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OpenAI's Insane Entity Structure · The Accounting Podcast

• Attention: This is a machine-generated transcript. As such, there may be spelling, grammar, and accuracy errors throughout. Thank you for your understanding! Blake Oliver: [00:00:04] Ai consulting is going to massively grow because we're going to figure out ways, as consultants to leverage AI inside of all these mid-market businesses. Public companies and the managers of these companies are not capable of figuring out how to implement it themselves. So they're going to hire consulting firms to do it. And when you can go into a company, you can say, look, you've got 100, you got 1000 people doing this thing, you've got 10,000 people doing this thing. And we can use AI to automate it. I mean, this is the new offshoring. David Leary: [00:00:35] Coming to you weekly from the OnPay Recording Studio. Blake Oliver: [00:00:41] Hello, and welcome back to the Accounting Podcast, your weekly news roundup for accountants and the number one show for accountants in the world. I'm Blake Oliver. David Leary: [00:00:51] I'm David Leary. Blake Oliver: [00:00:52] And, David, I heard you got up to some, uh, some fun stuff last night. What were you doing? David Leary: [00:00:57] I turned 50. I turned 50 yesterday. Um. Official. 50 years old now. And a place I spent my entire adult life at. Basically, I think the hockey rink down here in Tucson opened. I want to say, before I turn 22. So I was still 21 because I was working at the mall. I wasn't even working at Intuit then, so it was a very long time ago. It is closing because a casino is being built, and they're going to make that spot a parking lot. Oh no. Blake Oliver: [00:01:27] Literally, your life is like a Joni Mitchell song. David Leary: [00:01:30] Yes. So I went there and, uh, I didn't play hockey last night because I, you know, I'm old now, but I, uh, you know, had a couple of drinks. You used to play. Blake Oliver: [00:01:40] A lot of hockey, right? Like, you even, like, took a puck in the cheek once. David Leary: [00:01:44] Yeah, I had broken face here. Splits up here. Yeah, I've played a lot of hockey, but, yeah, um, you know, you start slowing down, and now. Now my life is. Which room did I leave? Which pair of glasses in? And I set my phone. I sent you a text. I made my phone my text font super big on my phone now, so I'm officially you can read it from the other, uh, seats in the airplane. Blake Oliver: [00:02:05] Well, you had fun last night. Maybe you're a little hungover, so I'm not going to ask you to do a lot of work today, David. But the good news is, I have plenty to talk about. I have open eye news and this crazy entity thing with OpenAI. Uh, accountants may have heard that OpenAI is a nonprofit, but then they have these for profit subsidiaries, and they're considering converting from a nonprofit to a for profit. And we deal with entity selection a lot as accountants because there are massive legal and tax implications for our clients. And often they do it wrong. And lawyers advising them tell them to do the wrong thing and other accountants advising them. Tell them to do the wrong thing. And it can cost you a lot of money a lot. And in the case of OpenAI, it could be billions and billions of dollars. So I have dug into this and I want to I've mapped out some entities, and while I may not have all the answers, I want to at least start asking some questions. And I would love if our listeners who are experts in this could chime in as well. So that's top of list for me. Is OpenAI. Their new funding round their their whole conversion from nonprofit to for profit. And then we also have a bunch of listener mail that we need to get to. David. David Leary: [00:03:22] Buckets and buckets. It could be two hours of listener mail. Blake Oliver: [00:03:24] A whole giant sack of listener mail. So we got plenty of time for that. And then also, I watched this amazing interview with Voorhes CEO. Are you familiar with the fashion brand Vuori? David. David Leary: [00:03:37] Yes, we just got one in Tucson and the wife tried to get me to buy a pair of pants there, and I'm just too cheap. I just can't do it. Blake Oliver: [00:03:43] This is the brand. David Leary: [00:03:45] Pants at Costco. Blake Oliver: [00:03:46] Okay, so it's the price thing for you. It's not the fact that it's basically taken, you know, women's yoga pants and made them for men. And they popularized this, right? Like before Vuori, if you were a dude and you wore a yoga pants, it was like a little weird. But now Vuori has made it like totally normal. And basically most of my attire on the bottom is has been vuori since since the pandemic. Um, so I watched an interview with the CEO, uh, at a Goldman Sachs event, and I learned that he was an accountant. He was an accountant at EY, uh, before he got into fashion. It's a fascinating story, and we'll talk about that as well. So those are my three things that we have to talk about. But first, David, uh, I want to thank our sponsors who are the sponsors of this episode. David Leary: [00:04:36] So relay Ignition and Mercury relay ads from all three of those later on. Blake Oliver: [00:04:43] Relay ignition and Mercury. Thank you so much for sponsoring this episode of the podcast. Stay tuned for information about how those apps can change your life as an accountant. Uh, but first, let's dig into the open AI news and welcome to all of our live stream viewers. Tyler says two episodes in one week. This is a nice Friday surprise lol. Actually, yeah, that's because, um, I am going to Tucson to celebrate David's birthday this weekend, and then I am going to, uh, on a vacation because it's fall break here. So we wanted to get this on. David Leary: [00:05:16] Vacation as well next week. So yeah. Blake Oliver: [00:05:18] Yeah, you're going to you're going to have a nice time in Cabo. Is it? Yep. Enjoy. Okay, so let's talk about OpenAI, the artificial intelligence company that is changing the world and will soon change the jobs of every accountant, I am convinced. Um, even if you haven't had it happen yet, it's going to. So OpenAI raised $6.6 billion at a $157 billion valuation, which I think I heard. That puts it above Tesla now or is it SpaceX? Space? It's one of the most valuable startups in the history of the world, is what I want to say. It's a big number. And there was also news recently about how OpenAI, in order to get this investment, has been considering transitioning