and the investors.

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Archives, Banking, Global Trade Daily, Special Reports

Why Investors Need to be Wary of the Investment Herd Mentality

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The past year has been one of exceptional volatility – volatility for personal lives while dealing with COVID restrictions, volatility in job markets due to government-mandated shutdowns, and volatility in markets as economies collapsed and began to rebound. After a drop of over 10,000 points from February to March 2020 at the onset of the COVID crisis, the Dow Jones Industrial Index entered a strong recovery. Investors flooded back into the market, driving prices to new heights in early 2021.

Much of this new investment came as investors responded to positive news about the launch of COVID vaccines and the prospect of world economies reopening. Markets began to show the effects of herd mentality investing as investors pursued profit opportunities. While herd investing may lead to profitable spikes, it is also capable of causing sudden drops with accompanying losses for the herd. 

Understanding the herd

Humans are naturally prone to herding. While perhaps originally a protective measure against predators, herding spread through every facet of human life. Throughout their lives, people join any number of herd groups – social groups, religious groups, political groups, sports groups and others. They rely on the mutual support found in these settings and the information sharing that occurs in the group.

Herd investing behavior has many underlying causes. Some seek to achieve the same wealth and status as the successful investors they see in the news. Many people who know little to nothing about investing but who also want to take advantage of investing in markets rely on the herd to provide them with information about investment opportunities. Many investors just have FOMO – the fear of missing out on a good thing. 

Frequently, it is uninformed investors, and those with the most to lose, who form the bulk of the investing herd. Trying to get rich quickly by following the example of successful traders, they wind up losing everything. 

But even with post-COVID volatility roiling markets, there are good opportunities in the markets for informed investors who pursue sensible investing strategies.

The dangers of following the herd

Unfortunately, herd mentality all too frequently results in the herd running off a cliff together. The history of markets is replete with examples of investors driving markets drastically upwards, only for herd panic to crash those markets. 

The dangers of herd investing first appeared in the 17th-century tulip buying craze in the Netherlands. Tulipmania, as it is now known, was the first market bubble. Just before the bubble burst, the most sought-after tulips were selling for upwards of 5000 florins. 

To put this in context, at the time, you could buy four oxen (and not just any oxen, fat ones) for 480 florins. A thousand pounds of cheese was 120 florins, and the equivalent of 65 kegs of beer was 32 florins. The cost of tulips grew to exceed annual salaries, and the most expensive tulips cost more than a house. 

Using margin contracts, buying on credit, leveraging assets, investors did whatever was needed to get their hands on tulip bulbs. But prices began to fall, and the market quickly and completely collapsed, leaving many investors bankrupt.

History has repeated itself several times since the beginning of the 20th century. The Great Depression of the 1920s, the dotcom bubble in the late 1990s and early 2000s, and the subprime mortgage crisis culminating in the housing crash of 2008 are all examples of herd-driven bubbles. 

Herd activity drives market volatility

Herd investing appears to be increasingly driving market volatility. The past year alone has seen several glaring examples of herd-created bubbles.

The herd creates crypto bubbles

A more recent example of herd investing is the explosion of interest in the cryptocurrency markets. From October 2020 to April 2021, the price of Bitcoin increased sixfold, from $10,000 to over $60,000. Since that time, it has lost a third of its value. And this is the second crypto bubble in less than five years. In early 2018, Bitcoin lost 65% of its value in a single month. By the end of 2018, cryptocurrency markets had seen a larger percentage decline than the stock market did during the dotcom bubble.

Cryptocurrency is an attractive investment. But it is notoriously volatile, and the crypto investing herd quickly responds to even minute suggestions about price direction. Tesla founder Elon Musk’s support for dogecoin helped its price skyrocket in early 2021. But when he made a joke on Saturday Night Live about dogecoin being a “hustle,” the price quickly plummeted.

Robinhood and GameStop

The GameStop price rollercoaster in early 2021 is a particularly alarming example of herd investing because it involved an intentional manipulation of the herd. A group of investors decided to punish investment firms that were relying on shorting stocks by driving up the prices of those stocks. They then promoted the stocks on an investment board on Reddit. GameStop became the poster child for their efforts, but other frequently shorted stocks also began to rise.

