In Episode 546, Rob Walling flies solo for a Q&A episode. With a backlog of great listener questions, Rob discusses qualified small business stock (QSBS), hiring entrepreneurially-minded employees, indie hacking while working at a large company, and more.
The topics we cover
[01:51] Should I switch to a C Corp to take advantage of QSBS in five years?
[05:40] How to attract entrepreneurial employees
[14:19] Indie-hacking while working at a large Fortune 20 company
[19:12] Finding a niche using the Disruptive Innovation
Links from the show
- Episode 442 | Corporate Structures and How the Choice You Make Now Can Impact You Years Down the Line
- Episode 519 | Profit Sharing, Stock Options, and Equity (A Rob Solo Adventure)
- The Stair Step Approach to Bootstrapping | Rob Walling – Serial Entrepreneur
- Qualified Small Business Stock (QSBS)
If you enjoyed this episode, let us know by clicking the link and sharing what you learned.
If you have questions about starting or scaling a software business that you’d like for us to cover, please submit your question for an upcoming episode. We’d love to hear from you!
That’s what Startups For The Rest Of Us is about and that’s what we’ll continue to focus on. Even as things change, as the landscape has changed so much back again, 10, 11 years ago, we were talking about info products, iPhone apps, one-time downloadable software, and SaaS was part of that, too. Back in the day. It was all about bootstrapping because it was such this binary difference of being in control and giving it all away to venture capitalists with their crazy terms. But things shift over time, we look at problems from different angles, and we take the best information that we have and we make smart decisions from them.
The show has many different formats. Sometimes there’s a conversation between myself and a founder or subject matter experts. We have startup news roundtable episodes where we cover news related to bootstrap and mostly bootstrap founders. We have QA episodes. We have breaking news episodes. All kinds of stuff. This week, I’m flying solo on a Q&A episode, which is something I do every once in a while. We have a great backlog of listener questions. It should be fun to run through a few today.
My first question is from Joe. “Should I switch to a C-corp to take advantage of QSBS in five years?” He says, “Hi Rob, longtime listener, first-time caller. Thank you for all you do for the mostly bootstrap founder community of which I have been a quiet participant for many years. My question is around QSBS,” For the listener, that’s Qualified Small Business Stock. “I’ve been fortunate enough to have had a couple of asset sales of my former SaaS businesses. I’m working on a new SaaS business now that I think I can grow and sell in five years. I’ve been operating under an LLC for all of my apps and I’m considering switching to a C-corp to take advantage of QSBS to save on taxes if I’m able to sell it in five years. Do you advise the companies you invest in to switch to C-corps for this very reason? Thanks. Joe.”
This is a complicated topic, to be honest. No, I don’t advise anyone to switch to a C-corp for a specific reason because there are so many trade-offs with C-corps and LLCs. Einar Vollset and I actually recorded an entire episode of Startups For The Rest Of Us focused on this question and the trade-offs of the two paths. If you want to check that out, it’s episode 442 Corporate Structures and How the Choice You Make Now Can Impact You Years Down the Line.
QSBS for those who don’t know is Qualified Small Business Stock. I’m now reading from Investopedia. I’m not a lawyer, I’m not a legal adviser, but Investopedia talks about how any stock in a small business that is acquired after August 10th of 1993, the capital gains from that can be zero from federal taxes not from state taxes. This is the US only, obviously. Can be zero if, and there’s a bunch of things. The investor must not be a corporation. The investor—meaning you, the founder—must have acquired the stock at its original issue and not on the secondary market. You have to get it when the company starts.
The investor must have purchased stock with cash, property, or accepted as payment for a service, must have held it for five years at least 80% of a company’s assets must be used in the upper… blah, blah, blah. There’s a limit. I don’t remember what the limit of the company size is, but it’s high. I’m going to say it’s something like $50 million in annual revenue. If you get above that, then you’re no longer a small business. It’s something to that effect. Zero cap gains. Imagine building a SaaS app and selling it for $10 million and paying zero federal cap gains on that.