from a nonprofit to a for profit structure. And this goes back to the very roots of OpenAI, and it's a bit controversial. Sam Altman started OpenAI as a nonprofit with the mission of developing safe artificial intelligence, and it seems that now that this technology is extremely valuable, they've decided. Sam Altman has decided that, you know, maybe, maybe I don't want to limit my ability to make profits on this. Maybe I want to be a for profit business, and I want to I want a chunk of that. Right. David Leary: [00:06:43] Wasn't this Elon Musk's model with the his rocket business? Uh, SpaceX and all. A lot of the businesses he started, he started kind of as a nonprofit first. And then once it had legs, somehow converted a lot of those. Right. Blake Oliver: [00:06:57] I don't know about that. I hadn't heard about that. But I do know Elon Musk was involved in this and had a falling out with Sam Altman because he put money, he put the biggest chunk of cash. Was it $40 million into OpenAI's nonprofit division? And he has yet to see any shares in the for profit entities he got. He he declined to to invest in these for profit subsidiaries that were created. And now that OpenAI is talking about converting from a nonprofit to a for profit, there's a possibility that, you know, he might get cut out of all of that. And so he has not been happy about OpenAI. It's what inspired him to create the competitor grok, which is part of X. And and it's like creating it's it's like the number one beef in the startup world right now is Elon Musk versus Sam Altman and these other guys who are investing in this profit arm. Um, so $157 billion is a lot, and OpenAI is a nonprofit. That was my understanding when I started digging into this. And I'm thinking like, well, how does this even work? Right? Like, and why would all of these investors Microsoft, Thrive Capital, Nvidia, SoftBank, Tiger Global, these giant investors, VCs, why would they put money into something that is a nonprofit? Isn't the whole point of making these investments to make a lot of money? And the news was that his I don't believe it's been confirmed, but nobody's denied it at OpenAI. Is that in order to get this additional investment of $6.6 billion, they had to, like, agree to try to get out of this nonprofit situation. So I was curious about like how these entities are set up, what is the structure of this? So I went and did a little research, and I created a nice little chart for everyone. David Leary: [00:08:48] So there's no I that could have done this for you. Blake Oliver: [00:08:51] Um, probably. But I found it helpful for me to actually construct this myself. But I did use perplexity to do the research for this, which helped me figure out what entity controls what, who does what, all that sort of thing. So, um, if you were looking at my screen here on the live stream, you can see a bunch of like, circles, nested circles and all that stuff. Right? So, um, I'll also do my best to explain this verbally for all of our podcast listeners. So the highest level entity is OpenAI Inc, which is a Delaware 500 and 1C3 not for profit. And it has full control over a second entity, which is called OpenAI GP, LLC. Gp stands for General Partner. This is a manager entity that is disregarded for tax purposes and this entity controls two for profit companies, OpenAI LP and OpenAI global LLC. They're both for profit companies and they have different investors. As far as I could tell. The LLC OpenAI global LLC has a $13 billion investment from Microsoft. That was the first big investment that OpenAI received, and that was for 49% of that entity. And the purpose of that entity is to focus on R&D activities and commercializing AI technologies. So that's the first for profit entity. And very importantly, this entity has a profit cap, meaning that Microsoft and any other investors that are in this entity that I wasn't aware of, they can only earn at most 100 times in profit off their initial investment. So for example, if you invest $10 million, the most you can earn in profit is $1 billion. Now that's a lot of money, right? But it's looking like OpenAI has developed this world changing technology. And so wouldn't you rather earn a thousand times or 10,000. David Leary: [00:11:04] Times a thousand billions, right? Yes. Right. Blake Oliver: [00:11:07] A hundred times is great, but it's not like, as good as the investors in some unicorn companies. Like if you'd invested in Amazon early, you'd have earned far more than 100 times your initial investment. Right? So this profit cap is really important. And the purpose of the profit cap is so that the nonprofit, which controls all of these entities, benefits from the research that is being done and all the profits in excess of that profit cap, they have to go back to the nonprofit and they have to be used for charitable purposes. They have to be used for the mission of the nonprofit. There's a second entity, and this is the one that's been in the news. It's called OpenAI LP Limited Partnership. This is also a for profit entity, and its primary purpose is as a financial vehicle to raise capital for AI development. There are many investors in this round, and the latest 6.6 billion went into this entity, according to my research. This entity also has a 100 times profit cap. So that 6.6 billion can only become 100 times more than that 606 billion. That's the most profit that any of these investors could ever see. And anything in excess of that for all time would have to go to the nonprofit to be used for charitable purposes. Again, the reason that OpenAI is considering getting out of this nonprofit is because of that profit cap. This could be one of the most valuable companies in the history of the world. So we've got OpenAI Inc, the overall Delaware 501 C3. We've got a fully controlled General Partner LLC. And then that general partner manages the LP and the OpenAI global LLC. So the question is, in my mind, how does OpenAI get out of the nonprofit? How do they get these entities out of this nonprofit and unlock the profit cap? If that's what that. David Leary: [00:13:21] Circle outside, just grab it and drag it. Blake, you solved it. Blake Oliver: [00:13:24] Well, it turns out that it's actually kind of tricky to do this, because what is the real big benefit of a nonprofit, David? Taxes, right. You don't pay taxes. Don't pay taxes. Nonprofits don't pay taxes. So when you want to convert the assets of a nonprofit to a for profit company, or