Dealing with the Nitty Gritty: Resources and Wrap Up

Part 6 and final post in a series in Startup Stages

Co-founders.  Suppliers.  Employees.  Customers.  Government.  So what are the compliance and risk management resources available to a startup?

• Do-It-Yourself Resources – There are a host of websites, guides, and other resources supplying legal templates, HR compliance kits, on-line payroll management etc. While inexpensive in terms of dollars, this route can be very time consuming, requiring the entrepreneur to learn about, select, integrate, implement, and manage all of the separate pieces.
• Attorneys, CPAs, and Other Professional Outsource Firms – Legal, accounting, HR, and other compliance professionals can be hired on an outsourced basis, greatly simplifying the management burden on the entrepreneur and increasing the quality of compliance and risk management. But these professionals are very expensive, need to be actively managed, and in the end, you the entrepreneur will need to integrate it all together. In addition, these professionals are advisors, not operating people, and are often more risk averse than the entrepreneur needs them to be, resulting in unnecessary expense.
• CFOs, CAOs, HR In-house Staff – Of course, you can hire your own CFO, CAO, or HR staff who will be able to take care of many of these issues directly, thus minimizing the use of the more expensive professionals.  They can also manage the professionals when more complicated issues arise, reducing the time burden on the entrepreneur. But it may be the case that you don’t need these positions staffed on a full-time basis, in which case hiring internal staff may not be the most cost effective solution.

In Summary…
While the startup must manage a number of compliance and risk issues, the main ones are liability protection, tax compliance, and employment law compliance. In terms of summary practical guidelines, the startup should:

1. Organize formally early to put in place basic liability protection and establish the most favorable tax treatment for the business.
2. Define intellectual property strategy and processes early in order to maximize the value of the startup’s intellectual property and minimize the risk of infringement.
3. Do the appropriate trademark searches, and register your domain names and trademarks early on, to minimize the risk of having to change your name after brand equity has been built up.
4. Be aware that hiring employees is a significant step up in legal compliance requirements and insurance overhead that the startup will need to bear and should have the processes in place to handle beforehand.
5. Delay leasing dedicated space, with its attendant addition of long term liability and insurance overhead, as long as possible. Consider hosted office space as an alternative.
6. Be aware that customer contracts will introduce an additional step up in potential liability and insurance overhead. The startup should have the processes in place to handle this before accepting a contract.
7. Select the appropriate resource/cost for the level and complexity of risk.  Do-it-Yourself resources are fine for simple, more mechanical processes, while ill-defined or complex issues, like intellectual property strategy, should be handled by the appropriate specialists.

Related posts in this series:
The "Nitty Gritty" of Startup Formation
Intellectual Property Creation and Startups
Startup Stage:  Buying Stuff and Independent Contractors
The BIG Risk Trigger:  Hiring
Space (and) The Final Frontier

Space (and) The Final Frontier

Part 5 in a series in Startup Stages

In this post, we deal with the last two pre-institutional funding risk triggers.

Leasing Space
One mistake startups make is leasing dedicated space too soon. In some cases this is unavoidable (e.g. if you are a manufacturing company handling hazardous materials or requiring heavy equipment). But for software, Internet, or light hardware development, there may be more cost effective options.

Leasing can add considerably to the cash burn, administrative overhead, and risk of a startup. While the NNN lease rate may be low, required insurances, taxes, utilities, common area expenses, and maintenance can easily double the rate. In addition, landlords often require multi-year (3-5) agreements with security deposits, tying up or committing limited cash.

On top of this, there are upfront costs associated with tenant improvements, furnishing, and permits.

New compliance issues include:

• Local fire department regulations/ inspections
• Insurance policies: property and liability ($1-3 million policy coverage required by most landlords)
• Worker health and safety including evacuation plans, notice postings
• Special operating permits depending on the nature of the business (e.g. environmental, hazardous materials)

Additional overhead:

• Utilities (electric, gas, water, janitorial, alarm service)
• Facility maintenance and repair (don’t assume the landlord covers it)
• Facility safety

Really think through whether you need to lease space. While employees create value, furniture does not.  If you must lease space, take a look at which employees really need to be physically co-located and which do not. (It’s amazing how space efficient a person with a laptop, Wi-Fi and a cell phone can be.)

