Why the IRS Loves Your SaaS Business and How to Keep It That Way – Daniel Craig

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0:14good afternoon sorry to dissapoint I am Daniel Craig but not that Daniel Craig you should have seen my wife's face the first time we actually met in person after online dating no it's just kidding so this talk is why the IRS loves your sass business admittedly probably the most boring talk title here this weekend but 56 of you voted for it so actually only 53 voted for I won't tell you how you got the other I got the other three votes but why the IRS loves your sass business essentially just a little bit about me run a outsource accounting firm called bloom and we do all things

0:52accounting and Finance for sass companies and I wish I could get up here and tell you that we had some really cool startup story like we began in our grandmother's basement or survived in a garage eating top ramen but I think our story is kind of cooler than that because our business started out as the entrepreneurial dream of two brothers and today we're actually living that dream out by helping other entrepreneurs pursue their dreams as well it's not a great stock photo by the way no just kidding that's that's actually us so real briefly just give you a little bit of an idea why you need to be tuned into

1:27some of the tax regulations that are coming out over the next little bit for SAS SAS as approaching 30% of total application enterprise application spend so it's an industry that's going to be getting more scrutiny and awareness I think we can plan on that and so a couple of regulations that I think you all should be aware of and hopefully this will be helpful reason number one why the IRS loves your SAS business first of all tax revenue obviously the IRS loves revenue and you need to be aware of this new regulation set of rules on how the IRS is going to have you report your revenue to them how many

2:06of you are familiar with ASC 606 okay great glad we're talking so this is a new set of rules that basically determines how you report your revenue to the IRS it's called revenue recognition and that basically means in the world of accounting if a customer pays you one twenty dollars you can't claim that 120 dollars as revenue until you've earned that 120 dollars by delivering your product or service so some of you are thinking okay that what what's so complicated about that well it's not complicated if you get your revenue and deliver your product in the same month but if you get your revenue in January

2:47and deliver your product for that revenue over the next 12 months you actually have to quote-unquote earn that revenue over the next 12 months that's what the regulations say and that affects how you report your revenue so this this drops right down to the bottom line of your IRS tax return as a company it determines how much revenue you report and as a result how much tax is how much you pay in taxes so a couple of things that you need to know about this regulation it's effective for public companies January 1 2008 and private companies January 1 rather 2018 and 2019 one last thing about this regulation it

3:31only applies to entities that file taxes on an accrual basis so if your cash basis and you're filing you actually don't have to worry about this if your accrual than you do okay if you want to get more information about this get these slides bloom accounting dot IO for it slash micro comp you can get this information the the next reason it's a little more exciting it's job creation how many of you are familiar with the section 199 deduction okay a couple of you are essentially this is a deduction to incentivize manufacturing jobs here in the US the creation of manufacturing jobs in the US and believe it or not SAS companies can

4:13actually in some cases qualify for this deduction so essentially how it works is you can if you qualify deduct nine percent of qualifying manufacturing income like your subscription sales not professional services you can deduct that for your tax purposes so quick example if you have a hundred million in revenue 1 million in revenue 900,000 in expense is 100,000 net income instead of paying taxes on that $100,000 you can get deduct ninety-nine percent of your 1 million which is a ninety thousand dollar deduction makes your taxable income 10 grand and if you're in the twenty five percent tax bracket you're paying 25 percent on 10 grand only

4:58twenty five hundred instead of twenty five thousand so it's again if your CPA is not talking to you about this deduction be sure to talk to your CPA about this deduction and see if you qualify essential qualifications you have to sell an on-premise version of the same software or have a competitor who sells an on-premise software that is substantially identical to your SAS product so those are a couple of things to be aware of and I don't know that I am seeing the timer here so there we go okay great wrong screen so that's a couple of things to be aware of on the tax regulation side of things again you

5:43can get the info there but in the a few minutes that I have left I want to talk just a little bit about financial management from a broader perspective and there's been a lot of talk about profitability this weekend and I just want to share a few things that we're finding as we work with our clients and maybe they'll be helpful to you all as well but I think we would all agree as we think about financial management that the primary goal of financial management is to maximize profit right you want to you know use your money in a way that at the end of the day you have a profit we