rather, let's say you want to dissolve a nonprofit and transfer the assets, actually, they don't want to dissolve the nonprofit. They just want to transfer the assets. Right. So they want to transfer control of this LP, these LLC, this general manager, they want to transfer that to a for profit company and therefore thereby unlock this profit cap. Well, there are rules to prevent companies from abusing this. Otherwise people would start everything in a nonprofit. And then as soon as it starts making money, you know, they would turn it into a for profit, right? Like, you could just switch it on and off, right? Oh, I want to pay taxes now. I don't want to pay taxes now. I want to pay taxes now. I don't want to pay taxes now. That's why these rules exist. So the rule almost everywhere. Like I couldn't find any exceptions to this is that if you transfer the assets of a nonprofit to a for profit, the for profit has to pay fair market value for these assets. David Leary: [00:14:50] Which makes sense, because in a way, you're using this word. It transfers out. But in a way it's like they're selling the asset now. They have this this income, and that's what they have to pay taxes on. Blake Oliver: [00:14:59] Yeah. Well, and the rule is that the assets of a nonprofit, right. They're supposed to be used for charitable purposes. So you can't just transfer them to a for profit like they raised all this money from, like, donors, right. Like Elon Musk to generate these assets, which are supposed to be used for charitable purposes. And the donors expect that to happen. Elon Musk would expect that to happen. Right. So, um, you have to pay fair market value of those assets to the nonprofit or to another nonprofit to then use it for charitable purposes. So what is the fair market value of OpenAI's assets? And it's right there in the news, isn't it? 100. And what did I say? $157 billion. Now, because that's the value of this LP and this LLC that are controlled by this managing entity. So that would be the most that the fair market value of the control of these entities could be for the nonprofit. Think about it. What is what is the interest of the nonprofit in these for profit entities? It's the future value of of the like, the cash flows that could come in to OpenAI. So my question about this is when they talk about converting from a nonprofit to a for profit is like, how much money are they going to have to pay to do it? It's going to be billions and billions and billions of dollars, at least tens of billions of dollars, I think, even if it's not that full amount. Blake Oliver: [00:16:30] Um, one advocacy advocacy group called Public Citizen, wrote an article and said that OpenAI should be required to pay at least $30 billion and share any artificial general intelligence technologies it develops because of the value of that controlling interest. Um, and I just think this is like crazy, right? It's crazy to me that OpenAI set itself up this way, and it makes me feel better about myself and about every entrepreneur that screws up entity selection, because this is about the worst mistake you could make, right? You see accountants on on Twitter all the time saying like, oh, my client set up this rental property in an LLC, or they elected S Corp status when they shouldn't have done this. Right. And there's all these tax consequences like this is this is crazy. Um, and it's even crazier when you consider that OpenAI is losing $5 billion a year right now. So let's say that, you know, the value of the nonprofit's controlling interest is like $30 billion. Like Public Citizen is saying. That means that in order for the investors to see any profits, OpenAI has to generate 30 billion of profits first. David Leary: [00:17:54] Where is this 5 billion being burnt at? Like. Blake Oliver: [00:17:57] I think it's compute. David Leary: [00:17:59] Because AI is so expensive. It has to be because I've met people that work for Microsoft. These these global workforces of hundreds of thousands of employees are I don't know where the or people that work for Amazon or people that work for HP, these big, huge companies or Google. But I've never ran into anybody that works for OpenAI. So is it just electricity there? It's just electricity and compute compute time. Blake Oliver: [00:18:21] All these chips they buy, right. These these GPUs from Nvidia that can do this AI processing. Like it is extremely expensive and and they're giving away a lot of it for free, essentially because people are paying 30 bucks a month for ChatGPT. But it's possible that you could use the more compute than $30, because they don't really limit you that much on your queries. I mean, if you use the latest model, they might limit you on that. But if you look at the cost of doing these prompts via the API versus what it costs to do in the chat window, you could very easily go over the API value just using the chat. And also there are free versions of ChatGPT that people are using all the time. And so they're, you know, offering that in order to gain market share. So what I'm trying to say is, like, they basically have screwed themselves out of at least tens of billions of dollars by choosing the wrong entity structure. Tens of billions of dollars. So the next time a client comes to you and you have to tell them, I'm sorry you chose the wrong entity structure. Blake Oliver: [00:19:34] This is going to cost you a lot of money. Maybe tens of thousands of dollars or hundreds of thousands of dollars. I guess it could be millions, right? Just you can make them feel better by telling them, don't you know? Don't feel too bad. Openai lost out on tens of billions of dollars by choosing the wrong entity structure. So it happens even to the best of us. It's insane. And there's one other really important point here about why this needs to happen is that the investors in these for profit entities have zero control, because the nonprofit board controls everything. So think about this. You've got Microsoft investing $13 billion here at the beginning. You've got, you know, another 6.6 billion coming in from these other investors recently. They've raised, uh, I forget what the amount they've raised so far is, but it's like many, many billions of dollars. And normally in a startup, the investors would demand board seats, they would demand like a significant amount of equity. But that's all meaningless from a control standpoint, because everything's set up under a nonprofit, and the nonprofit board has