As an alternative, consider hosted office space (also called executive offices). While at first glance, base lease rates are more expensive than dedicated space, total operating costs may actually be cheaper. Hosted offices usually come fully furnished with utilities, are available on one year or shorter leases, don’t require insurance, and have a range of amenities including kitchens, meeting rooms rentable by the hour, office equipment charged on a per use basis, and reception desk services.  Just watch the notice period requirements for cancellation; they can be as long as three months!

The Final Frontier:  Accepting Customer Purchase Orders
Congratulations! You're no longer pre-revenue; you’ve closed your first sale! The P.O. or contract just hit your email… and with it a new set of legal obligations.

A purchase order is a legally binding contract and by its acceptance, the startup is obligated to perform in accordance with the terms and conditions negotiated. In addition to price and delivery, terms to be negotiated should include:

• Product or service acceptance criteria (specifications to be complied with or other conditions that allow closing of the contract and subsequent invoicing)
• Warranty terms, indemnities, and other liabilities
• Damage exclusions
• Title risk transfer
• Payment terms

In order to avoid reinventing the wheel for each contract, the startup should have its own standard sales T’s and C’s covering these. If the startup doesn’t furnish its own T’s and C’s, it could inadvertently end up agreeing to the customer’s T’s and C’s.

Assuming the startup has the associated operational infrastructure for sales order processing, development, production, quality control, and shipping, the additional administrative overhead required includes:

• Sales terms and conditions
• Accounts receivable, invoicing, and collections
• Insurance policies: product liability and/or errors & omissions (services)

If the startup uses distributors or sales representatives, it will also need the appropriate agreements defining the commercial relationship.

Next and final post in the series:  Dealing With It

Startup Stage: Buying Stuff and Independent Contractors

Part 3 in a series in Startup Stages

So you think the purchasing of products and services from is straight forward?  While generally true of the former, the hiring of services, particularly that favorite of all startups, the independent contractor, can expose the startup to significant liability.  Let's take a look at the issues surrounding third party purchases by the startup.

Purchasing by the Business of Products and Services from Third Parties
Once a business entity exists, the founders need to shift the purchasing of supplies, equipment, and services from their personal accounts to the business, in order to take advantage of the limited liability benefit.  Keep in mind that goods and services paid for by the founders (i.e. via personal credit card) do not automatically belong to the business.  They must be transferred in.  The easiest way to do this is via some form of expense reimbursement policy.

Still assuming no employees at this stage, three additional compliance issues must be met:

• Ensuring that independent contractors (if any) are not de-facto employees under Federal or state work rules.  Just because your service provider is willing to be an independent contractor, does not necessarily make it so.  The government has a say in this.  (For more details, see my post.)
• For tax purposes, properly classifying inventory, depreciable assets, and expense items
• Obtaining a state resale certificate in order to avoid paying sales tax on items purchased for resale

In terms of risk management, overhead necessarily increases and involves:

• Executing independent contractor agreements with contractors
• Filing/issuance of IRS 1099-MISC and California EDD DE-542 forms or your state's equivalent (if independent contractors)
• Setting up a business checking account
• Creating accounting controls with respect to purchasing, expense reimbursement, and payables to reduce the risk of fraud and monitor cash burn
• Establishing purchasing terms & conditions
• Obtaining personal property and casualty insurance (if there is a high value to inventory or capital assets)
• Protecting intellectual property (see last post)

For the hiring of services, a well written independent contractor agreement is key. At a minimum, it should (a) define contractor status, (b) assign to the business any intellectual property the contractor creates, (c) spell out contractor responsibility for withholding taxes and insurance, and (d) define the financial terms of the relationship.

Personal property insurance may not make sense unless the startup has expensive capital assets or a high value of inventory (both of which the startup should ideally avoid by outsourcing or building to order).The same goes for establishing purchasing terms and conditions (“T’s and C’s”), although unlike insurance, this costs almost nothing to set up. Having your own set of purchasing T’s and C’s will ensure that you are not inadvertently agreeing to the vendor’s T’s and C’s.

Next post:  The BIG Risk Trigger:  Hiring.

Related posts in this series:
The "Nitty Gritty" of Startup Formation
Intellectual Property Creation and Startups

The "Nitty Gritty" of Startup Formation

Part 1 in a series in Startup Stages

I'm often asked by first time entrepreneurs what's involved with setting up a business.  Do I need to incorporate?  What do I need to know about hiring?  Payroll?  Do I need a CPA?  How do I register my business?  Why do I need to bother with any of this at all?