In fact, Josh Pigford, who was on this show just a few episodes ago, talked about how we sold Baremetrics. He qualified for this and he only paid state tax because he lives in Alabama and they have a tax that he wasn’t exempt from. Is it worth switching to a C-corp? If you plan to run it for five years and sell it personally, that’s not a bad idea. If you plan to pull dividends out, it’s not a good idea because C-corps have double taxation. Where whatever income you make, the company pays income tax on it, and then if you were to draw a dividend, you pay an additional dividend tax on it. Currently, that rate is 15% or it’s 18% if you pull out. I don’t know if your income is above a lot like half a million or a million a year.
If it really comes down to that, there’s no right or wrong answer here and most bootstrap startups are LLCs, sometimes S-corps and that’s because they’re pass-through entities and you can have the money flow out to you and it goes straight to your personal. You don’t have to pay double taxation, but there are many companies, I see in many companies that I have invested in, in fact, the vast majority of companies that have invested in are C-corps. That’s both my personal angel investments and TinySeed companies. But there is absolutely some portion. It’s definitely a minority portion who remain LLCs such that they can run a long-term profitable business that they draw dividends as their payout and they really don’t plan to sell it.
That’s probably how I would think about it. I hope that helps, Joe. Thanks for the question. My next question is from someone who asked to remain anonymous. He says, “Do you have any advice on what sort of offers or arrangements can work for attracting entrepreneurial employees when offering equity doesn’t make sense? For context, where a team of seven now doing north of $5 million a year before payroll and there are a few people in my network I’d love to convince to join the team who have been trying to get their own ideas off the ground for a few years while filling the gaps with contracting and stuff but never really making it. These sorts of folks would be a huge value to the team because they think like entrepreneurs and have the right values. But I don’t think they’d ever want to settle for just a regular old salary job without some other factors to scratch their entrepreneurial itch. Even if they haven’t been able to reach escape velocity with their own stuff. Offering equity feels tough because we’re not based in the US and our staff is all over the world and we don’t have any ambitions of building a big team or trying to exit. We’re just super-profitable and pay out tons of dividends to ourselves. I also kind of feel like giving people some tiny percentage of the company over three or four years still doesn’t really scratch the entrepreneurial itch. Nobody I know with that tiny equity stake in their company seems to actually act like it’s their company or takes meaningful responsibility for the company’s success. Any thoughts on what we could offer people who have dreams of running their own thing that would be attractive and feel like a good opportunity that is still somehow aligned with their goals, instead of feeling like it’s delaying their own ability to try and make their own thing work? We thought about profit sharing, four-day workweeks instead of five, so more time for side projects. But do you have any other ideas? The answer might well be nothing that I am prepared to accept. Thanks, and hope things are awesome for you.”
It’s a good question and I actually know the asker. I know of his business and it makes sense. I don’t think that they’re going to sell the company long-term. I do think they’re going to run it and run it highly profitable and have built an amazing company. Frankly my hat’s off and congratulations on all your success. I do have some thoughts on this. I think some of the options you named if properly engineered, could work. But honestly, my first thought is are you sure that you want to hire people that really just want to do their own thing?
There’s a difference between hiring entrepreneurial-minded employees who maybe think like entrepreneurs a bit, but don’t actually plan to strike out. You can hire them and they will stick around as long as they’re doing interesting work, they’re paid well, and they like who they work with. They’ll stick around for years at a company, especially an interesting start-up like this, a small team where they can have a big impact. But on the flip side, there are those truly entrepreneurial-minded people who, the whole time, they’re just thinking, I want to do my own thing. If you realize that kind of no matter what you do, those folks will go out on their own at some point.
A good example is Derrick Reimer. Derrick, when he and I met, he was 21 or 22 years old and he was hacking on these amazing little SaaS apps that he was building. He won a couple of local startup competitions. That’s where we met. I was one of the judges of these competitions. When he and I started working together, he was a contractor on HitTail, and then he was a part-time contractor on Drip. Then he was a full-time contractor on Drip, and then he was a W2 employee on Drip. At a certain point, we started talking. He was like, yeah, I’m going to go do my own thing because really, I want to be a founder of something. I want to own something.
If you know Derrick today, you know that he’s a gifted and talented entrepreneur. He always wanted to go out and build his own thing. That was at the point where he and I decided, okay, we’d move forward the way we’re going without you having equity in the company. I had bootstrapped and done all these lifestyle businesses. I saw Drip as the next phase of that, maybe a more ambitious version of that, but I hadn’t honestly given a ton of thought to giving out equity. It just wasn’t really in the game plan for a lot of the reasons that this question asker is mentioning. I just didn’t know that it made sense.
