Thoughts on Running a SAAS Business From Hawaii

Comment

Comment by John on August 26, 2008 at 1:23pm

Laurence,

I assume you have considered the 37signals approach to monetizing web applications? Note the fairly famous video lecture by DHH on this matter.

I view the subscription model as being a better fit for Hawaii's competitive positioning then professional services. Primarily because the ratio of technical people to revenue tends to be lower in a subscription model than in a prof services model. Needing less technical people makes you less dependent on finding people in Hawaii.

Have you already rejected the subscription model?

Cheers,

John

Comment by Clifton Royston on August 26, 2008 at 12:27pm

I believe you are confusing the Use tax (which you're supposed to pay on purchases from anywhere, though few do) with GET on your income. I have been told that no GET is due to the State on service sales outside Hawaii. I am not a tax accountant, etc. etc. But spend a small amount of money and get good tax and legal advice - it sounds to me as though you are preparing to make some major decisions based on assumptions.

Oh, and good luck! It's an exciting phase.

Comment by Laurence A. Lee on August 25, 2008 at 10:37am

Hi Guys,

Thanks for the very helpful advice and reference links.  The tax code link was especially helpful -- thanks Truman!  Thanks for the pointer to HiBeam, John, I'll be looking into that soon.

Obviously, I'm still trying to get my head wrapped around it all.  I'm not concerned about the tax rates per se, just about paying what should be a "fair share" to Fed and State. 

I've never cared for the Hawaii GET, as it's designed to cover all incoming and outgoing transactions; whereas a sales tax only handles sales transactions.  I'm also not thrilled with the idea of the Corporation paying Hawaii Taxes if it operates Online with servers out-of-state, programmers out-of-state, and customers out-of-state.  In that case, the argument running through my mind is, "What did Hawaii do to deserve those Taxes, aside from handing me a piece of paper saying I incorporated in Hawaii?"

Obviously, I'm not making any moves until I have a better understanding of the Business and Legal aspects.  At this point, it's just loud thinking. 

On Businesses Designed for Flipping
When I was living in Silicon Valley, I met a lot of startup employees who were hopping from failed startup to failed startup -- hoping for that big PayDay when their company gets bought out so their stock options would be worth something.  I've nothing but comtempt for such people and businesses, because they're in it for the Fast Buck instead of believing their company will succeed over the long-haul.  I always think "Snake Oil Salesman" whenever I hear of a business hoping to be bought out as their "business model".

If anything, I'd keep it as a privately-held Corporation and forge ahead; and only sell if I have a ridiculously good offer.

On the Business Growth Plan
Part of the business plan is Professional Services to write Customized modules.  This is where I'm hoping to grow jobs and opportunities.  I'd rather handle these through an in-house team of developers, rather than outsource or defer to a licensed partner to build.  The flip-side to this, though, is to ensure the amount of incoming work can sustain employees.  This has always been a problem for anyone engaged in Professional Services.

Knowing where to find Programmers from is necessary, in case this business experiences the "Good Problem" of a high adoption rate.  I'd need to know whether I can find people who can hit the ground running, or if I need to anticipate having programmers ramping up on my dime.  That kind of investment decision would influence whether I'd hire subcontractors, or invest in long-term employees.

For 'Doki to succeed (and so I can move onto the next pet project without getting sucked into Code Maintenance), it will need to transition from a Lone Wolf's pet project into something a dedicated group can work on.

Comment by Kurt Sussman on August 22, 2008 at 10:14pm

Collecting 'foreign' revenue is a huge grey area, tax-wise. My accountant sets up Cyprus corporations for his clients with significant offshore (i.e. non-US) income, and it saves those companies a ton of money. It's also totally legal.

Nevada corporations can be used in a darker grey manner to save on state taxes. If your business is incorporated in Nevada, your agents in NV know the location of the information regarding your true identity; note the double indirection. So your business can look like a Nevada business and pay Nevada taxes. Whatever you pay yourself is taxable in your state of residence, obviously. For more on the legality of this, talk to a CPA who knows about out-of-state incorporation.

