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Kagi Shuts Down After Falling Prey to Fraud

The news was as sad as it was unexpected. Kagi, one of the earliest digital commerce companies and long a favorite of many Mac shareware developers, has shut down as of 31 July 2016, just shy of 22 years in business.

Kagi’s home page gives a brief explanation of the situation but to find out more, I spoke with Kagi CEO Kee Nethery, whom I’ve known since he was a product manager at Apple in charge of the Mac-based Apple Internet Server line. Here’s the story.

Over ten years ago, Kagi was looking to expand its business. In the process, they started handling subscriptions for a company selling a legal consulting service — the idea was that you’d pay a $29 monthly fee and be able to get answers to legal questions. The company was both legit and seemingly successful, and the service was real, but what Kagi missed in their due diligence was that the firm’s sales team used high-pressure sales tactics. As a result, many customers were unhappy, and to avoid further pressure when trying to cancel their subscriptions, they instead disputed the credit card charges, generating what Kee described as “an amazingly large number of chargebacks.”

(A brief aside here. When you dispute a credit card charge, the credit card company will usually reverse the charge for you without asking any questions, forcing the merchant to refund your money and charging the merchant an additional fee in the process, $25 in this case. Plus, such chargebacks reflect poorly on the retailer’s reputation with credit card companies. If you’ve been treated badly, disputing a charge may be appropriate, but it’s overkill if you just want a refund from a legitimate merchant who would be more than happy to give you your money back.)

All those chargebacks had two adverse effects on Kagi. First, both Visa and MasterCard put Kagi on a “watchlist,” which is usually followed by dropping the company as a customer. That would have been the end of Kagi. Kee was proud of the fact that Kagi was able to work its way back from the brink and be reinstated as a customer in good standing. He told me that a person who worked at Visa mentioned to him that he’d never seen anyone get off the watchlist before.

The second problem was more serious. The legal consulting company had quickly become Kagi’s largest client, to the point where it was averaging about 20,000 transactions per month. The percentage of chargebacks was high, but not initially beyond the pale. Plus, at that point in its history, Kagi was still processing chargebacks manually because there had been so few up to that point, and that manual processing obscured the severity of the problem. After four months of refining the legal consulting company’s process to set customer expectations appropriately and improving the chargeback process, however, Kagi realized that the problems weren’t going to go away and dropped the company as a client.

The legal consulting company then reneged on its responsibility to repay Kagi for both the $25 chargebacks and the $29 subscriptions, leaving Kagi with a massive debt. That’s an unacceptable way to run a business, to say the least, but when Kagi eventually took the matter to arbitration and won, the settlement didn’t even pay for Kagi’s legal fees.

Kagi could have shut down then and there but instead tried to work off the debt. For the last decade, they’ve been doing just that, working off $600,000 of the overall amount. Unfortunately, that required borrowing against the money they had to pay out every month to suppliers — the developers who sold their products through Kagi. The technique worked well as long as the monthly payout was larger than the debt, but in the last few months, the monthly payout has slowly dipped below the necessary threshold. Rather than string developers along, Kagi decided to cease operations entirely.

(As another aside, we’ve seen Take Control book sales dropping over the last six months as well. I don’t know if the unsettling tumult in national and global politics is responsible, or if there’s some other explanation, but it is concerning. Perhaps things will recover after the U.S. presidential election and once there’s a path forward for Brexit.)

You’ve undoubtedly heard of companies filing for Chapter 11 bankruptcy, part of the U.S. Bankruptcy Code, which allows companies to avoid paying creditors all that they’re owed while continuing to operate. There’s also Chapter 7 bankruptcy, under which the company goes out of business and its assets are liquidated to pay creditors. Chapter 11 wouldn’t work for Kagi, because what developer would continue to work with a company that couldn’t guarantee to pay on time? Even Chapter 7, while simpler, still involves courts and high legal fees.