In the end, Derrick and I did land at, obviously, an equity split. He took the title of co-founder since he had been around since the early days. But I always knew if we didn’t sell Drip at a certain point that Derrick was going to transition out. He was going to do something where he owned the whole company in essence. That was fine. That was the understanding. Back to the question, do you want to hire those people knowing that the clock will be ticking and almost no matter what you do—unless you give them ridiculous amounts of equity that I don’t think you want to do until someone has 10% of equity, it depends on the person but it doesn’t have to be 10% equity—they don’t really feel like an owner.
To your point of giving someone 0.5% or 1%, it doesn’t tend to mean that much. That’s the first thing I think about is even if someone’s skills and their attitude are a perfect fit for your company, if truly what they want to do is their own thing and you think you’ll have them for a year or two years, think about whether that’s what you want to do. Or do you have these friends who have that attitude, but you do think that with the right motivations, they could stick around for years assuming you plan to run your company for years. That’s the first step. I would give that some thought.
The second thought is I like the idea much more than equity since you’re not going to be selling. You’re not looking for liquidity events. I would really think about profit sharing. I would think since the company is so profitable—obviously, seven employees making millions of dollars, I’m guessing millions of dollars in net profit being thrown off—that’s where I would think about hefty profit sharing. There is an interesting thing of do you know what their motivations are, aside from I want to be an entrepreneur?
The ones who might stick around for the longer term, if they made a solid base salary for where they live and then had the opportunity to really make a big chunk of money through profit sharing and feel perhaps again, on a team of seven or eight people, you can feel like you have ownership. Especially with profit-sharing, not only are you thinking about growing the top line, but you can also think about, are there ways we can potentially save money for being a little extravagant with things. There’s this ownership of both the top line and the and the bottom line because that profit turns into money in my pocket.
If I were going to do any of those options, there’s profit sharing, there are bonuses, there’s equity. I actually covered this in a solo episode, episode 519, Profit Sharing Stock Options and Equity. I talked about bonuses there, too. If you want to hear my general thoughts on when I would use which, that episode is where I would go.
The other thing to think about is if someone could bring so much value that you think even if they work with this for a year and they were only three days a week or four days a week, they would still bring more value than anyone else I could find. I don’t know if that assumption is actually correct, but maybe that is. Then, that’s what I would be thinking. I’d probably start a conversation with a couple of these folks and try to figure out, is it individual motivations that some people be happy to make buckets of money, an egregious amount of money because you do have the luxury to be in that Basecamp situation where Basecamp importantly, has 55 employees because they’ve grown so slowly over so many years and they have so much net profit coming off that they pay all of their people no matter where they live. It’s like the 90th percentile of a San Francisco salary for the role. They have that luxury, most people can’t. You have that luxury, too, in theory. Again, I don’t know all your numbers. But you have the luxury to do things that are outside the conventional wisdom because your company is so profitable and you’re looking for these high achievers.
My guess is if we took four of your friends, there might be one or two of them who would stick around for an extended period of time if they literally made twice as much in salary and had a great job where they contributed, worked with you, and worked with the rest of your team. They might stick around for several years and maybe could put their side project thoughts and ambitions into your company. I know that at certain points, I did that.
I was always working on side projects and then I’d get into a really interesting contract or really interesting job and I would turn it off for a while because that creative itch was being scratched. I was working with really cool people. That allowed me to turn it off in the short term. Then the other two may be motivated by working a few hours a week and making a full-time salary or working a few hours a week and just working on interesting projects with you. I think that’s the big thing is, do I think this is possible? Yes. I almost feel like it is potentially not a blanket approach. It might depend on the individual. Obviously, without knowing the individuals, it’s hard to know. I’d be curious if you brought this up with one or two of them independently and just started the conversation on how that might pan out.
Those are my thoughts. I hope that was helpful. My next question is from Anonymous Hackerman. I’m getting a lot of anonymous questions today. You’ll see why. The subject line is actually Anonymity. He says, “Hey, I have a question regarding Anonymity. I’m currently at a large SMP 20 company and would love to begin indie hacking. But I feel like I’m at a disadvantage as I can’t exactly hack with the garage door open as I’m assuming it would not go down well with my current employer. Do you see any way out of working around this?