full final say over everything. David Leary: [00:20:47] And they've had a lot of people leave. Right. The nonprofit board, a lot of drama at the top, including Sam leaving for like a week and then coming back. Yeah. Back in the day. Blake Oliver: [00:20:57] Uh, Gator NYC says, was it really a setup mistake or greed overtaking the original altruistic goals? It's a great question. I'm going to go with, uh, greed, but also, like, it's kind of a I would consider it a mistake not to think about this as like a potential like, like, I guess you could say it's greed, but in retrospect, it's a giant mistake because they should have, like Sam Altman should have realized that he's going to want this money someday. I don't know, like, like, did he have a sudden change of heart? Like, well. David Leary: [00:21:40] I can see how this goes down. It's a bunch of rich, rich guys. They got billions and billions of dollars. They know there's something out there with AI. Well, none of them on their own. Companies wants to go and research this for decades to to make the discovery. So they create a nonprofit knowing there's lots and lots of failures. And somehow this bubbled out. But they discovered the magic formula. And now you're like, oh, we're going to make billions off of this. Oh, crap. We're stuck in this nonprofit, right? Because because this could have never amounted to anything. Right? It was just a nonprofit. People put money in and it's just a research company. Blake Oliver: [00:22:15] And when it was started, I was a toy. It was not an application. And they figured out how to, you know, turn it into a real world application that has incredible value. Um, but yeah, it's going to be very expensive to get out of it. And again, I'm not even sure that that $30 billion number is, is high enough, because fair market value of the controlling interest in all these for profits is basically the future profit for ever beyond 100 times the profit cap. Right? 100 times whatever the investment was. So, um, let's say total investment in OpenAI so far. I want to see what the number is. I'm looking up in perplexity. It's thinking. Most recent was the 6.6 billion. Come on, add it up for me. Uh, it's just saying 6.6 plus 13. So anyway, tens of billions. Mathias says their LM computation costs are higher than rented costs per API. So they're basically taking a loss on the API pricing in order to, uh, probably gain market share, right? Sure. Like, yeah, that makes sense. I don't know that for sure, but, uh, maybe you could put that sauce there. Mathias. I'd love to look at it. All right, David, that's it for OpenAI's insane entity structure. Let's thank our first sponsor, relay. David Leary: [00:23:59] Yeah. So between Blake and myself, we now have three, four, maybe five business entities with 20 or so checking accounts, dozens and dozens of virtual cards. And it would be impossible for us to track all this if we were not using relay as our small business bank. Really, it's truly a part of our tech stack we use to run our business. It allows Blake and I to each have our own logins. We don't have to share passwords, right? We can grant access to our team, even our accountant, without sharing passwords or two factor authentication codes. Blake Oliver: [00:24:31] It's the best. David Leary: [00:24:32] And really allows us to grow and scale our banking needs without ever going into a physical branch. I recently added an account to receive inbound merchant services with just a couple of clicks. Had to create a payroll checking account again, a few clicks and I instantly had the ACH info to give to the payroll provider. With relays virtual cards, we can issue debit cards to your team around the world with for needed business expenses, and I can instantly spin up a new visa debit card and set both daily and monthly spending limits. And if a team member doesn't need their card, I can just freeze it until they need it again. Really also has an automation feature to sweep money automatically from one account to another based on dates, amount or target balances, or even percentages. So for example, your inbound payments could be split daily to your payroll sales tax payable operating in savings accounts based on predefined rules. To learn more about using relay for your firm and clients, head over to The Accounting Podcast dot promo slash relay that is The Accounting Podcast dot promo forward slash relay. Blake Oliver: [00:25:31] Awesome. And that is going to appear on the screen shortly that link. I'm going to go ahead, David, and thank our second sponsor ignition while we're at it. Thank you ignition for sponsoring this episode. Imagine increasing your revenue by an average of 24% in just 12 months. Think about saving your team 18 hours every week. Picture 91% of your payments being collected automatically without you having to chase down a single client. Ignition makes all of this possible. It starts with professional proposals and engagement letters that clients can review and sign online within minutes. This means you kick off every client relationship on the right foot, with crystal clear clarity on the scope of work and fees. Then it gets better. Ignition will take care of the automatic billing and payments. So that means when a proposal is signed, the payments are automatic. After that, there's no more late payments, no more invoicing hassles, just a smooth, seamless process that lets you focus on providing top notch service. And when the scope changes, you can simply adjust your services. Or you can even bill instantly for any ad hoc work. But that's not all. Ignition connects with your favorite apps, automating workflows that spring into action the moment a proposal is signed. And with the business dashboard, you gain visibility into your projected revenue and payments at a glance, it's time to reclaim your firm's revenue and time. Stop doing work for free and start engaging clients with clear scope, pricing, and terms from day one. To discover how ignition can revolutionize your practice, head over to The Accounting Podcast promo slash ignition that is The Accounting Podcast dot promo forward slash I g n I t I o n. And now David I want to talk about Vuori and their CEO, and I want to play the beginning of the interview, uh, with Goldman Sachs. Goldman Sachs Interview - Vuori: [00:27:30] Our next guest is Joe Kudla, the founder and CEO of activewear brand Vuori. Joe grew up in Seattle before moving to California. He graduated from the University