The fact of the matter is that for most entrepreneurs non-core activities like filing DE-1 forms and negotiating insurance rates are at best a necessary distraction to the value added tasks of creating product, finding customers, and building a team.  At worst, they can be a confusing labyrinth of rules, regulations, and risks which if ignored or mismanaged can hurt your business.  Unfortunately, business does involve some non-core, administrative overhead that cannot be ignored.  And what you don’t know can bite you.

Compliance with regulatory requirements and contractual terms is a risk-mitigation matter that must be properly managed. While entrepreneurs are often comfortable managing technical and business development risk, they are often less comfortable at managing the legal, financial, and insurance risks.

Poor execution in these areas can hurt a startup’s chance of success in several ways:

• Subject the startup to legal sanctions or other penalties
• Unnecessarily increase overhead cash burn, the lifeblood of a startup
• Jeopardize intellectual property rights
• Impair the startup’s ability to obtain downstream funding
• Cut into an entrepreneur’s most precious resource: TIME!

Large companies can afford the legal, accounting, and other risk management specialists to the degree required (i.e. $$$) to ensure compliance and minimize other risks. But unless you’re a lawyer or CPA or you have an exceptional amount of startup capital, it is unlikely that you’ll be able to do the same.

However with some upfront planning and an understanding of what to look for, it is possible to ensure regulatory compliance and mitigate the largest risks while minimizing cash burn and the impact on your time.

Understanding Risk/Cost Tradeoffs
Using the example of a prototypical technology-based startup in California with eventual plans to seek institutional funding, let's trace its evolution to show how compliance and risk management requirements increase as the business grows.

For most startups, the burden of compliance and risk management increases when the business begins undertaking specific activities that trigger new levels of risk.  The main risk triggers are:

• Formal Organization, “Friends & Family” Funding, and Issuance of Founders’ Shares
• Intellectual Property Creation
• Purchasing by the Business of Products and Services from Third Parties
• Hiring Employees
• Leasing Space
• Accepting Customer Purchase Orders

Let's start by looking at the very first stage leading up to formal organization.

In the beginning....
Prior to the creation and registration of a formal business entity the founding team is informally affiliated, with each person contributing time and money on a voluntary basis and with each individual responsible for his or her own expenses. At some point, as the startup begins to gain momentum and both time and expenses mount, there is usually a desire for the founding team to organize formally so as to limit the founders’ liability to third parties. The founders may also be raising seed capital from “friends and family,” most of whom will be passive investors unfamiliar with the day-to-day activities of the startup.

Formal Organization and Issuance of Founders’ Shares
Corporations and limited liability companies are artificial constructs which serve to limit shareholder and employee liability to third parties. To achieve this, one must comply with the governing laws. In addition to limiting liability, formal organization as a corporation or an LLC defines the following:

• How the economic benefits and risks are to be shared amongst the founders and investors (i.e. shares, share classes)
• How those benefits will be taxed
• The rights and responsibilities of the parties involved
• The compliance requirements to keep the entity in good standing

For startups, the most common business entities chosen are:

• Limited Liability Company (“LLC”)
• IRS Sub-chapter C Corporation (“C-Corp”)
• IRS Sub-chapter S Corporation (“S-Corp”)

The decision as to which business entity to select will have the following implications:

• Tax treatment
• Eligibility for financing from institutional investors
• Administrative burden(least for an LLC, greatest for a C-Corp)

There are tradeoffs associated with the above that need to be considered. While there are a number of “do-it-yourself” books available to help you select and register the proper entity, an attorney is usually the most cost effective way to ensure this is done correctly.

At this stage, assuming there are no employees, compliance requirements are low and involve just a few items:

• Filing Articles of Incorporation or Articles of Organization with Secretary of State
• Board adoption of Bylaws and organizational resolutions (in the case of a corporation) or execution of Operating Agreement (in the case of an LLC)
• Issuance of shares to founders in compliance with Federal and state securities laws
• Securing of a Federal Employer Identification Number (“FEIN”) from the Internal Revenue Service
• Filing a fictitious name statement if the business will be conducted under a name different from the name stated in the Articles of Incorporation or Articles of Organization

Even if there are no employees, an FEIN is usually required by registering agencies and frequently needed for setting up bank and supplier accounts.