GameStop’s price skyrocketed as social media-based investors followed the Reddit group. Trading volume increased as well, with GameStop becoming the most traded stock on the S&P 500 at one point. Once again, Elon Musk got involved, sending out a tweet about GameStop that exacerbated the frenzy, causing the price to nearly double shortly after the tweet. 

GameStop quickly fell again after the Robinhood trading platform and others suspended trading. The fallout from this event is ongoing.

Fears about post-COVID inflation

At present, the herd is spooked about the prospect for significant inflation as world economies rebound from the COVID crisis. Consumer prices have been rising, even more so than expected at this point in the recovery. And, despite reassurances from the Fed that the inflationary spike is temporary, the fears of the herd have made themselves known in the markets. 

The fastest increase in the consumer price index in nearly fifteen years caused selloffs in the markets. At the same time, yields on treasury bonds have been rising. Home prices are also experiencing rapid upswings, leading to fears of another housing bubble.

The herd may be edging towards its next cliff.

Don’t get trampled by the herd 

Knowledgeable and prudent investors can still take advantage of hot market opportunities while avoiding suffering substantial losses by simply following the herd. Portfolio diversification is one important tool savvy should employ to counteract the effects of market volatility. Balancing risky herd-friendly investments with more stable options like bonds, mutual funds, or even gold helps portfolios avoid wild swings from market volatility.

There are also positive herd-style options, such as investment funds, that take advantage of the knowledge of investment experts. According to London-based financial advisor Alex Williams of Hosting Data, investment funds are a collection of capital that is owned by a conglomeration of investors. 

“These investors collect shares together, while each member remains in full ownership and control of their own individual shares,” says Williams. “The benefit to investment funds is that you have a wider selection of investment options and opportunities. You can also get access to better management expertise and there’s less commission than you’d be able to get on your own.”

And for those investors who do want to rely on social media, like the Reddit GameStop investors, without risking the downsides of herd investing, there are more well-founded options. Social investing platforms (distinct from socially responsible investment platforms) allow inexperienced investors to benefit from the knowledge and insights of experienced traders through copy trading and mirror trading.

Conclusion

With a bit of effort and prudent selection of a range of investments, even the most novice investors can take advantage of a booming stock market while protecting themselves from the whims of the herd.

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Archives, Global Trade Daily, Special Reports

Staying Away from Bubbles and Fads

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Here is a story that has been floating around for years: Once upon a time in a village, a man appeared and announced he would buy monkeys for $100 each. The villagers, seeing that there were vast amounts of monkeys around, went into the forest and started catching them. The man bought thousands of monkeys at $100 and as supply started to wane, the villagers stopped their efforts.

The man announced that he now would buy at $200, so the villagers redoubled their efforts and went back to capturing monkeys. Soon the supply diminished even further and people in the village started returning home. The offer then increased to $250 and the supply of monkeys became so scarce, it was an effort to even spot a monkey let alone catch it. Finally, the man announced that he would buy monkeys at $500. But he had to go to the city for business and his assistant would buy them on his behalf.

While the man was out, the assistant told the villager; “Look at all of these monkeys in the cages the man has collected. I will sell them to you for $350 and when the man returns you can sell them to him for $500 each.” The villagers rounded up all their savings and bought all of the monkeys. Then the assistant left, and they never saw him or the man ever again, only monkeys everywhere.

This could be an allegory for the current ‘monkey business’ with meme stocks and a host of other “hot” items. The modern-day “man” has been selling his goods to all the villagers sitting home during the pandemic. A shortlist of today’s “monkeys” could include:

Cryptocurrency – last March, bitcoin was trading just above $5,000, today it is around $56,000. Even more exciting: the dogecoin, a crypto that is based on a meme, has risen over 1,000% this year.

SPACs – AKA Blank-check companies. Of the 302 IPOs this year, 80% have been via SPAC. This is an area that’s starting to look “bubbly.”

NFTs – Non-fungible tokens. These monkeys utilize the blockchain to prove ownership of original pieces of internet “art.” The piece by Beeple below sold for $69 million (he never sold a piece of art for more than $100). And Jack Dorsey’s first Tweet went for $2.5 million.

Meme Stocks – AMC just announced they intend to offer an additional 500 million shares of stock, while GameStop intends to offer 3.5 million shares. Not sure if the villagers will be around for the man this time.