of San Diego with a degree in accounting. Okay. And then he worked as a model. Now, how many accountants do you know that work as models? They're very, very few. But he then, after working as a model, went and became an accountant, which is really I mean, very few people do that too. But then somewhere after that, he decided to move back to San Diego and start doing startups. And so here we are today. In 2015, you launched your third most successful venture to date, Viera, with the tagline Built to Move. Styled for life. Activewear. With a West Coast esthetic quickly grown in popularity, in 2021, Vehari received $400 million of investment capital from SoftBank Vision Fund, valuing the company at $4 billion, marking one of the largest investments ever in a private apparel company. I think the largest ever in a private apparel company. Goldman Sachs Interview - Vuori: [00:28:30] Yeah, I was up there. Goldman Sachs Interview - Vuori: [00:28:31] Yeah, it was definitely up there. So, you know, first of all, please welcome Joe. Delighted to have Joe. Thank you. I mean, it is an interesting story. I mean, you studied accounting, you were a model, and now you're selling kind of cool activewear and living on the beach in San Diego. But talk a little bit about your personal journey. How did you get interested in fashion? Yeah. Goldman Sachs Interview - Vuori: [00:28:51] You know, growing up, I was the opposite of somebody who you'd predict would end up in fashion. All I wanted to do was play sports and run around outside. I was never interested in retail or style or fashion. I went on to the University of San Diego, as you mentioned, and studied accounting. Um, and my my senior year, I had I had interned with Ernst and Young and I had a plan to start a job with the firm in the in the fall. We graduated in May, so we had a summer break and somebody approached me about working as a model in Europe, and I had never been to Europe before. So it checked that box and I needed a summer job. So, you know, two for two. And so I ended up, you know, going to this casting and I met this agency and I went and what was supposed to be a summer job ended up. I ended up spending two years traveling the world, meeting people from all of these different walks of life. And I never really resonated with being a model, but it was the first time that I, like, became interested in a creative endeavor. I loved watching designers work with textiles and tell stories and build collections. And, you know, I had never taken an art class. I had never nurtured a creative bone in my body. Um, but I became a really intrigued with this idea of building product, and I started to get in touch with that creative side of myself. So ultimately, I decided enough modeling. It's time to start my professional career. But I think that that really stuck with me and I carried it. And eventually I think it's why I ended up in this field. Goldman Sachs Interview - Vuori: [00:30:20] So Vearey was your third startup. Blake Oliver: [00:30:22] So it goes on, and I highly recommend the full interview. It's about a 25 minute watch, and I'm going to put the link here in the chat for everybody. David Leary: [00:30:33] So I'm trying to and maybe this is a spoiler and maybe you don't want to tell me because I'm going to ruin it for everybody who wants to listen to it. But I'm trying to like, how did he go? He's working in an accounting firm. He's an accountant. One day, and then he's like, I'm going to start making pants. Like. Like, what was the, uh, the prep prep prep space for that to happen? Precipice. Blake Oliver: [00:30:55] The. So he well, he was was interning at Ernst and Young and so he was going to become an accountant. But then he got this invite to go do modeling in the summer in Europe. And he did it. And that's how he got into fashion clothing. He liked he he didn't like the modeling as much as he liked seeing the process of making the clothes, and he thought when he came back, I can do this here. It really reminds me of how the Starbucks CEO, um, the guy, the guy who grew Starbucks, what was his name? Howard Schultz. Yeah. Schultz. He went to, you know, Italy on a vacation with his family. He was just managing this coffee shop in Seattle, and, uh, and then he, like, saw the espresso, and he was like, we can bring this back here, right? So, uh, so Joe Kudla, he came back and he started two activewear, two fashion brands, and they both failed. So Vuori is actually his third startup. And when he did the third one, he knew that he had to be really careful with his money because the first two hadn't worked out right. And what's what's I find interesting about it is I think his accounting background probably helped a lot because in the interview, he talks about how they raised a $400,000 convertible note, and his mission was to be extremely careful with that money. And he says, you know, he wasn't good at raising capital. Right. Most, most accountants are not great at, like, sales. Right. So he's he knows he's not great at, like, selling the company, raising the capital. So he said, all right we got this money. We have to make it work. They only raised in the first two years, 2.5 million, which is a very small amount of money to start an apparel company like that. You know, you've got huge costs, right? The manufacturing costs, the shipping costs, sales and marketing costs. David Leary: [00:32:48] Factories. Blake Oliver: [00:32:48] Yeah. So that's like a very small amount of money. And he developed a working capital model. He uses those words. He said I was either going to lose all my equity in the business, or we were going to have to figure out how to develop a working capital model that would fund the growth of Leary. And that's what we ended up doing. And working capital model simply means that they needed to figure out a way away where they could use the revenue coming in from sales to fund the manufacture of more clothing to sell. Right. And not have to borrow huge sums to create a ton of inventory. So that means like having very little inventory on hand. And it means, you know, just being very lean as a company and running a profitable company. David Leary: [00:33:34] It's like the opposite of OpenAI, right? Blake Oliver: [00:33:36] And one way they did this was they originally started out by, you know, doing what most brands do, which is putting their apparel in like yoga studios, because that's where Vuori started is Joe Kudla got into yoga, and so he noticed