Beyond the Headlines: What Founders Need to Know About 2024's Economic Outlook

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Kate 00:18
Welcome to startup success. Today, we have a real treat. We have Burkland colleagues joining me to talk about 2024 and what founders can expect. I’d like to welcome Ardy Esmaeili, who is Managing Director of Burkland’s Tax Practice. And Steve Lord, who is the Managing Director of our Service Delivery teams and Knowledge Share program. Thank you both for being here. So this is the time of year when everyone starts to stress a little about next year, right? You’re wrapping up the holidays, making your plans for 2024. And a lot of founders have been submitting questions into the show about what next year is going to look like 2023 was very strange, as I’m sure you both can agree. Steve, let’s start off by talking ‘big picture’, like what do you see in store for the US economy and other kind of macro climate things on deck?

Steve 01:23
Sure. You know, I mean, one of the interesting things is, is something you just said, and that 2023 was a very strange year, we all feel like it was a really tough year macro economically. But when you look at the actual numbers in the data, it was not. It was actually a pretty good year, from a macro perspective, when you look at things that are beyond the realm of just the founder community or the startup ecosystem. So I think we’re gonna see more of that heading into next year, the higher level of interest rates is doing its job. If anything, we may find that it’s doing too good of a job, and there may need to be a rapid readjustment there. But for right now, what I think people are expecting the most, and where the data seems to be shaping up is that we’re going to stay sort of at a higher level of interest rates heading, at least in the first half of the year. But they won’t be going up, the Federal Reserve has already signaled they’re going to hold and see how this goes. Generally speaking, interest rates need 12-18 months, you know, changes in those interest rates, the 12-18 months to percolate their way all the way through the economy. So we were all crazy about inflation. A year ago, interest rates went through the roof. And now we’re seeing that down, we cut to 3.3 Print last week on inflation. So those rate cuts and we haven’t even started to see the impact of the most recent rate hikes. So it’s way too soon to start talking about cuts, I think we’re done going up. And that’s going to be the main macro backdrop. The last thing I’ll say before I shut up is it is an election year. Typically, election cycle is a real thing. Economies tend to do well during election years.

Kate 03:02
So expand on that a little bit more. Is that really true? Because everyone says that.

Steve 03:09
No, it is really true. The best years for the stock market in the four years is typically the third and the fourth year, as it is whether they know they’re doing it or not, they tend to put a lot of things out in the world in order to get the economy running, so that they can get elected. And it’s been, you know, people look back to this since the 20s. Now, this year will be a little bit different, I think because of where we were. And we’re still in the hangover fees from 10 years of rock bottom interest rates, tons of liquidity in the system. That’s partially also when we feel. We feel liquidity kind of leaving and going other places. And that’s part of why you see, you know, real estate sales still sort of sideways based on where you would have expected it to be with high interest rates.

Kate 03:54
Okay, that’s really helpful. I want to go back quickly to something you started off by saying and that is it wasn’t a strange year, it was a pretty good year. Why does it feel like it?

Steve 04:05
Well, it was a strange year? No, I mean, I wasn’t clear. Yeah. Okay.

Kate 04:08
Yeah. Let me clarify the question. It was a strange year. But if you look at all the numbers and data, it wasn’t that bad of a year. Why does it feel like it was worse? Why did the founders listening they’re shaking their head like “no, it wasn’t a great year.”

Steve 04:24
Right, because a lot of the things that I think that founders track, this is long term enterprise sales contracts, right? New business development, whether their fundraising went the way they want it, a lot of those things were impacted in 2023 because of where they entered the year or even 2022 at very skewed levels. So you add some sectors in the startup economy that were just going crazy post pandemic and of course, we came off that boil a little bit in ‘23. When you look at the leading indicators for the overall economy Employment, wage growth, things like that, the reduction in inflation that we’ve seen, those are all things that speak to the long term underlying health of the economy. But if you were a startup trying to sell to IBM, in June of 2023, no one was answering your emails, because those folks were pulling back and waiting to see what happened.

Kate 05:21
Got it that makes perfect sense. So the pullback that founders felt was real, but it was being driven in a different way.

Steve 05:32
From a macro perspective, it was okay. From a micro perspective, everybody felt it. Yeah, we all feel like it was kind of a tough economic year.