Kagi is instead using a state-based option, called ABC, or Assignment for the Benefit of Creditors. It’s most common in California, where Kagi is located, but many other U.S. states have similar statutes. The advantage of ABC is that the costs are significantly lower, which means more money for creditors. Under ABC, an independent company takes over, liquidates all assets, and manages the payout of all the leftover money.

Right now, Kagi owes money for June and July to about 2000 clients, of whom fewer than 1000 were active sellers. Unfortunately for those companies, between the time necessary to work through the ABC and the fact that credit card companies are holding onto a lot of Kagi’s money to cover refunds and chargebacks, it will probably be six months before it’s known how many cents on the dollar each client will receive after taxes are paid.

In the meantime, Kagi is busy tearing down its racks of servers and shredding the hard drives that contain customer and credit card data. Kee has set up an entirely separate Web site and email system to handle support email, which mostly involves sending developers dumps of their license codes and customer data.

It’s a bad time to be a company that relied on Kagi. Payments for June and July will be both delayed and reduced by an unknown amount. Worse, these companies are scrambling to find a new digital commerce solution, such as Avangate, Comecero, FastSpring, and Paddle.

You might wonder why I didn’t include payment processors like PayPal or Stripe in that list. Both are fine choices for certain situations, and they charge lower transaction fees. But there are two big differences between a simple payment processor and a full digital commerce solution such as Kagi and the others provide.

First, digital commerce companies offer full-fledged shopping carts with options for bundles, coupons, subscriptions, order management, refunds, and more. That used to be worth a great deal, but there are now numerous independent Web apps that provide similar features for systems like WordPress, not to mention standalone platforms like Squarespace that offer their own e-commerce capabilities. These apps and platforms all work with systems like PayPal and Stripe.

Second and more important, anyone who sells to customers in other countries has to be aware of the tax implications of doing so. When a company sells to any country in the European Union, along with Canada, Japan, Norway, South Africa, South Korea, Switzerland, and the United States, it may need to pay taxes in that country. The details vary widely, and in some cases (like Canada, Japan, and South Africa), thresholds apply, so a handful of sales won’t matter, but most companies selling to the EU will have to collect and remit value-added tax (VAT).

The full-service digital commerce companies act as the “merchant of record,” which means that end users are actually buying from them, not the company selling the product, and because of that, they handle all tax collection and remittance. That’s hugely helpful for any business in the United States, where sales tax rates vary by state, county, and sometimes even city (but are required only in states where you have a “nexus”). It’s even more important when dealing with international tax authorities — Kee told me that paying Kagi’s VAT taxes to the EU was complex and required personal attention every financial quarter.

Simple payment processors like PayPal and Stripe don’t automatically do anything related to taxes because the company selling the product is the merchant of record. With extra configuration and integration with external services like Taxamo and Avalara, carts that work with PayPal and Stripe can be enhanced to identify the location of each customer in real time, and to calculate and collect the appropriate tax. It’s then up to the company to register for, file, and remit taxes to U.S. states, the EU, and other countries. (Avalara has a service that claims to handle VAT entirely, but I haven’t evaluated whether or not it’s a complete solution or if the
pricing is reasonable.)

Put bluntly, I cannot imagine most software developers having the time or expertise to tackle the task of managing taxes. It’s the primary reason we’ve long sold Take Control books and TidBITS memberships through eSellerate (parent company Digital River has eSellerate in maintenance mode, which is why I didn’t include it in the list above). It’s worth giving up a few percent of every sale to have Digital River’s tax team handle everything for us. My strong suspicion is that the vast majority of small companies relying on PayPal and Stripe are just ignoring their international tax responsibilities and hoping they’re small enough to fly under the radar. I have no idea what the liabilities of doing that might be.

Regardless of what companies who previously relied on Kagi end up doing, it’s sad to see the end of such an important player in the history of the Mac, and especially depressing to learn that the reason was an unsuccessful attempt to recover from a situation involving fraud.

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