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Fits and Startups

ChipIn runs into a unlikely opponent as it goes online

It’s amazing how much, and yet how little, things have changed since we last met with local dot-com startup ChipIn. In the past few months, the founding team has gained a lot of momentum, tripling the staff, moving into new digs, designing a new logo and quietly soft-launching the public beta version of their Web site. What hasn’t changed is the unstable nature of the business. In the midst of all the excitement, while gearing up for their major public launch (which at press time was scheduled for sometime this summer), the boys ran into the most unexpected obstacles—the Hawaii state government.

(left to right) Olin Lagon, Song Choi, Kevin Hughes, Carnet Williams

Oddly enough, just as ChipIn was hiring employees from firms like eBay and PayPal, and as Worldwide Web hall-of-famer Kevin Hughes readied the system for its first public appearance, the Hawaii state tax department concluded that ChipIn was not, in fact, a Qualified High Tech Business (QHTB). Now that’s a very watered down statement — for a more detailed look at the issue, see bottom of this page. What it basically means is that, without QHTB status, ChipIn, one of the most promising tech firms to come out of Hawaii in recent history, would not qualify for the state’s highly touted and publicized Act 221/215 tax credits for high-technology businesses.

However, as ChipIn CEO Carnet Williams always says, these sorts of dramatic setbacks are the nature of the beast. “In the life and times of a startup, there’s never any definite clarity in what’s going on,” he says. “Startups are all about flexibility, agility and constant change. You’ve got to understand that there’s going to be ups and downs, and that you’ve got to react proactively to those changes and just make the best decisions you can to work through it.”

In other words, Williams says, you deal with it and you move on.

INSIDE A STARTUP
In March and April, we introduced you to ChipIn, Hawaii’s latest dot-com venture, created by four already accomplished entrepreneurs. In this issue, we continue our behind-the-scenes coverage of this promising startup as it prepares for its public debut. This is the third installment in the series, Anatomy of a Startup.

The Dream Team

In the early days of ChipIn, president Olin Lagon’s job included a hodgepodge of duties, including, believe it or not—cooking. Operating on a startup budget, eating out every day was taking a toll on their wallets. Yet while Lagon excelled at his tech and operational duties, the kitchen wasn’t quite his domain, and it wasn’t long before his fellow founders kicked him out.

The guys didn’t go back to eating out though. Nor did they subject themselves to a daily regimen of saimin and water. Instead, they hired Roxanne Hanawahine to be a den mother of sorts, to shop, cook and clean for a couple of hours each day. Williams says the arrangement makes a lot of financial sense, but that the biggest savings has been in time. “There just isn’t enough time in a day for us to do what we do and cook and clean,” says Williams.

Hanawahine hasn’t been the only hire. Since our last installment in April, the staff has tripled from the four original founders to a total of 12 team members. The new hires include two developers, two programmers, one customer service rep and two vice presidents, who operate out of the company’s new San Francisco office. Williams says each hire was a score in its own right, but the latter two, in particular, were major coups for the small Hawaii company.

As we noted in our last ChipIn installment, the company divided the chief marketing officer role (formerly held by Song Choi) into separate positions. It filled one of those slots with Mike Hannum, a close friend and former colleague of Lagon’s, who joined the team as the vice president of business development in April after being subtly courted by ChipIn for nearly a year.

“Olin actually called me last July with the original idea for ChipIn and it sounded like a tremendous opportunity, but, at the time, I was pretty overwhelmed,” says Hannum, a seasoned entrepreneur with 12 years of experience under his belt. “I was in the process of selling my own software company. So I said, ‘I’m going on a long vacation and maybe later we can have a conversation.’”

With that, Hannum checked out of startup mode and checked into paradise. He spent seven relaxing months in Australia, during which Lagon intermittently emailed him updates on ChipIn’s progress. Toward the end of his trip, the emails came more frequently. Hannum says, “I was on the beach one day when Olin tells me, ‘I think we’re ready to ramp this thing up. We really want you to be a part of it.”

With Hannum handling business development, and Choi assuming his new role as director of communications, the team was almost ready to rock. They still wanted someone who could help build a marketing strategy, someone experienced and well-rounded to fill out the marketing team.

Enter Todd Kurie, who read about ChipIn on a commerce blog. “Basically, this really kick-ass guy finds us and says he’d love an opportunity, can we talk?” says Williams. “So we met and I realized just what an all-around capacity guy he is. I mean, we really scored.”

The guys say there couldn’t have been a better fit. In addition to serving as director or VP of marketing in many different incarnations for companies such as American Express, eBay, PayPal and Visa, Kurie’s got experience in fraud and regulatory compliance and has also done business development. “With that background,” says Lagon, “it would’ve been really hard for us to come up with a more perfect person for that position.”