Commensurately, ongoing administrative overhead is low, involving:

• Filing annual Statements of Information with the state
• Filing annual Federal and state tax returns
• Basic accounting and record keeping throughout the year adequate to support the tax filings
• Execution of annual written consents reflecting actions of the shareholders and Board, including election of Board members and appointment of officers
• Periodic updating of minute book share registry to reflect stock or option grants

It is advisable to keep the share registry updated, especially as the startup approaches the professional funding stage. There is nothing more frustrating than preparing to close a multimillion dollar funding deal and not being able to get cousin Bobby’s signature because he’s moved to Timbuktu, address unknown.

At some point, the startup may raise funds from “friends and family” or angel investors. As part of the financing process, it will have to make certain representations regarding financial and legal matters. So compliance with these matters will greatly facilitate the financing process, while compliance gaps will complicate it.

Next post:  Implications of Intellectual Property Creation

Process Overkill

I just got off the phone with potential new client, the CEO of a pre-Series A startup.  I feel bad for him because the poor guy just wanted to get his financial accounts in order.  So he hired a well known, reputable accounting firm.  60+ billable hours later, his accounts are still not in order.

Instead, it sounds like a great deal of effort has been expended to automate and integrate his accounting, payroll, banking, and payables systems.  It sounds like the accountants burned through some of the 60+ hours trying to set up ACH electronic transfers between vendors and the company and linking in a SaaS bill pay system instead of just posting entries.

All this for a less than five person, pre-revenue bootstrap startup that probably does less than twenty purchasing transactions a month, most of which are on the company credit card.

Another victim of process overkill.

In a different case, one of my current clients, a thriving $20MM+ revenue business, is just now upgrading from Quickbooks to a conventional ERP system.  As part of the implementation, they are putting in place a formal purchasing process.  The process owner has a common sense approach.  For her, the purpose of the process is to contain costs by reducing redundant buying.  She's scoping the process to facilitate the most common buying situations, not to cover every situation.  She wants the process to be easy for people to use; no massive purchase requisition forms.  And most refreshingly, she knows that she will have to handle exceptions to the process.

Part of startup conventional wisdom in Silicon Valley is that one should build ahead of where you plan to be. Planning to be a $100 million revenue company in three years?  Better get that SAP or Oracle ERP system in place now!

But in my experience, to avoid process overkill, startups would be better off if guided by a different principle:  scale appropriate.

Scale appropriate means working with processes set at the level you are currently at.  Still trying to validate your business model and build prototypes?  You don't need an ERP system.  You don't need elaborately defined purchasing requisition and approval processes.  You don't need ISO9001 level ECO (engineering change order) controls.  And while nice, you don't need your online banking system integrated with your accounting software.  Quickbooks plus a bookkeeper doing manual entries with an occasional account review by a CPA should be suitable for financial tracking.

So how do you determine when it is time to upgrade process and infrastructure?

• Routine tasks are increasingly getting dropped
• Increasing error rate on routine tasks
• High personnel cost associated with the people running the processes (either because you need a lot of people or you need highly trained ones who are really expensive)

Process Implementation Guidelines
So how do you go about implementing scale appropriate processes?  Here are a few of my guidelines:

• Know the Objective - It seems obvious, but before implementing any process, be sure you know what the end goal is.  Is is error reduction?  Workflow simplification?  Scope expansion (i.e. enabling less skilled people to perform the task)?  When you document your process, this should be the first thing at the top of the page!  Why?  Because over time, the purpose for the process will be forgotten and the people who put it into place may be gone.  Soon the process takes on a life of its own and you end up with mindless bureaucracy.  Don't believe it?  During my first turnaround, at an ISO9001 certified company, in forcing a review of every ECO process we had, we discovered one that had never been used in the ten years it had existed, but was driving 25% of the data collection fields for the entire ECO process.  Why had it been implemented?  It was a what/if scenario.
• Set the Metric(s) - Once the objective is set, make sure you have a way of measuring whether the process is being effective  This way, you can determine whether future changes to the process are helpful or harmful.  Frequently, this will help prevent process overkill.
• Evaluate Whether Existing Processes Can Be Pushed Harder - Before implementing a new process, see if the existing processes or infrastructure can be pushed harder.  While I know this is going to go against the advice of every business process person out there, don't fall prey to the "blank paper approach" siren.   This especially goes for evaluating  a new ERP system.  You'd be surprised how hard you can push a legacy ERP system.  And while pushing a legacy system can seem like a lot of useless work, be sure to compare it against the disruption of transitioning to a new system.
• Design for the 80/20 Rule - If you do need a new process, design it to handle the 80% most common work outcomes, not the 20% exceptions.  Designing a process to handle 100% of the contingency situations that might arise is the path to process overkill.  It's usually simpler and more effective to let a person handle the 20% exception cases.  Be very careful listening to the "what if?" person in the room!
• Don't Over Automate/Integrate - While it is tempting to want to automate and integrate all your various processes and systems together for push button convenience, there can be a price to pay as well.  Integration to improve data transmission accuracy or eliminate multiple or complex manual steps that can lead to errors may be worthwhile.  However, the more processes are interlinked, the more you may run into unintended consequences particularly if changes to any of the independent processes are made.  This can lead to a situation where one is spending more time troubleshooting and fixing processes than performing a manual step once in awhile.