The ‘villagers’ – AKA retail investors – seem to be going back to their farms and slowly walking away from the monkey business. NYSE volumes are at 80% of the 30-day average while the Nasdaq is at 90%, while GameStop is far off their January high. The pandemic cleared calendars, boosted savings, and led many to the stock, crypto, sneaker, and baseball card markets.

The US equity market posted positive returns for the quarter, outperforming the developed international markets as well as emerging markets. Market participants cheered on the push for higher levels of vaccination as well as the government’s printing press.

With the vaccines coming on strong, market participants are eyeing companies that would benefit, including value stocks such as industrials, materials, travel, and banks. There was a heavy rotation out of growth stocks to value. Value stocks outperformed growth stocks across large and small-cap stocks in the last quarter, and small caps outperformed large caps. Most of that was the “opening up trade.” The top searches on Google are now for “airlines” and “hotels,” not GameStop, Bitcoin, or NFTs. Boredom may be over; calendars are filling up and money will be spent.

The rotation out of the high-flying stocks and sectors into companies with actual earnings and are not on the brink of bankruptcy is a welcome sight. Bubbles and fads have always been around, but they don’t last.

_____________________________________________________________________

Morgan Christen, CEO and Chief Investment Officer of Spinnaker Investment Group, has more than 28 years of investment management experience. He earned a Bachelor of Science in Business Finance from the University of Southern California and an MBA from Pepperdine University. In addition, he is a Chartered Financial Analyst (CFA), Certified Financial Planner (CFP) and Certified Divorce Financial Analyst (CDFA) and serves on the board of directors for the Pepperdine Graziadio Business School.

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Archives, Banking, Global Trade Daily, News

Congress Passes Bipartisan Legislation Requiring Chinese and Other Firms Listed on US exchanges to meet US Audit Standards

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In near lightning speed, Congress now has passed, and the President is expected to imminently sign into law, the Holding Foreign Companies Accountable Act (HFCAA), a bipartisan piece of legislation that, while applicable more broadly, is directed at the audit practices of Chinese companies, especially those owned or controlled by the Chinese government, and establishes a process to delist from US exchanges those companies that do not meet certain US audit standards.

This legislation follows on the heels of the Trump Administration’s action last week to bar US persons from investing in publicly traded securities of Chinese firms determined by the US government to be owned or controlled by the Chinese military. Unlike this more limited investment prohibition, which was established by Executive Order and can be revoked by the new Administration by executive action, the HFCAA is binding legislation that President-elect Biden would have no authority to waive.

Thus, the legislation mandates the process for delisting and directs the US Securities and Exchange Commission (SEC), an independent agency, to implement the listing ban.

HFCAA requirements

The HFCAA, which was first introduced in the Senate in May 2020, passed the Senate by unanimous consent that same month and was just passed in the US House of Representatives by voice vote on December 2, 2020. It now goes to President Trump’s desk to be signed into law.

Specifically, by its terms, the HFCAA establishes that an issuer’s securities will be banned from trading on US national securities exchanges in the event that, for three consecutive years, the issuer utilized a registered public accounting firm that has a branch or office located in a foreign jurisdiction that the US Public Company Accounting Oversight Board (PCAOB) is unable to inspect or investigate completely because of a position taken by an authority in the foreign jurisdiction. Each year in which this occurs is referred to a “non-inspection” year.

The SEC has the authority to eliminate an initial ban if the issuer certifies that it has retained a registered public accounting firm that the PCAOB has inspected, but the SEC may also reinstitute the ban in the event the issuer experiences a subsequent non-inspection year. A reinstituted ban lasts for at least five years, after which the SEC may end the ban if the issuer certifies that it will retain a registered public accounting firm that the PCAOB is able to inspect.

The HFCAA also has important disclosure obligations for issuers that experience non-inspection years. Specifically, among other things, in each non-inspection year the foreign issuer would be required to disclose to the SEC:

-The percentage of the shares of the issuer owned by governmental entities in the foreign jurisdiction in which in the issuer is incorporated or organized;

-Whether governmental entities in the applicable foreign jurisdiction with respect to that registered public accounting firm have a controlling financial interest with respect to the issuer;

-The name of each official of the Chinese Communist Party who is a member of the board of directors of (1) the issuer, or (2) the operating entity with respect to the issuer; and

-Whether the issuer’s articles of incorporation (or equivalent organizing document) contains any charter of the Chinese Communist Party, including the text of any such charter.