there wasn't yoga pants, yoga clothes for men. It was all for women. Right. And so they were putting it in yoga studios. But that ends up being very capital intensive because you have all this inventory sitting on shelves in stores and, you know, you you don't get paid until it sells. So they developed they pivoted to a direct to consumer model. Right. And and you could just buy it online and they would ship it to you. So that meant they didn't have to have that much inventory. And they could have very little working capital. And they priced their product at a premium price. And all the people that were advising them said, no, you can't charge this much for men's activewear. Men are just not willing to pay that much. And he said, I think they are. I think they will if we market it right. And he was right. Right. Men are willing to pay $100 for or more for a pair of pants, and that's why they have a crazy $4 billion valuation. So I credit, you know, Joe's accounting background for helping him to be able to build a working capital model and understand the importance of keeping an eye on that money. And I bet you he was there reconciling those books, looking at those books a lot. David Leary: [00:35:06] And we've said this before, like getting that accounting degree, regardless of what you do in life, is going to make you more successful. Yes. If you would have went to school to be a fashion major, yeah, chances are he probably would never have been able to start this company. Blake Oliver: [00:35:19] He would have blown through the cash. He wouldn't have understood how to control his costs and there would be no Ferrari. So yeah, accounting is a great major if you want to be an entrepreneur. We need to, like, figure out how to make accounting courses more interesting so that we get more general business people who want to major in accounting, future entrepreneurs. Because I'll tell you, as a entrepreneur, this is my second business. I find understanding, you know, my cash flows, my income statement, my balance sheet to be so incredibly helpful. And it's what's allowed us to, you know, bootstrap earmark. And if I didn't have that knowledge, I don't know how I would do it. It would cost a lot more. Right. So being able to be lean and and that is like, you got to keep your eyes on the numbers. You got to know your numbers. So I love that interview. Go check out the full one. You can get that at Goldman sachs.com/insights. And uh yeah great job Goldman Sachs. David Leary: [00:36:23] Do you want. Can I do one news story before we jump into listener mail. Blake Oliver: [00:36:27] Go for it. Yeah. David Leary: [00:36:28] So FreshBooks I'm wondering if their days are numbered here. They just had a layoff. They laid off more than 20% of its staff. So that's about 140 employees across all levels and and locations of the total staff is about 500, right. But this follows a March 2023 layoff of approximately 80 folks and then a December 2023 of an unknown number of layoffs. And so, according to the interim CEO, Mara Reif, she noted that the last 18 months have been challenging, and about 18 months ago, they shifted their strategy from a grow at all cost model to trying to become popular or profitable. Um, so I kind of look at this. And in August 2021, they hit a $1 billion valuation, which was shocking because they've been around for like a decade. But that's when money was free. Yeah, that was the peak of the valuations. So their valuation today is probably a lot less maybe 500 million, maybe 300 million. Who knows what their valuation is. But it's not probably not a billion anymore. Nobody's valuations are that high. So Shopify's market cap is 104 billion. Wow. And they're basically neighbors up there in Canada. And I if you look at what Shopify has and you even look like what MailChimp has or how Intuit bought MailChimp and this whole suite, in a way, Shopify has got a lot of things similar to MailChimp, but Shopify doesn't have. I mean, they have inventory management, stock management, automating your business. They just don't have a GL, right? They've got invoices and billing and B2B type management stuff bill pay, but they don't have a GL. And just as Intuit discovered how great it was to have MailChimp, I think Shopify could buy FreshBooks in a second. And from a market cap, it's not much. Blake Oliver: [00:38:17] Yeah, but would they want to? Part of my worry about FreshBooks is that where did they start? What is the roots of FreshBooks? It's time tracking and invoicing. Yeah, it's used by small professional services firms. A lot of freelancers to track time and bill for time. And is that a growth area? Tracking time and billing for time. We are moving away from that as a profession. I think most professions are moving away from that because it's not ideal. It's not really a growth area. And look at Shopify. What do they earn a piece of? They earn a piece of every single e-commerce transaction that is happening on, which is. David Leary: [00:39:00] A growth industry, which is a. Blake Oliver: [00:39:01] Huge growth industry and which is where we're all moving to because, you know, we're getting comfortable more and more comfortable with ordering stuff online and just returning it. And, and these days when you use Shopify, they've got this like something like Easy Returns I think is what it's called. So it's just as easy to return something as with Amazon. So yeah, that's the place to be I wonder I wonder what FreshBooks future will be. Right? They've they've rolled out this accounting GL, but it's not very full featured. I mean they were single entry for a long time. And you know, you got to have all these double entry tools to to build a product that accountants are willing to recommend to their clients is extremely difficult because QuickBooks is already so good. Even something as robust as Xero struggles to gain market share against QuickBooks. So I don't know what their strategy is going to be long term. Like how do you how do you grow? It's an interesting question. I don't. It's a rhetorical question. David Leary: [00:40:02] Yeah. I mean, they were one of the original, you know, cloud accounting products that were out there. Freshbooks was very early on for, for SaaS. Blake Oliver: [00:40:09] It was like the first app I ever used, a cloud based app as an accountant was I was tracking my own time as a freelancer and invoicing for it. David Leary: [00:40:18] Early days of the QuickBooks APIs. Because the story was always