One of the biggest sources for process overkill that I see comes when someone attempts to design a process to eliminate a human being.  For all except the simplest processes, this rarely works.  In my mind, it's better to design a process to leverage the capability of a human being, not eliminate them.

Establishing highly integrated and automated processes comes with a price.  Where transaction volume is high, complex in nature, or the consequence of output error is high, it may be worth paying that price.  There is a reason that large multinational corporations, financial institutions, and government agencies tend toward these type of processes.  But they also spend hundreds of millions of dollars with fairly large dedicated IT staffs for the privilege.

For small businesses and startups, the focus should be on effectiveness in getting the job done.  Whether it is done by people, processes, or a combination should be secondary.

Related blog post:  Process vs. "Product" People

Tracking Cashflow (for Non-Accountants)

One of the most important things an early-stage startup must do is track cashflow (see my previous post My Top 10 CEO Lessons).  But for a variety of reasons, many startups do this poorly, spend too much time doing it, or don't do it at all.

Because many entrepreneurs are not trained in accounting (nor do they want to be), the two most common questions I get are:

1. Is there an easy way to track cash without having to be an accountant or spending large amounts of time learning QuickBooks (or the equivalent) short of hiring an accountant?
2. I use accounting software, but the standard reports don't really help and looking at my bank balance doesn't help me with outstanding checks.  Is there a better way to get a forward projection of my cash?

Before I go any further, let me first clearly state that in my opinion, if you are running a serious business, you should at a minimum be tracking accounts using QuickBooks or the equivalent.  This goes triple if you've taken "friends and family" money in any way, shape, or form.  If you can't or don't want to do this yourself, then spend the few dollars a month it takes to hire a competent bookkeeper.  You have a fiduciary responsibility to your investors to do so.

In any event, to help our clients, I've developed a simple cash tracking spreadsheet in Excel that you can download for free here from my company's website.  I recommend tracking cash weekly.

Disclaimer:  This spreadsheet is meant to be simple.  There are no macros, automated routines, or fancy error-checking routines built in.  If you insert or delete cells, be sure you haven't messed up any formulas.  Use it at your own risk.

Additional tips for maintaining control over cash for an early stage startup:

• Maintain a separate bank account for the business - Its virtually impossible to maintain control over cash when it's co-mingled with a founder's personal bank account.
• Limit the number of company credit cards to just one (and preferably zero) - Credit cards are a recipe for runaway spending.  The more cards, the tougher it is to maintain control.  If you must have a credit card (some services require submitting a credit card for auto-billing) have just one.  It's better to have auto-payments done via online bill pay.  If its a convenience issue, reimburse personal credit card use via an expense report system.
• Require employees to submit expense reports for company expenses that they pay for - See above.  You'd be amazed at how much more careful people are with the company's money when reimbursements are subject to approval.
• Anti-fraud control #1:  Dual check approvals - Have the person who initiates a check, online bill pay, or wire be different from the person who approves it.  If there is only one person, then it should be the CEO/founder.
• Anti-fraud control #2: Dual bank deposits - Have the person who receives checks be different from the person who deposits them in the bank.  If there is only one person, then it should be the CEO/founder.

Startups die when the cash runs out.  It's worth the effort to track it so you don't get surprised.  Know your cash.

The Tyranny of the Tangible

As human beings, we enter life with a natural bias towards the tangible, those things that we can see, feel, hear, or touch.  Furthermore, those of us trained as engineers, scientists, mathematicians, accountants, economists, or financial analysts have an almost holy reverence for data especially the numerical kind.  "Show me the numbers!" we cry.