The SEC is required to promulgate regulations implementing the HFCAA within 90 days of enactment.

The HFCAA in context

The HFCAA has enjoyed bipartisan support and little organized opposition since it was introduced in the Senate in May 2020. Its passage and impending enactment is the culmination of ongoing public debate in the United States on whether to delist from US exchanges Chinese companies—especially those owned or controlled by the Chinese government—with audit practices that do not meet US standards.

In December 2018, the SEC and the PCAOB, which oversees the auditing of public companies, issued a joint warning to investors about the challenges US regulators face when seeking to conduct oversight of US-listed companies whose operations are based in China and Hong Kong. Chinese law requires that records remain in China, and the Communist Party restricts access to typical accounting information on the grounds of national security and state secrecy.1 In February 2020, the SEC released a statement regarding the difficulties that US regulators face when auditing US-listed companies based in China, and said that US investors and the US capital markets have become generally more exposed to companies with significant operations in China.2

Thereafter, in February 2019, the US-China Economic and Security Review Commission identified 156 Chinese companies—including 11 state-owned enterprises—listed on three of the largest US exchanges with a combined market capitalization of $1.2 trillion.

Subsequently, in July 2020, the Presidential Working Group (PWG) on Financial Markets, at the direction of President Trump, completed its examination of measures to protect US investors and recommended policies consistent with those contained in the Senate and House versions of the HFCAA.3  The PWG was chaired by the US Secretary of the Treasury Steven Mnuchin, and included the Chairman of the Board of Governors of the Federal Reserve System Jerome Powell, the Chairman of the SEC Jay Clayton, and the Chairman of the US Commodity Futures Trading Commission Heath P. Tarbert. The PWG ultimately recommended Chinese companies be delisted beginning in 2022 unless US regulators can obtain access to their audits.

The American Securities Association, a securities advocacy group, also issued a report in August 2020 recommending that Chinese firms failing to comply with SEC audit requirements be forced to deregister within six months—a considerably shorter time frame than the three years set forth in HFCAA.

Potential impact of the HFCAA and what comes next

Under the HFCAA, as noted above, any foreign issuers would be delisted from US exchanges if, for three consecutive years, it utilizes a registered public accounting firm with an office or branch in its jurisdiction to conduct its audit and the issuer refuses inspection of the audit report based on the law of said jurisdiction. Additionally, for each “non-inspection year” identified by the SEC, the foreign issuer would be required to submit additional disclosures.

While covering all foreign issuers of securities traded on US exchanges, the HFCAA in fact is directed to Chinese companies listed on US exchanges that utilize auditing firms not subject to standards established by the PCAOB.  For example, SEC Chairman Jay Clayton has stated that “[t]he [HFCAA] is a legislative attempt to get China to comply with the oversight requirements” and that “[t]he status quo is not acceptable.” 4

While some might view this measure as spillover into the financial sector of the ongoing US-Chinese economic and trade tensions, other observers have noted that it is hard to argue with the logic that firms listed on major US exchanges, which are afforded access to the most liquid capital markets in the world, should without exception be subject to transparent and robust audit disciplines compliant with western standards.

Implementation issues

The SEC is required to promulgate implementing regulations within 90 days after enactment, and it is possible the SEC will attempt to push out proposed regulations before President Trump leaves office on January 20, 2021. Any such proposed regulations must go through a public comment period before final regulations are issued and implemented, however. Thus, it is also possible that the latter part of the rulemaking process would occur during the incoming Biden Administration.

As noted at the outset, the HFCAA mandates the delisting process and only affords the SEC the authority to establish rules to implement this process and provide the details of obligatory reporting by covered companies. Moreover, the SEC, as an independent agency, is not directly subject to oversight by the new Administration on its implementation of the HFCAA.

Nevertheless, there is the prospect that some greater flexibility can be injected into the delisting process. In this regard, US news outlets have recently reported that the SEC is also working on a separate proposal that would allow Chinese auditors to comply with the US inspection requirement without violating its own jurisdiction’s laws by permitting the companies to get a second review of their books by an accounting firm based in a country where auditors comply with PCAOB oversight.5  Such a rule would take weeks or months to finalize.

Moreover, it is possible that there could be some negotiations between the US and China over applicable accounting standards for Chinese issuers that meet PCAOB standards. Whether such negotiations occur, however, remains to be seen.