6:14we get that but what's interesting is as we actually look at the day to day way in which we manage our finances it often doesn't match up with that goal for many of us managing finances is about making sure we have enough money in the bank or making sure we can you know run a P&L so that we know what our tax liability is or budgeting revenue and expenses but what's missing from all of these approaches to financial management is any real focus on profit as the driving force and consideration in our management of finances and essentially what this does is it puts profit in the leftover category just

6:57what's left over after we get our revenue and spend our money instead of putting profit first it essentially is a paradigm of thinking about profit where profitability defines our approach to or MRR our goals and our expenses instead of having our mo our goals and our expenses define our profit so essentially just to put it in a nutshell and the the paradigm that I want to suggest as you as you think about managing your finances is basically this financial management is the discipline of pre determining your profitability financial management is the discipline of pre determining your profitability and essentially what this means is that not not you know come up with some fake

7:47profitability goal and throw your app at the wall and hope you hit it but actually defining at the very outset what your profitability goal is and reverse engineering your business in such a way to reach that goal it means that we have to get rid of the idea that hey I'm going to build my app and wait till my revenue stabilizes and my product stabilizes to think about profitability think about it from the very beginning you say okay well how does that work here are three basic keys to the discipline of pre determining profitability and just to give credit where credit is due a couple of books

8:24that speak to these ideas and have drawn some of this from these books a simple numbers by Greg Crabtree and profit first by Mike McCalla with key number one is to pay yourself a market-based wage and this is crucial not just when you have the money to do so this is actually crucial when you don't have the money to do so now some of you're thinking ok wait how do I pay myself a market-based wage if I'm a startup and I don't have the cash to do so well here's how you do it ninety percent of entrepreneurs actually under pay themselves and so what you got to do to

8:59figure out your market base wage is essentially ask the question if I were to quit my startup today and go higher on as an XYZ software company what could I get paid you come up with that number say it's $80,000 then you go to your profit and loss statement and here's what you don't do if you're an early stage startup really early say you're generating $30,000 in revenue you say okay hey I I can't pay myself 80 grand I'm gonna pay myself 20 grand I have $5,000 in other expenses hey cool I have a net profit of $5,000 actually no this is how you have to and

9:34how we have to begin thinking about our market base wage go to your P&L and look at it this way revenues $30,000 my salary is $80,000 20 percent 20 grand of that is a cash payment and the other 60 grand is sweat equity investment into my business but it's absolutely a line item on my profit and loss statement so that when you get to the bottom you realize it's a total gut check I'm not making five grand I'm actually going into the whole fifty five thousand dollars this year and this isn't a fun exercise but it's a crucial exercise because it gives us clarity on where we are in terms of our

10:11profitability so that we have laser focus on where we need to go Jason Lumpkin puts it this way working for free or too cheap has another downside it gives you an excuse if you're taking an expensive salary you know you have to deliver so great quote their second key define done what does this mean essentially in in businesses and I think particularly in software development it's a constant temptation to keep tweaking the product and when you keep tweaking the product you spend more your costs accumulate and you really lose sight of profitability so defining done is basically answering this question how much will it cost me to get to 20%

10:51profitability at the beginning of developing a product or at the beginning of developing a new feature set ask yourself this question how much is it gonna cost me in terms of all my costs including my sweat equity investment to get this project to produce 20% profitability and then say okay do those numbers make sense for me and some of you who might be thinking okay I don't know if I can calculate this number how do I do that well I think it's important - because if we're not calculating this number basically what we're saying is I'm willing to put an undefined amount of money for an undefined amount of time

11:27into a project with an undefined result and I think that's kind of scary so number three enjoy regular profit distributions this is key to getting a profitable mindset you enjoy the distributions you want them to keep coming and Jason freed has a great quote on this from base camp he says profit protects you from your ego profit creates reasonable borders and boundaries and that's a very healthy thing especially early on so you know another thought is profit of this is is using the resources God gives us to invest it back in our family and our community so it's not about being a big fat selfish Pig

12:05lastly here this book simple numbers straight talk big profits has a lot of great content and I've talked with Greg Crabtree recently and he's actually agreed to do a series of video chats applying these calm concepts to SAS directly so if you want to get those I'll be sending those out over the next few weeks Blum accounting I owe ford slash micro comp and happy to share those videos with you hope this was helpful thanks [Applause] [Music] you