First, I’m not a lawyer, a standard disclaimer. The first thing I would do is I would definitely look at my employment agreement and any IP agreements I’ve signed and figure out legally, do they think or could they make a claim to own everything you do even if it’s on your personal computer and on your personal time. There are certain states where that’s allowed and there are certain states where it’s not. Even in those states, some employers still have you sign things that maybe would be inadmissible in court, but you’d have to fight it in court and on and on. But I would at least in my head know have I signed anything that essentially commits everything I own to them so that I know if that’s at least on the table.
Then if I had the means or if I had an attorney that I knew, had worked with, or I could maybe go to Google, I would try to figure out does my state enforce that. Is the state that you live or the state where the company’s headquartered—I don’t know, not a lawyer—but I would try to do some research whether that involved paying an attorney or whether that involved just using the interwebs to try to figure out, do I have a case if I were to try to go on. I‘m not saying you would ever want to fight this in court, frankly, if anything, it would probably be settled out of court as most of these things are. But at least then, you have the information. The first process is 30 minutes of reading through your docs and then the second process is a few hours of either conversation or some research to just get yourself educated on legally what it is.
Then there’s this whole other idea of it not going down well with your current employer because whether they own stuff or not, if the culture frowns upon you doing side projects or you doing any kind of side work, then that’s a whole other issue. It’s not necessarily a legal issue, but it is an issue that could cost you a promotion, a raise, or it could cause them to let you go because there’s obviously a big difference between them having a legal case against you which is a real problem. It’s something that will come up in due diligence if you ever sell. It will come up if you ever decide to raise funding or it can come up and it’s a problem.
Personally, it’s your risk tolerance. I would not mess up if I had signed something that said that someone else owned all my stuff, even done in my own computer or my own free time. I would not indie hack. I would then think to myself, I have three options. I can not work on side projects, I can find a different job, or I can risk it. Of course, I couldn’t risk it if I had signed something. But that would have to be your choice. It comes down to personal risk tolerance.
If I had not signed anything that said that they owned all the stuff that I’ve done and in fact, I will say, at the last salary job that I had, this was 15 years ago, it was right as IP agreements were becoming a thing, especially with developers. I signed all the HR paperwork. When I came to the IP agreement, I looked at it and I don’t even remember if it said they own everything. I just remember thinking, I don’t want to sign this and I never signed it and no one ever said anything. I guess HR maybe didn’t have their act together enough to realize that I hadn’t signed it because I knew I was going to be working on stuff on the side and I needed to know there couldn’t be a case, in essence, brought against me, a claim, a threat, or whatever it was.
If you haven’t signed anything, then you have the choice of being secretive about it and trying to be anonymous online as much as you can be and still launching things. Again, this is your choice. You have to assess the risk tolerance because if you get caught doing this then potentially, you could lose your job, not get a promotion, whatever. I’ll tell you, in my personal experience, I just did it on the sly on the slide. I built some tools and launched them. I acquired DotNetInvoice. I’m trying to think if I would still work there if I was contracting. I honestly don’t remember the series of events. But I was definitely hacking on things on the side. I had my blog, and then I also had software side projects that were generating at the time not a ton of income, but I was definitely coming home nights and weekends and working on them.
There’s no insight. This is such a personal decision and I think a big part of it is getting educated so that you know what you’re actually dealing with and that you’re comfortable with the risks you’re taking. I hope that was helpful, Anonymous Hackerman.
The last question for the day is from Pramad. He says, “Do you think the disruptive innovation idea by Clayton Christensen can help find a niche? Disruptive innovation is the idea that former Harvard Professor Clayton Christensen came up with where a product is targeted at the lower end of a market and which is ignored by the big players. A new company can target this market segment by creating a product that leverages new technology which may not be mature enough for the higher-end market. For example, Google Docs versus Microsoft Word. Do you think disruptive innovation can be applied by bootstrappers to find a niche??
I think this is the play of every bootstrapper, to be honest. Not necessarily a disruptive innovation where you need technology because your disruptive innovation as a bootstrapper is you move extremely fast, you’re extremely capital-efficient, and you only need $10,000 a month to quit your job. You probably only need $50,000 a month or $100,000 a month to completely change your life. You hit seven figures of ARR and if your SaaS app feasibly sells that company for $4 million, $6 million, $7 million, $8 million depending on how fast you’re growing, that’s it.