_______________________________________________________________

By Jeffrey P. Bialos, Ginger T. Faulk, Mark D. Herlach and Nicholas T. Hillman at Eversheds Sutherland. Republished with permission.

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Archives, Banking, Executive Education, Global Trade Daily

Tales from the Trenches: Founder Equity and Founder Agreements in the Pandemic

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From day one, it’s crucial to put your company on the right path. With proper planning, you can avoid a number of common problems that would make investors run for the doors, such as co-founder disputes, tax issues, and cap tables. Startup equity is one of those things that most founders struggle with unless they have an MBA.  But as with all of life, founders’ paths may grow apart for different reasons. It’s one thing when the “divorce” is peaceful, but sometimes situations become very complicated. In a blink of an eye, you’re fighting over the “custody” rights with someone who was previously on your side.

With the added stresses of the pandemic—working from home or working from anywhere—and the pivots required for businesses to adapt their models and work styles to the new normal, we are seeing significant pressure placed on the relationships between founders and other founders, between boards and founders, and between investors and founders.

Founder equity splits. When considering how to initially split founder equity among the various co-founders, some of whom may be present, and some of whom are merely a twinkle in your eye, startups should think long term.

First, consider the relative contributions each person will make.  While everyone says they are “all in” at the start, are they quitting their jobs? Have they invented something? Is their role critical to fundraising or engineering? Who is adding the most value now, and who will add value later? What cash is available? Get clear on these issues from the start and understand that they will evolve over time.

Types of startup equity. As to the types of startup equity, they are generally structured as common stock at formation. The price per share is usually insignificant, or what is referred to as “par value,” a “peppercorn,” or close to zero. This is referred to as “sweat equity,” which is vested over time.

Founder stock terms can also include some of the elements typically found in preferred stock, such as governance rights, liquidation preferences, and super-voting rights. Special founder terms can be a red flag for venture capital investors, and for that reason, particular consideration should be given as to whether such terms are reasonably obtainable.

At formation, cash investors typically receive a convertible note, a simple agreement for future equity, or series seed preferred stock. Some founders put in cash at the formation and structure the cash investment in one of these instruments.

Who gets what? There are four groups of people who typically get equity in the early stages:  founders and co-founders, advisors, investors, and employees, and consultants. Who gets what is more art than science, and there is no simple answer. Numerous websites offer purported “co-founder equity split” calculators and practical advice.

Equity incentive plans. Stock options are the typical currency for employees, consultants, and advisors of startup companies. Restricted stock units, restricted stock awards, phantom stock, and a large assortment of hybrid instruments may also exist.  In early-stage and venture-backed startups, the currency is usually a stock option. Stock options can be structured in a number of ways for tax purposes. Typically, they can be “incentive stock options” or “ISOs.” If options do not qualify for ISO status, they are referred to as “non-qualified” stock options, or “NSOs.” An ISO gives an employee the right to buy shares with the profit taxed at the capital gains rate, not the higher rate for ordinary income.

Vesting. Founder equity, like stock options, typically vests over time. Founder equity is usually subject to repurchase by the company, with one-fourth of the equity ceasing to be subject to repurchase, or vested, after a one-year cliff. After that, founder equity vests monthly or quarterly until the culmination of four years from the formation. Sometimes, repeat entrepreneurs can obtain equity without offering the right of repurchase or reverse vesting, or with reduced vesting, but four years is the standard.

Stock options are not actual ownership, and there is no cash outlay upon grant. These options become exercisable after one year from the initial vesting date, which is usually the date of grant, and they vest in monthly or quarterly installments until four years have transpired from the initial vesting date. In order to exercise stock options, the holder pays the exercise price, which for tax purposes must correspond to fair market value upon the date of the grant. Unless the option has ISO status, upon subsequent exercise and sale, it would be taxed at ordinary income tax rates.

Cap tables. Founders are well served to ensure that their companies use a technology-enabled vendor to store the company’s capitalization records in an automated, secure, and cloud-available format.

409A valuations. In a nutshell, Section 409A of the Internal Revenue Code provides a safe harbor. It suggests that the IRS will not challenge an exercise price as being below fair market value if a third-party independent valuation firm established the fair market value, and that value was approved by the board of directors, all within the prior year of the grant. While there is much fine print and some exceptions, a 409A valuation is generally important to obtain once a year and after each financing round. This risk of doing nothing is that the IRS could argue that the option was granted below fair market value and impose a higher tax rate on the income or gain.