MOVIN’ ON UP: ChipIn staff move into their new Kahala office.

Breaking the System

Both Hannun and Kurie work out of ChipIn’s new Bay Area office, an 8,000-square-foot, four-story warehouse they share with six other companies. The spacious digs are poles apart from the company’s Hawaii office in Kahala, where they can’t so much as lift a soda can without bumping elbows. But what the Kahala office lacks in size, it makes up for in usability.

For the entire first half of the year, it served as ground zero for the team as they busily prepared for their big midsummer launch. Day after day (and often night after night), Kevin Hughes and his team of developers holed up in the office, tweaking and fine-tuning the system.

In the spring, the place got even more chaotic, when the team hand-picked a group of around 50 people to come in and “break the system.”

“Larger organizations have more time and more resources to do a bunch of [internal] testing before they let the public on the system. As a startup, we didn’t really have that kind of luxury, so we did things a little differently. We got a small group of users involved very early on so we could get some early feedback,” says Choi, who facilitated the process.

The private alpha testing consisted of small groups following scripted, non-transactional chipins in four-hour shifts at the ChipIn office. In the private beta phase, 500 people were asked to start an actual ChipIn, soliciting donations from friends and family for the event of their choice. Both groups provided priceless market research. “Our approach was a little different. We purposely let people in on an early, buggy version, even though we knew some of the features weren’t as rich and some things weren’t ready yet,” says Lagon. “Because we know what features we think are important, but we want to know, how are other people going to use this? We wanted them to tell us what works and doesn’t.”

Ever the techies, ChipIn solicited feedback via every method possible—user-group forums, discussion boards, blogs, email support—you name it. And so, the people spoke. They commented on every little nuance and, soon, a priority list began shaping of the bugs to be fixed and features to be added. The list was long and invaluable.

“We had the general process of chipping in right, but there were a lot of little bugs and things that were caught that we never would have discovered in the process of normal development,” says Hughes. “A lot of them seemed to revolve around simple things like wording and the way that people are accustomed to using their computers.”

The use of semi-colons to separate email addresses, for example. Initially, ChipIn only accepted commas, because the engineers all work on Macs, and don’t run Outlook, which uses semi-colons. “It was a relatively easy fix for us, and all of a sudden we’re a little more compatible with people who are familiar with Outlook, which is a pretty big crowd,” explains Hughes. Other quick fixes included short explanations of things they thought all users were familiar with (i.e. security codes on the backs of credit cards) and making “Credit Cards,” rather than “PayPal,” the preselected payment option for chipping in.

3, 2, 1 …

During the closed testing phases, it wasn’t unusual for users to login and discover new features being added daily. By the time ChipIn launched its public beta version in mid-May, the system was a little more stable, and even looked prettier too, with softer colors and a new logo designed by Hughes. (Early feedback suggested the site looked too “masculine,” although the then-all-male team couldn’t quite figure out why.)

So far, the makeover’s proven a hit. By late June, the company had gone from about 1,000 registered public beta users to roughly 10 times that amount in one month. While user feedback still trickles in, the number of major grievances has dramatically dwindled.

Still, the team doesn’t want to get ahead of itself. At the time of this writing, the guys had targeted July 15 for their big public launch, in which they’ll strike Beta from the name and introduce ChipIn to the world. But, they remind us, in a couple of weeks, anything could, and probably will change.

“We want to have that sort of Big Bang effect that I think we can achieve during our big launch—if we do it right,” says Williams. “Right now, we’re still getting the marketing strategy into place, revamping the engineering structure, putting in for a couple of patents and finalizing a couple of projects [including one major one with the University of California at Berkley]. So anything can happen.”

One thing they definitely don’t want happening is system failure due to overload, which is why they’re not likely to do any major launch until Hughes and his team complete the second-generation ChipIn engine. “We have a first-generation prototype running everything and doing a lot of heavy lifting,” says Hughes. “With our current-generation technology, we can handle about 1.5 million page views a day. But we can’t go much beyond that. So right now we’re building the next-generation engine. It’s going to handle our emails and all the transactions. And instead of 1.5 million users, it’ll be able to support as much traffic as you can throw at it. It’s basically going to be a much more efficient and highly scalable system.”

Now if that isn’t high tech, what is?

Does This Look High Tech To You?
Believe it or not, the state of Hawaii says “No!”

Aside from being some of the most popular Internet businesses ever, what do dot-coms eBay, MySpace, Yahoo! and Google have in common? None of them would have qualified for Hawaii’s high-tech tax credits intended to grow the Islands’ high-tech sector. And because ChipIn delivers its software in a fashion much like the aforementioned companies, it too doesn’t qualify for the credits.