Naturally, this bias carries over to the startup world, particularly if the entrepreneur comes from one of the aforementioned disciplines.

So?  What's wrong with that?

Nothing, provided that we remember that much of the value inherent in a startup lies in the intangibles; intangibles like inspiration, creativity, employee morale, ethics, customer loyalty, brand awareness, energy, boldness, and vision.  What is the value of a creative environment?  How does one measure the ROI of employee morale? How does one assess the impact of workplace energy?

People have tried and continue to try quantifying intangibles with satisfaction surveys, brand unaided recall percentages, and customer retention indices. But even these are difficult to tie to the financial bottom line. At best, the intangible's metric is statistically correlated to some revenue, expense, or asset measure, but it's still squishy, lacking the firm certainty of a hard expense like wages.

One of the few places financial accounting¹ and intangible value cross is when a company is sold and a mysterious item called goodwill appears on the balance sheet of the acquiring company.  What is goodwill?  It's the excess of the purchase price over the net tangible assets of the acquired company.  This gap represents the intangible value created by the acquired company. In the case of an initial public offering (IPO), the intangible value usually shows up as additional paid in capital which is the cash the company receives from the sale of its stock in excess of par value.

If you don't think this is significant, let's take a look at Google.  On June 30, 2004 just prior to their IPO, Google had a net assets of $589 million.  On September 30, 2004 shortly after the August 14th IPO, Google's net assets were $2,589 million due mainly to an increase in additional paid in capital of $1,540 million.  In other words, investors paid over 2-1/2 times what Google's pre-IPO net assets were worth!  And goodwill?  Well Google is an acquirer of startups as well.  As of December 31, 2009 the goodwill on Google's balance sheet stood at $4.9 billion.

So am I saying that we should ignore the numbers in running our businesses?  Of course not.  (Anyone who's ever worked with me can attest to my penchant for metrics.)  But given the human bias towards the tangible, it is up to the entrepreneur to make sure that the intangibles are not marginalized by what's been called the tyranny of the tangible and that it receives a proper weighting in decisions that affect the long term value of a company.  Small wonder that in recent years, the elevator pitch, which rarely contains distracting numbers, has become such a prevalent sorting tool by many VCs.

Here are three tips for tempering the tyranny of the tangible:

• Beware of false precision - Beware of decimal points.  Just because the number popping out of the sales forecast spreadsheet says $1.5427 million, does not mean that it is so.  How precise were the numbers going in?  Are you sure this isn't more like $1.5 +/- $0.5 million?
• Know the limits of your financial models - Closely related to the above.  Linking your total available market and customer acquisition estimates into your revenue model does not make them more precise².  Models are useful for understanding dependencies and possibly variable sensitivities.  But don't expect a +/-5% sales figure derived from input variables with a +/-25% uncertainty.
• Temper the numbers with common sense - Do the numbers seem surprising?  Maybe they need a closer look.  But how do you do this when you have no idea what a surprising number looks like?  This is where business can be more of an art than science, where experience, intuition, and a dose of common sense come into play, and often what separates the successful from the unsuccessful entrepreneurs.

With respect to this last bullet, let me recount a story from my college days:

As a chemical engineering undergraduate at MIT, I was required to take a class in heat and mass transfer.  One of the exams required us to calculate the time it would take to cook a strand of spaghetti.  Of course, we had been armed with all the appropriate equations, knew the simplifying assumptions, and were given the relevant dimensions.

I don't recall whether I got the answer right but what I do still remember was the post-test review.  Here, the professor informed us that student answers to the spaghetti problem ranged from less than 1 microsecond to over 1000 hours!

He then proceeded to pull out an exam book (not mine) and read what the test taker had written at the bottom after pages and pages of scratched out calculations.  To paraphrase³:

"Dear Professor.  I've obviously made a mistake in my calculations because it shows the spaghetti taking 100 milliseconds to cook.  Now I know that's wrong because spaghetti takes at least 5-10 minutes to cook...."

The student received an A.

Footnotes:

1. For all you accountants out there, yes I am aware of the fact that I 'm grossly oversimplifying things. 
2. For all you statisticians and investment analysts, yes, I'm also aware of Modern Portfolio Theory, Harry Markowitz, and the concept of co-variance which I'd argue rarely applies here. More applicable here is the old programmer's rule of GIGO ("garbage in, garbage out"). 
3. Sorry, I just can't recall the exact wording after 25 years.