When things change. After your company’s formation is complete, the founder equity has been divided, the equity incentive plan approved, and stock options doled out, life goes on. The world turns, and things change. Co-founders join, co-founders leave, co-founders fight, key employees join and depart, venture capital is raised, and M&A transactions come and go.

Founder roles adjust over time. It’s only natural. So, as well, should their salaries, bonuses, commissions, downside protections, and equity stakes. These are all easy to adjust when things are going well, but what about when things go sideways? Management carve-out plans can provide incentives for people to struggle through a tough spot.

Founder break-ups and departures. When founders leave, the first questions asked are whether the equity is vested and what happens to it. If unvested, the company should repurchase it at the issue price. For vested equity, founders will want it bought back at fair market value, and investors won’t want precious dollars going out the door to provide liquidity to someone who is leaving. Deals are struck where founders have something that investors want, like super-voting rights, board control, and exit rights. When the parties can’t agree, founders who push the envelope too far risk getting recapitalized and diluted, being terminated for cause, undergoing investigation, and having their information rights clipped. Does the founder have the right to severance? Is it enough to buy peace?  Non-competition agreements post-termination of employment are generally not enforceable in California, so this can be another carrot that departing founders can dangle in exchange for a buyout of their shares. Will the remaining team know where the bodies are buried, or is a consulting agreement with the departing founder required to make sure her or his services are available when needed? Was there a bonus due? A commission? Inevitably, companies and departing founders will need to get along to ensure a good exit.

Mergers and acquisitions. It is not uncommon for companies to be put up for sale when a founder departs, and market participants expect it.  So for boards and founders in a deadlock, is it the right time to bring things to a boil? Who constitutes the universe of potential strategic and financial buyers? Is it feasible to raise a growth equity round or “minority recap” with primary and secondary capital to reshuffle the C-suite and the cap table? Is a management carve-out plan needed? A new retention plan? Or restructuring? Potential scenarios abound…

What happens next. Invariably, after a founder divorce, the parties need to find a way to get along…in the board room…to raise capital…to help sell the business…to market the message…to evangelize the mission.

Things sometimes fall apart. Founders have to know how to keep things together until the next off-ramp is in sight.

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Louis Lehot is the founder of L2 Counsel. Louis is a corporate, securities, and M & A lawyer, and he helps his clients, whether they be public or private companies, financial sponsors, venture capitalists, investors or investment banks, in forming, financing, governing, buying and selling companies. He is formerly the co-managing partner of DLA Piper’s Silicon Valley office and co-chair of its leading venture capital and emerging growth company team. 

L2 Counsel, P.C. is an elite boutique law firm based in Silicon Valley designed to serve entrepreneurs, innovative companies and investors with sound legal strategies and solutions. 

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Archives, Global Trade Daily, In The News

230 years of Data Show Rates Will Soon Hit to 0.50 Percent

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While everyone has been concerned about the sell-off in the stock market in the past two weeks, this decline should be contrasted with the rapid rise in the price of government bonds. For the first time in history, the yield on the 10-year government bond fell below 1%.

As Figure 1 illustrates, the 75-year interest rate pyramid is continuing its path toward new lows. The pyramid began on November 30, 1945, when the 10-year bond yielded 1.55%. The yield gradually rose for the next 36 years, peaking at 15.84% on September 30, 1981. The yield has trended downward for the past 39 years and now has sunk below 1%. The past 75 years have provided a near mirror image in bond yields.  So what does it mean?

Before the current downturn, the lowest yield on the 10-year bond was 1.37% which occurred on July 5, 2016. We analyzed the 75-year interest rate pyramid in the blog “Government Bond Yields and Returns in the 2020s” which was published on January 8. We predicted the continued decline in government bond yields in the United States during the coming decade. With negative interest rates on most 10-year bonds in Europe and Japan, there is no reason why yields in the United States shouldn’t continue to decline.

The 10-year bond yielded over 3% in November 2018 and by December 31, 2019, the yield on the 10-year bond had fallen to 1.92%.  Today, the yield is half that. This decline has provided an 8% return to fixed-income investors during the past two months as the price of government bonds has risen. A 10-basis point decline in the yield rewards investors with a short-term gain of about 1%.