There are many other legal tricks; royalties are taxed at a lower rate than other kinds of income, so you can extract the IP from your app, sell or trade it to an entity (e.g. NV corp) that has more favorable tax treatment, and pay royalties for the use of the IP. This is also nice for a company that is built to flip, because you continue to be paid the royalty after selling the core business; a chunk of money and a longer-term revenue stream too. Your own ethics determine whether or not you tell the seller that the IP is licensed from yourself... Legally you don't have to disclose that.

I'm not doing any of this right now, but if you want to talk to my tax guy, feel free to email him and tell him I sent you. Dan Morris, dan@cpadudes.com. He's in Silicon Valley, in the middle of a move to Portland Oregon. He has prepared Hawaii returns for me, so he's got at least a passing familiarity with the state law here.

Comment by John on August 22, 2008 at 6:59pm

Hi Laurence,

I have been a part of a number of startups both bootstrapped and VC funded over the last few years. I am currently running and self-funding a SaaS startup in Hawaii. Here's some thoughts that might be relevant or helpful to you.

"I'm also not optimistic about finding enough programmers in the Islands, as compared to hiring out of the West Coast."

- I am not sure this is a criticism of the SaaS model. If anything, SaaS companies by their web nature require far fewer programmers and overhead than their shrinkwrapped counterparts. To me, SaaS is a far better fit for Hawaii than any other business model I have seen for software companies.

"don't even get me started on the jungle of paperwork involved in hiring Employees on a Payroll, versus simply hiring hourly contractors on a 1099 basis."

- But that's mainly the reality of being a business owner. More importantly, I would ask why are you interested in hiring employees so early on? Why not simply use oDesk for short term help or get an equity partner or partners?

"I really don't have the patience to run a software shop AND a back-office with all its HR-related issues."

- This is why most angels, VCs, incubators, etc recommend having a partner or partners with one partner on the business side. This brings to mind Paul Graham's famous and insightful comment on how to start a startup.

"I'm not even considering the Personal Income Tax aspect of this yet."

- Most states have personal income taxes (such as California); Nevada and Florida are famous exceptions.

"I should look at incorporating in a more tax-friendly state."

- I don't think your state of incorporation makes a major differences in tax rates. Tax rates are general determined by where you conduct business. Lots of Hawaii companies are incorporated in Delaware but certainly pay Hawaii GET, etc.

"I'd still need to find a lawyer to draft up the service agreements for the customers, and the NDA and Non-Compete agreements for the developers."

- Most people I know tend to keep this aspect simple and or delay until they have revenue and/or initial angel funding.

In general, then, I think you should consider doing it by yourself or taking on one or two key partners that have an equity stake in the business. These are the tried and true ways.

Also, as I mentioned in a previous post, I recommend you go to HiBeam monthly founder's lunches. That's the best forum I have seen in Hawaii for you to discuss these issues.

In any event, I'd be interested in your feedback. If you'd like to discuss further, I am also happy to talk offline.

Cheers,

John

Comment by Truman Leung on August 22, 2008 at 10:36am

All income derived from intellectual property you have created (i.e., your software) is tax free in the State of Hawaii.

http://www.capitol.hawaii.gov/hrscurrent/Vol04_Ch0201-0257/HRS0235/HRS_0235-0007_0003.htm

Comment by Daniel Leuck on August 22, 2008 at 9:49am

So, it seems to me, a SAAS business in Hawaii configured the the way I'm considering would get a "double whammy" from Hawaii's General Excise Tax -- once for accepting Payments from SAAS customers (as the GET applies to all income received per transaction); and once again for "importing" out-of-state programmer services for the business' consumption. Correct me if I'm wrong, but that's how I'm interpreting the GET requirements at the moment.

I think you will find this post from Truman very interesting. It is squarely on point. It was of great interest to me because we are also launching an SaaS company. Obviously, like Truman, I am not a tax professional so you should check with your CPA.

I really don't have the patience to run a software shop AND a back-office with all its HR-related issues.

There are several companies in Hawaii to which you can outsource virtually all HR functions including payroll, health plans, resolution of legal issues, etc. We plan to switch to one of these next year. Once I get around to evaluating them I'll post back to this thread.

Good luck with TokiDoki!