Kate 05:45
And I want to come back later and ask you about fundraising and how this plays out for a founder. But Ardy I want to talk to you about what founders should have on their radar for 2024 as far as tax changes, because that’s something we all have to deal with.

Ardy 06:03
Yeah, as always tax compliance is like paying attention to tax filings and, you know, filing your tax return on time to avoid any penalty or, you know, interest. And that’s huge as always. However, there are three main things that I would recommend to work with your tax accountant for next year. So one of them is R&D tax credit, and also R&D, tax expense capitalization. So these are two different things. However, you know, a lot of startups if they’re working on an R&D project, they have to start capitalizing their R&D expenses for tax purposes. So that makes the company profitable, you know, if they do have a lot of R&D expenses, so working with a tax professional to make sure, you know, if there is a profitability, how much their tax liability they have, also, if they qualify for R&D Tax Credit, not all of their R&D expenses are qualified for R&D Tax Credit, however, there is a majority of them that will qualify, and then they can claim the credit, and they can use some of those credit against the tax liability. That’s definitely one of the huge topics for next year. Another one is sales tax, especially if the product is SaaS and digital goods, and software. So we’ve seen a lot more states starting to impose sales tax on software, and SaaS products, and we have seen a lot more audits. So working with a tax professional to figure out where they have nexus, where they need to start collecting sales tax, and if they should start implementing a system for automating the sales tax collection. And the last thing is not necessarily tax items, however, it is related to the Treasury Department. There are ew changes with the corporate Transparency Act, which all of the businesses regardless if they are a corporation or an LLC, they have to have annual reporting, which the first one is doing 2024, and most are due at the end of the year. So the penalties are significant for missing those reports or not correctly reporting it. So definitely working with their finance team, working with the legal team or tax accountant to understand a little bit about filing requirements. And hopefully, they’re already in compliance and there shouldn’t be any problem.

Kate 08:24
Okay, so thank you a couple follow up questions that annual reporting, is that something that a founder should talk to a tax professional about first?

Ardy 08:33
Definitely we recommend talking to their tax professional to make sure if they are filing those as part of the tax preparation. If they’re not, then definitely talk to their legal counsel. Okay. The corporate filing requirement is not a tax calculation of them. They’re not reporting any numbers. However, they’re reporting the ownership, the ultimate beneficiary of the company. And so how they report it and how the reporting needs to be reviewed at the end of the day with legal.

Kate 09:06
Got it. Okay, that’s a helpful clarification. Then you mentioned sales tax, which not every founder has on their radar, and they should. And you said a word that I know not everyone’s familiar with, but it’s really important, and that’s Nexus. Can you just give a quick overview not too detailed about what that is, and why a founder needs to have that on their radar sales tax nexus?

Ardy 09:33
Sure. So there’s two different types of Nexus One is physical Nexus and the other one is economic Nexus. So the physical Nexus, if the company has some sort of presence in the state, like having an employee having the office, having a warehouse, maybe they traveled there to support the customer. So that creates a physical Nexus. means they are doing business in that state. So if states now ask them to allocate some sales or the sales that they have in that state for the purpose of not only sales tax, but maybe income tax purposes as well. So that’s one thing on the Physical Nexus. The other thing is Economic Nexus, which is based on the dollar amount and the number of transactions that they may have. For example, the state of Washington – if you don’t have physical presence, but you do have $100,000 in sales or 200 transactions, then you establish a nexus, which means that you need to start collecting sales tax and filing a tax return.

Kate 10:31
Thank you. I think that was a very helpful explanation, because I think that’s why founders don’t always have it on their radar. Last clarifying questions. So for years, you know, R&D tax credits have been out there, lots of hype. But this R&D expense capitalization, can you just give a little more detail about it so founders know what to ask their tax professional?

Ardy 10:58
Yeah, so the R&D expense capitalization, or we call it Section 174. And this is the new tax law, which was passed back in 2018, however, the effective date was 2020 tax year, which means that if any company starts working on R&D, and they have R&D expenses, they’re not able to expense that and they have to capitalize it and expense it over a period of time. If those expenses are in the US, and are all domestic expenses, those are amortized over five years. And if there are foreign or non US expenses, they are amortized over 15 years, which means if you spend $100,000, paying a contractor outside the US to work on your R&D, you’re not able to deduct it this year, you will have to deduct it over the next 15 years. So that automatically makes a lot of businesses, which have revenue and are profitable and they have to pay tax.