In the blog “300 Years of the Equity-risk Premium” published on February 5, we predicted that the total return to government bonds over the next 10 years will be around 2% per annum or less. This return can only occur through the continued decline in bond yields and increase in the price of government bonds. As we explained, government bonds have outperformed stocks since 2000; however, our analysis indicates that the return to bonds will be lower than the return to stocks over the coming decade.

The 5-year bond yield fell to almost 0.5% back in 2012.  So why can’t the 10-year bond yield decline to 0.5%in 2020? Figure 2 provides 230 years of bond yield data, which shows each decline building a deeper valley indicating that interest rates will soon reach a lower low. We believe it is only a matter of time before the yield on the U.S. 10-year bond hits 0.5%.

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Dr. Bryan Taylor is President and Chief Economist for Global Financial Data. He received his Ph.D. from Claremont Graduate University in Economics writing about the economics of the arts. He has taught both economics and finance at numerous universities in southern California and in Switzerland. He began putting together the Global Financial Database in 1990, collecting and transcribing financial and economic data from historical archives around the world. Dr. Taylor has published numerous articles and blogs based upon the Global Financial Database, the US Stocks and the GFD Indices. Dr. Taylor’s research has uncovered previously unknown aspects of financial history. He has written two books on financial history.

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Archives, Global Trade Daily, Special Reports

Is It Time To Play Defense with Your Investment Portfolio?

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The bull market has been charging ahead for more than a decade now, but financial professionals are starting to wonder whether the good times are about to come crashing down on the American public’s prosperous portfolios.

That means it could be time to become a bit more defensive with your investments, says Dr. Joseph Belmonte, an investment strategist and author of Buffett and Beyond: Uncovering the Secret Ratio for Superior Stock Selection(www.buffettandbeyond.com).

“People will talk about having good luck or bad luck in the market, and you never want to depend on blind luck,” says Dr. Belmonte says. “But another definition of luck is when opportunity meets preparation. And if a recession is coming, as so many people fear, then you want to make preparations.”

One suggestion for doing that, he says: Stay away from cyclical stocks, which are stocks that perform well when the economy is humming along, but struggle when things turn sour. These are companies that provide something that’s not essential to daily living or that consumers can at least postpone purchasing when times are tough.

Examples are car manufacturers, higher-end retail stores, and mortgage companies. Specific examples are Ford, General Motors, Caterpillar and Macy’s.

With the potential for a recession looming, Dr. Belmonte says, it’s vital that you review your portfolio, examine whether you have cyclical or non-cyclical stocks, and decide whether you need to make adjustments.

He says a few things worth remembering as you shift your portfolio to the defensive mode include:

-Look for efficiency. The companies you seek for your portfolio should be efficient. “They must have a relatively high return on equity and a consistent return on equity,” Dr. Belmonte says. “If the ROE is high and consistent, we know the firm has the capacity to create value because it is already doing so.”

-Examine a company’s history. Dr. Belmonte says that Warren Buffett likes to look at a company’s average return on equity over a 10-year period, most likely because over any 10-year period the economy goes through recessions and also economic expansions. “As the economy goes through these cycles, expectations about a company’s future will rise and fall with the mood of all of us,” Dr. Belmonte says. “Buffett probably feels that over a 10-year period, we see the average of at least one complete economic cycle, and of course, the ensuing mood swings that accompany both the good and bad times.”

-Consider value. Price follows value, Dr. Belmonte says, so invest in stocks that increase their value “every minute of every day.” He says McDonald’s is one example. The stock’s price may drop in tough times, but eventually the price catches back up to the company’s overall value. To find such companies, he says, look at how a stock performed during the last recession from June 30, 2008, to March 30, 2009. Value-added stocks didn’t fall as far as the overall market, and recovered much more quickly.

-Focus on businesses you understand. A company might sound good in theory, but if you don’t really have a good grasp of what it does and how the market for it might develop over the long haul, then it could be a risk for you. Dr. Belmonte suggests looking at businesses you have a good understanding of, so you can make an educated guess of where they likely are headed. “If you take a business you understand, and that company has a high and relatively consistent ROE, you are probably looking at a pretty good contender for your stock portfolio,” he says.”

“I always tell people to remember the good, the bad and the ugly,” Dr. Belmonte says. “The good stocks should be in our portfolios; the bad stocks should be in someone else’s portfolios; and the ugly stocks should be in nobody’s portfolio.”