At issue is the state tax department’s interpretation of Act 221/215, which says that companies may qualify for tax credits after becoming a Qualified High Tech Business (QHTB) by passing one of two tests: The “activities” or the “income” test. The activities test requires that “more than 50 percent of a company’s business activities be qualified research.” Currently, since it’s still in its R&D phase, ChipIn actually qualifies as a QHTB under this definition. However, in time, as they transition out of R&D, they’ll need to pass the income test, which requires “more than 75 percent of its gross income be derived from qualified research.”

Here’s where it gets tricky. Software development—which is what ChipIn does—is on the “qualified research” list. But because ChipIn (like Google and eBay) delivers its software as a service over the Web, rather than a physically manufactured package that can be wrapped, sold and licensed to consumers, the state is refusing to recognize its software as qualified research.

“Basically, the tax department’s current definition of software is outdated. It dictates that software must be developed and licensed to the end user and the income must be derived from that license. A good example would be Microsoft Office. You buy it in a box, it’s packaged and licensed to you. That model was fine five, 10 years ago. But now, income can be derived from software as a service,” explains ChipIn CEO Carnet Williams. “In other words, Google doesn’t license you any software, you don’t actually download anything. But you’re using it as a service on the Web and they’re generating income through ad sales. And that’s the trend in technology.”

Simply run a Google search for the phrase “software as a service” and you’ll see that he’s right. Millions of pages pop up, the very first of which is a Wikipedia page detailing the key characteristics of Software as a Service, which even has an acronym, SaaS. ChipIn attorney Greg Kim, of Vantage Counsel, points out that even Microsoft is moving in that direction: “That’s just the way the software industry is evolving today. And if we as a state don’t recognize that, we’re going to miss the boat.”

Kim crafted a white paper in support of their QHTB approval. It included several articles covering the SaaS movement, as well as a dozen testimonials written by local and Mainland-based supporters. The list of supporters included heavy hitters such as Allegis Capital managing director Barry Weinman and Sennet Capital partner Richard Lim, and some lesser-known, but battle-tested entrepreneurs such as Stephen Wakita, CEO of decipho.com.

Even House Rep. Brian Schatz, who co-authored the legislation for Act 221, submitted a letter—something he cringes at having had to do. “That was the first time I’ve ever done that, because I don’t like to intervene with rulings by the tax department,” he says. “But I thought it was important for them to know that the purpose of the act was precisely to support companies such as ChipIn. And that we don’t find any basis in the law for the Department of Taxation’s interpretation.”

The tax department chose not to comment on the issue, but Kim offered this small nugget on why the department won’t issue a favorable ruling on ChipIn’s income test: “Their concern is that there’s not enough clarity in the statute. What they’re saying is that it’s not clear that they can permit software companies to use their software to sell services and remain qualified.”

Instead, the tax department offered what it thought to be the best way around ChipIn’s dilemma: “They specifically suggested that ChipIn would qualify if they established a drop-down subsidiary company, and nested into that,” says Schatz. In other words, the DOT suggested ChipIn form a separate company to create the software and then license the software back to ChipIn. You may recall that this very abuse of the law became highly controversial shortly after Act 221 was enacted in 2001.

“That’s exactly the loophole we were trying to close with 215. What the department is supposed to be doing is making sure that nobody is creating artificial structures or redescribing what they’ve already been doing to trigger the credit,” says Schatz.

Both Schatz and ChipIn prefer an administrative fix over a legislative one, although, at this point, the latter appears to be the only option. In January, Kim plans to head to the Capitol to lobby for legislation that clearly authorizes the tax department to acknowledge SaaS as a legitimate software delivery method, so that ChipIn can get QHTB status and qualify for tax credits.

The interesting thing is, ChipIn doesn’t necessarily need the tax credits. “We’re fortunate to have some great investors who believe absolutely in our company, so it didn’t affect our funding,” says Williams. “What it did impact was our time. This has been a horrendous use of my time, writing memos, collecting testimonies and spending hours trying to educate the DOT. I think I have a couple of grey hairs.”

Nevertheless, ChipIn will continue to fight for QHTB status, not so much for its own benefit, but for the general good of the industry. “The reason we started ChipIn here and are committed to keeping it here is because we want to build a robust high-tech sector, and we felt that if we did not make our best case, other dot-coms won’t start in Hawaii,” says chief technology officer Kevin Hughes. “But, after all we went through, my question would be, ‘Does Hawaii want a Google in this state or not? Do they ever want a company like PayPal in this state?’” Or, as Williams puts it, “Do they even want a ChipIn?” — JLY

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