this clients using FreshBooks because FreshBooks is a very good marketing clients on FreshBooks. And then as soon as they go, they grow big enough to get an accountant. The accountant basically tells them stop using that and then puts them on QuickBooks, when really what FreshBooks should have done is had a good deep integration to QuickBooks, because then you could tell your client, hey Blake, stay using FreshBooks, track your time, send out your invoices, and I'll just those will sync perfectly into QuickBooks. But FreshBooks would have kept they could have still kept their clients or their customers and not have that migration, because that's what basically happens. They grow to a point and then they just get sucked off of FreshBooks into a different GL. Yeah. So it's a lot of churn if you want to think about it that way. Yep. Blake Oliver: [00:41:04] Makes a lot of sense. And that makes a growth strategy like a high growth strategy really hard. Because what's the lifetime value of these customers when they're churning after a few years. You can't spend that much to acquire them. And that's why FreshBooks did well at the beginning, because they were very much a word of mouth kind of product. They didn't spend a lot, you know, they they didn't they weren't spending a lot of money to acquire customers. It seems like they, they pivoted to a like you said, was the phrase growth at all costs mindset. Yes. And so you're trying to just get users, get users. You don't care what it costs. That's how you blow money. Actually, going back to the story, Vuori didn't do that, right. They didn't spend all this money on ads to try to get people to buy, like Casper and Warby Parker and all these direct to consumer brands that like, blew up and got really big, but then they imploded Loaded because it costs them so much to make a sale. They were actually losing money on every sale. And you can only make money as a direct to consumer brand if your consumer comes back again. And it's very easy with spending a lot of money on sales and marketing and ads to make it look like you're doing great because your sales growth is going up. Right. But these are not customers who are going to come back because there's some fundamental issue with your product. You haven't focused on the product enough and they're not going to buy again. Or like in the case of a mattress, how often do you need a mattress with clothes? You might start by buying one pair of shorts and then you love them so much you go out and buy like four more, and then you buy more apparel and more. And it's, you know, it's something that you'll buy quite a lot of. David Leary: [00:42:44] It's better to focus on real customers because that's the same problem Groupon and all those coupon companies had. Every small business did it once and they realized like, wait a minute. Yeah I had I had to sell things below cost, pay a fee, and then you got too much volume I couldn't handle. Yeah. And really, these people just move on to wherever they get their next coupon. They're actually not customers. You're better off earning customers slower. Blake Oliver: [00:43:08] They're customers of Groupon, not of your restaurant or your store. Yeah. David Leary: [00:43:14] It's everybody. Everybody gave Groupon a ride once. Yeah, that was it. Blake Oliver: [00:43:19] Well, David, I think it's time to get to listener mail. But before we do that, we should thank our third sponsor of today, which is. David Leary: [00:43:27] Which is Mercury. Blake Oliver: [00:43:28] Mercury. David Leary: [00:43:29] So I'll read the ad if you want to put up the the banner. Okay. Mercury is already the trusted banking solution for over 200,000 ambitious companies, and for good reason. They offer checking and savings accounts, FDIC insured up to $5 million, corporate debit and credit cards, free wire transfers, and treasury services that can earn your clients over 4.75% 5% interest on their idle funds. And now they've launched a partner program specifically for accountants like you with Mercury. For accountants, you'll be able to oversee all your clients banking from a single dashboard. Their Panorama feature lets you view multiple clients accounts at a glance, so you can toggle between account balances, transactions, and more with just one click. But Mercury isn't just about simplifying your workflow, it's about empowering your clients, too. They'll get access to a full suite of financial tools, banking bill pay with custom approvals, invoicing, document uploads, and even a general ledger code mapping all in one seamless platform that integrates directly with QuickBooks online, Xero and NetSuite, making it easy to keep everything connected. And now let's talk about growing your firm as a mercury partner. You'll get your own co-branded referral webpage and be rewarded for every client you bring on board. Plus, you'll receive dedicated onboarding support, ongoing assistance from a personal partner, manager, and resources to help you and your clients thrive. So if you're ready to watch your accounting firms soar with mercury for accountants, head over to The Accounting Podcast dot promo slash Mercury. That's The Accounting Podcast dot promo forward slash Mercury. Blake Oliver: [00:45:08] All right. Thank you. And that's a. David Leary: [00:45:09] Great example of Mercury has invoicing in it right. So FreshBooks the main use case is just a feature of a bunch of other things now right. If you think. Blake Oliver: [00:45:20] It's a it's a feature not a product. David Leary: [00:45:23] Yeah. Blake Oliver: [00:45:23] That was the problem that Dropbox had. Although I guess Dropbox has done okay. Probably because they got into enterprise and it was like that. Right? Freshbooks need you need to if you're a feature and not a product, you need to go way up market and sell to enterprise. All right. Let's let's do some listener mail, shall we? It has been a long time since we opened up the mailbag, and we've got quite a few. Here's a message from Don. Don says, hey, Blake, I have a question for the podcast. I'll have to ask what you think about getting the CPA license if you don't want to make a tax or audit firm. Do clients actually care about seeing the CPA letters or is it just hogwash? I want to create a cloud bookkeeping firm, and I only want to offer that and fractional CFO work. The other branches are just too much stress in comparison. Ha ha ha ha ha! So as the CPA on the podcast, I guess this is my question to answer. But I