 

 

Dr. Joseph Belmonte, author of Buffett and Beyond: Uncovering the Secret Ratio for Superior Stock Selection (www.buffettandbeyond.com), is an investment strategist and stock market consultant. He is fond of saying, “If you want to live on the beach like Jimmy Buffett, you’ve got to learn how to invest like Warren Buffett.” Dr. Belmonte has developed hedged growth income strategies for family offices, and has lectured to numerous professional and investment groups throughout the country. His weekly video newsletter is sent to thousands of investors, money managers, and academics both nationally and internationally.

Archives, Commentary, Global Trade Daily

If The Bull Market Turns Bear, Is Your Portfolio On The Right Cycle?

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The current bull market – at 10 years and counting – is the longest in the nation’s history. But instead of celebrating that longevity, plenty of people are worried about how much longer the good times can last, and whether we could be headed for a recession.

What does that mean for investors fretting that the next bear market will devastate their investment portfolios?

For one thing, those investors might want to ask themselves whether the stocks they are invested in are cyclical or non-cyclical, says Dr. Joseph Belmonte, an investment strategist and author of Buffett and Beyond: Uncovering the Secret Ratio for Superior Stock Selection (www.buffettandbeyond.com).

The answer could be critical, he says, because cyclical stocks perform well when the economy is humming along, but struggle when things turn sour. That’s largely because cyclical stocks are companies that provide something that’s not essential to daily living or that consumers can at least postpone purchasing.  

“Sometimes a cyclical stock will begin to decline nine months before the market begins to weaken because of a pending recession,” Dr. Belmonte says.

Examples are stocks for companies such as car manufacturers, higher-end retail stores, and mortgage companies. Specific examples are Ford, General Motors, Caterpillar and Macy’s.

Non-cyclical stocks, on the other hand, are the stores or companies people flock to for bargains when times grow tough. Some of these stocks are Dollar Tree, Costco and Ross Stores.

But for investors, just knowing the answer to the cyclical, non-cyclical question is not enough, Dr. Belmonte says. They still need to review a company’s numbers.

“If properly used, the numbers will tell us almost everything we need to know about a company,” he says. “If we use the correct numbers in the correct way, the bottom-line results will tell us which companies we want in our portfolio.”

The problem, Dr. Belmonte says, is that most analysts and investors use the wrong numbers when trying to decide whether a stock is a good or not-so-good option.

A comparable method of measuring the efficiency of a company’s operations. That’s why Dr. Belmonte is a proponent of what’s known as clean surplus accounting. He says the most prominent investor who uses this method is Warren Buffett. Here’s a quick overview of how clean surplus accounting works:

-Traditional accounting determines the return on equity (ROE) by using earnings from the income statement divided by the book value (owners’ equity) from the accounting balance sheet. “This is not a good measure of comparing one company to another because that’s not what it was meant to do,” Dr. Belmonte says.

-Clean surplus instead uses net income from operations as the “return” portion of the ROE. It then constructs its own “owners’ equity” as the “equity” portion of ROE.  The return on equity, as configured by clean surplus accounting, is truly a comparable method of measuring the efficiency of a company’s operations, Dr. Belmonte says.

-Net income minus dividends, of course, will net a different owners’ equity than will earnings minus dividends. It is this new calculation of owners’ equity (net income minus dividends) that allows a truly comparable return-on-equity ratio to be developed. And it is this comparable ROE ratio that is the foundation of the success of clean surplus, Dr. Belmonte says.

With a potential recession looming on the horizon, Dr. Belmonte says, it’s vital that you review your portfolio, examine whether you have cyclical or non-cyclical stocks, and then put those companies to the clean surplus accounting test.

About Dr. Joseph Belmonte

Dr. Joseph Belmonte, author of Buffett and Beyond: Uncovering the Secret Ratio for Superior Stock Selection (www.buffettandbeyond.com), is an investment strategist and stock market consultant. He is fond of saying, “If you want to live on the beach like Jimmy Buffett, you’ve got to learn how to invest like Warren Buffett.” Dr. Belmonte has developed hedged growth income strategies for family offices, and has lectured to numerous professional and investment groups throughout the country. His weekly video newsletter is sent to thousands of investors, money managers, and academics both nationally and internationally.