Kate 11:54
This is why you need a tax professional helping you.

Steve 12:00
Right, every founder listening to this, if you don’t worry about sales tax yet you will worry about it later. So one way or the other. This needs to be on your radar, because if you wait too long in your backward audit, it is going to hurt. Yeah. So that is very, very important.

Ardy 12:18
We’ve been through a lot of due diligence for M&A and acquisition, and sales tax is often an issue. Often the founder didn’t pay attention to sales tax and now the liability or exposure, it’s millions of dollars that the buyer doesn’t want to take responsibility for that, so what they do is they go back and reduce the purchase price.

Kate 12:40
Wow. Ding ding.

Steve 12:42
Get set up. And it’s so easy to get set up.

Kate 12:46
I hope everyone listening heard that. Yeah. Yeah, exactly. You set it up early, you’re fine. Otherwise, look at it, right. impacting your sale,

Steve 12:57
And it grows quickly if it is not done right.

Ardy 12:59
And penalties and interest can be significant.

Kate 13:04
Okay. So all very important things to have on your radar for next year. Switching back. Now, fundraising, Steve, just to wrap up that area, because I know a lot of founders listening want some insight on where you think that will be in 2020.

Steve 13:22
So I think what’s important that everybody realizes that venture is a very cyclical industry, it moves with the economic cycle, and it has almost like a sine wave to it, if you look at it very objectively, and it has a lot to do with interest rates, of course. So it’s it’s pretty negatively or inversely correlated with the interest rate rise. Interest rates go up, VC activity goes down, and vice versa. So one thing I think is important for founders to realize is that the venture business, the ecosystem, in and of itself, with the biggest marker being transactions, valuations, you know, deal counts, and things like that really was already declining last spring before the news got bad. And it’s already gonna start to improve before the news gets better. It is an array, not only is it cyclical, it is an early cyclical sector. So it starts to turn before a lot of other sectors do. If you wait to think that the fundraising environment is going to come back to life, when you’re reading about it on CNBC, it’s already happening. It’s way too late. So I think the best thing for founders to think of is to begin prepping for a much more favorable fundraising environment, probably heading into the back half of next year, might happen a little sooner than that. Sometimes the exit out of a cyclical downturn can be very steep. But it’s definitely, to me anyway, going we’re much closer to the end of this down cycle and venture financing than we are in the beginning. I would prep everybody to be thinking about a good – doesn’t mean it’s back to where it was, right? Because we were dealing with the over excess. The opposite of the cyclical turn was two years ago where everybody you know, you needed a pulse and a pair of feet to raise money. We’re now on the other side of that. What will happen particularly in the back half of 2024 is the normalization of that trend and an upswing in venture activity.

Kate 15:21
That is so encouraging to hear, that’s great news that I also liked that you said, you know, it’s kind of already started, and it’s happening, and then it won’t, we won’t, because the news is so negative, and so discouraging.

Steve 15:36
So right, but it isn’t really turn. So it’s a lot of counter cyclical, or contrarian thinking about macro economics. It’s all around, you know, sort of zigging when other people zag, we’ve priced that negative environment into valuations. So founders, you know, you’re not going to get, I think, anyway, in the back half of next year, you won’t be having the kind of valuation conversations you’re having now. You won’t be having the ones you had in 2021 and 2022, either, though. It is a normalization of that movement. And in particular, I think for Series A to Series B, the folks that are right now needing to do follow ons, A+ rounds, maybe flat, maybe even a little down. I think those folks in particular should be careful to raise as little as they can, or raise just enough to get to that more positive environment, and then do a bigger round in the back half of next year. Because the valuations will ne stronger.

Kate 16:34
Great advice. And I like how you use that word normalization. Like, you know, we’re not going to get back to the height, but it’s, it’s correcting. It’s moving in the right direction. It’s trending that way. Yeah, this is okay. I want to leave it right there. I will tell everyone listening that Ardy and Steve are two of the busiest people I know. So I want to let them go. But great news. And to leave on that encouraging note is really helpful. So thank you both for being here today. Happy Holidays, and I appreciate your time.

17:06
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