If you truly are a bootstrap or mostly bootstrap founder and you want to change your life, you don’t need to own a massive market like a venture-backed unicorn land grab startup. Those are your advantages. The way you’re disruptive is what I just outlined, you don’t need all the things that such a large company needs. Leveraging new technology is fine, too, but then that introduces product risk. There are three types of risk when you’re launching a new product. There’s the product, there’s market risk and there’s essentially marketing/execution.
Product risk is, can we build this? If you’re using new technology, the answer might be no. Building Google Maps at the time and Google Docs took a lot of work because it was Ajax technology, they called it back then. It’s just having web apps in the browser that are super interactive and don’t need to refresh every time you submit anything. There are a lot of risks there. There wasn’t a ton of risk for Google because they had a bunch of really smart engineers and billions of dollars. But for an individual trying to build those, it introduces product risk. Most SaaS apps have almost zero product risk, and that’s why you’ll hear me say don’t go build the product because there’s no risk there.
The risk usually is in the market or in the execution. What I mean by market risk is does anyone care? Will anyone buy it? Will you build something that people want? Is there a market for this thing? Can you find a product-market fit? Does it even exist for the product that you’re inventing and usually the more novel you go in, the more new, and the more innovative with those ideas the harder it is to find that. The more you stay in the lane of an existing category, like electronic signature apps, like email service providers, and marketing automation providers, like online scheduling apps, things that everyone uses, the more you need to put your own spin on it. You either need a marketing channel that you own or you need to have enough differentiation in your positioning in your feature set that a certain subset really wants it, but staying in those existing categories helps reduce that market risk.
Then again, there’s product risk, market risk. Marketing or execution risk is can you implement, can you drive leads because you can build a great product and there can be a great market for it. But if you don’t know anything about marketing or sales, building a product and expecting people to find you is just not going to happen. That’s probably the most common mistake that I see with early founders is, especially developers and designers who think that the product is everything, where in fact, it’s 25% of the things and really all the other things, the marketing and making sure you hit the market right, is the rest of the equation.
To summarize, I don’t necessarily think you need disruptive innovation per se. But I do love the idea of entering larger markets at probably a lower price point in a niche that’s ignored by bigger players. I’m going, to be honest, if this truly is your first time launching a SaaS app, then, of course, I would say go back to the stair-step approach, play high school baseball, then go to college, and then play minor leagues, major leagues before you really get to the big time. That would be the stair-step where I would try to build a smaller add-on with one-time sales.
You can hear me talk about stair-step approach on many other podcasts because entering these larger markets is awesome, but if you don’t have the experience, or you don’t have some funding, you don’t have just some prior knowledge of how to do these things, there are so many things that have to fall into place in order to build a SaaS app in order to launch it, in order to market it. It’s quite hard to do that. I think for a first-time founder, it often requires an exceptional amount of luck or an exceptional amount of hard work and skill. I tend to want to do things and recommend people to do things that are repeatable and that don’t need to be exceptional.
They don’t need to be outliers in order to succeed and that’s what I see with the stair-step approach is that you can put one foot in front of the other and you can execute and you pick a small niche. You get it to $5000 or $10,000 a month and that’s amazing. Maybe that one app gets there, maybe have to cobble a few together, then you buy out at your own time. Now you have all the experience of having supported customers, having learned which features to build, learned how to market learned, how to do some innovation, learned how to manage products, learn how to manage developers, and potentially, support people and VAs. You don’t have to tackle that all at once if you try to launch that SaaS app into a large market right at the start when you’re still pretty green on all these fronts.
Thanks for the question, Pramad. No one’s ever sent that question in before and I actually think it’s an interesting mental model for thinking about bootstrapping SaaS.
That’s going to wrap us up for today. Thanks again for joining me this week. I have a favor to ask, if you have posted on Twitter or LinkedIn about Startups For The Rest Of Us or just told a friend that you get value out of it, I’d appreciate it. We’re @startupspod on Twitter and if you feel like these episodes help keep you motivated if they’re entertaining, if they’re tactical or strategic or what have you, I’d really appreciate a shout out, and of course at @startupspod, @robwalling on Twitter. Thank you for listening and we’ll be back again in your earbuds next Tuesday morning.