Then go get a loan which should be easy because you’ve demonstrated $1M revenue with 100% gross profit margin. A complete non issue and painfully unrealistic because how are you paying for the $1M capitalized expenses before you have the revenues? Yes, you have to raise funds to start a business. Shocking.
Which most banks or investors are going to be pretty hesitant to do, because cash crunch with low assets?
Some business environments, sure. Others? Not so much.
Is it impossible? Hopefully not. But is is a major change from how it used to work.
Which is why there is such a huge push for offshoring.
As stated, without some significant changes that company is doomed in short order with the new rules.
Software dev as 'opex' (actually R&D, which had the same treatment as opex) == the old way. 800k in 'income' you've already spent to do what your company exists to do, but have to pay taxes on this year == the new way.
On a cash accounting basis it’s actually worse, because that company is seriously in the red after paying taxes with the new rules. Previously it would have netted out at $0.
Of course someone is going to be hesitant to loan money in that situation, unless you can cut those expenses. Which if you’re in a highly competitive market could mean death to your company.
Is it overly simplistic? No shit, it’s an example to illustrate why startups are getting worked up right now because they have sudden cashflow issues. And why larger companies are also doing layoffs and trying very hard to reduce their software dev spend. Including outsourcing, where they can.
Because the actual way most companies will solve this once they figure it out is to not spend all their cash on software dev, and instead reduce it significantly.
Because this new treatment means instead of being able to write income off as a straight business expense in the year they spent it, they have to pay taxes on money they’ve already spent in that year, and then can only make it up fractionally after that.
So in the example I gave? Companies taxes that year are zero with the prior R&D rules. They had zero taxable income.
With the updates to section 174, now they owe taxes on $800k of taxable income the first year.
Huge difference.
They can still eventually write off the whole $1mln they spent in year one, but that is a hell of a big difference in cash flow. Even if dev spend is flat for 5 years, it will take that long for it to look the same cash flow wise. And it’s rarely ever actually flat.
And that is not even taking into account the increased cost of money going on, tightening access to credit. If you pulled off this situation while being in a safe industry that a bank will write a loan for you easily, then cool.
But they’re surprisingly weird sometimes, and if you’re in year one it can be hard to get anyone to return your calls at all if there is anything ‘non-traditional’ about you. Which is most startups.And the ‘startup banks’ where it was easy (SVB and first republic) all got nuked.
So you could easily end up paying 25% APR on short term financing to close this gap, if anyone is talking to you at all.
No, it’s not. Net income here is $800k (20% amortization). Gross income is $1M. Because accounting recognizes that the value of your investments today are useful next year. If you sold a million dollars of your software this year, it’s extremely likely that you will be able to sell the same software next year. You’re not starting from scratch in 2025.
> On a cash accounting basis it’s actually worse, because that company is seriously in the red after paying taxes with the new rules. Previously it would have netted out at $0.
And that’s an example of why cash based accounting is not they way businesses track their financials. It’s misleading.
Your understanding of finance here is completely backwards. Think about it. Would you rather loan money to a company that paid $1M contractors to do work for $1M in revenue? Or to a company that spent $1M building a product that sold $1M in services that year?
Obviously, OBVIOUSLY, the second one is more enticing. The contractor company is extracting zero profit and is poised to do the same next year. The software company built a product and they can continue selling. Whether the market is really competitive and whether they might need to continue investing in the product to stay competitive is a tangential concern and a secondary consideration about the business environment that does not factor into our basic understanding of assets here.
Whining about funding being hard to get or that business is hard does not define what an asset is. Imagine a factory owner saying “well the Chinese just built an automated factory so I’ll need to double my investment next year to make sure my products can compete in the market, so I’m going to say that my building of factory doesn’t count as an investment because that just works out nicer for me. It’s only fair. The business environment is competitive!”
Because in theory sure.
Though previously there was the far more profitable and easy to deal with theory of building an actual asset of large value (monetized via stock/equity) while treating the expenses to do it as straightforward business expenses with no amortization to be a PITA, and the IRS was willing to go along on that.
In practice, this is exactly how you run your startup into a wall at 100 mph while you bounce payroll checks and end up in a morass of legal trouble. Because cashflow absolutely matters, and startups and small businesses rarely can just get ‘free’ debt at a moments notice to smooth it all out. Even large ones are having more difficulty than ever.
Call it whining all you want - it’s a significant concern partially driving market behavior. Remote work also meaning outsourcing is back on the table being another.
“Business is hard” is not an argument to redefine what an asset is
Because this was all due to a change of the rules on existing behaviors, and created a new capital asset which previously didn’t need to be recognized.
And because you seem to be saying ‘suck it up’, which of course sure whatever. Business is what it is, and folks get what they get.
But of course what is going to happen is the related companies are just going to fire some people/lay them off, or go bankrupt and then do that to everyone.
I don’t actually care - I pivoted in a way it benefits me several years back - but what else does anyone expect to happen?
Then the whining and finger pointing happens of course on the state of the labor market, and no one ever points one back to themselves. shrug