think, David, you know, you as a consumer of services, can also offer your insights as to whether or not you think the CPA has value. So let me ask you this, David, if you are evaluating tax preparers. Well, actually, no, he says if you're off, if you're evaluating a cloud bookkeeping firm to do your books and maybe they offer fractional CFO services, do you care if the person providing the services is a CPA? David Leary: [00:46:46] I'm going to say yes. And the reason why is the word accounting and CPA are so the same word. And it would be odd if they did not. It doesn't mean. But now that's just me being like an uneducated consumer. If you want to call it that. But knowing this field, there's plenty of people that aren't CPAs that can do all this work. I understand that, I think, but from a brand and a marketing perspective, if all everything's the same side by side, somebody's probably going to go. They're going to probably go down the CPA path first and try to choose that right or that business to work all things equal. Blake Oliver: [00:47:21] If somebody's a CPA and somebody's not, you'll go with the CPA. And I think there's more value to it than that. Um, you know, I and my experience as a CPA and before I was a CPA, people give me a lot more. I have a lot more credibility as a CPA. I can just tell as soon as I tell people I'm a CPA or if they see that I have the the letters after, especially if there are other professionals or if they are people with advanced degrees like it really means a lot. It makes a meaningful difference. It's made a difference for me. Raising this round of funding just adds credibility. It gets to you. It gets your foot in the door. You know, all that stuff. So I would say, yes, it is valuable and it will help you and it is worth it. But you have to balance your other priorities in life. And so there is a tough decision where if you are in a position right now to start this firm and you don't have time to do the CPA as well, you might be better off economically just starting the firm. And here's the thing is, if you plan to be the business owner and you want to grow this thing bigger than yourself, eventually you can hire people who are CPAs to do this work, and you can be the entrepreneur running the organization. And you don't have to be a CPA if you don't set up as a CPA firm. And that's the thing that I would say maybe isn't as valuable as it used to be. And you probably might want to consider not being a CPA firm because there's all this red tape around being a CPA firm, and you can get the benefit of not being a CPA firm and still having CPAs who work for you and have those three letters after their name. Does that make sense? David Leary: [00:49:11] That actually is a better way to hack in, right? Yeah. Now you get to provide CPA services. You don't actually have to do them yourself. And you're not going to lose the clients who's like, oh, there's no CPAs here. Blake Oliver: [00:49:23] Now you have to be careful. Depending on what state you're operating in, you might get in trouble with the Board of Accountancy. Texas, for example, is very strict about who can call themselves an accounting firm or say they're providing accounting services. Only CPA firms can do that. And in Texas. And so there are workarounds, right. You got to say we're consulting firm. We offer consulting services. We offer management, finance services, that sort of thing. So you just you got to be careful, but you can totally get around it because, uh, you know, it's it's very specific. The word accounting. Um, all right. This is from Wyatt, David and Blake. I love your podcast. I've enjoyed the discussions in the last couple of episodes on the state of audits. It is a disgrace to the profession, and I'm glad to see a podcast with your influence bringing it to More to light. I'm not sure of the solution for the profession fixing the issue. I do think as long as the company being audited by the CPA firm is the client and the one paying the CPA firm, there will always be issues with audits. My only thought for how you fix this conflict of interest is to change the party that is compensating the CPA firm for the audit, though I don't really like the idea of creating other regulations regulating entity, I'm not sure you can fix it without changing this dynamic. One idea is you could charge a small fee on all trades in the public markets. Blake Oliver: [00:50:44] That goes to a pool of funds used for paying for audits of the public companies. Then the regulating entity pays the CPA firms directly to do the audit of the public company. Another idea is you have public companies pay directly into the pool of funds the regulators use for audits based on their market cap or another metric. Those are just a couple of top of mind ideas. We'd love to hear both of your ideas on ways you could eliminate the direct conflict of interest in the relationship between the auditor and the company being audited. Keep up the great work, Wyatt. Wyatt. Thanks for listening and writing in. I feel like both of those are actually great potential ideas that could be considered, uh, all the public companies pay into a fund, and then somebody has to then select and hire and pay the auditors. It shouldn't be the companies themselves that select the auditor, I don't think. Um, and, you know, maybe the exchanges themselves could do this, right. The exchanges, like the New York Stock Exchange, could collect a transaction fee or charge the companies based on some metric. That's objective. That all goes into a fund, and then they hire and pay the auditors. And who better than the exchanges to do this? Because aren't the exchanges interested in protecting the investors who are using the exchanges? That's one option it seems would. David Leary: [00:52:02] Be more valuable. But I still think there's enough competition, right? Like, if you if you're my exchange, my companies that are on my exchange are vetted better than all the companies on your exchange. It's just there's enough competition. Everybody's sitting there all already won. Well, there's a brand new company. Blake Oliver: [00:52:20] Nasdaq. There's New York Stock Exchange. There's the one that Texas wants to make. There's Hong Kong, there's London. I mean, there's global exchanges, right? So there's there's but I agree, it's not there's not that many. But I still think it would be better to have that set up than the one we have now. Yeah. And I think that setup would be better than having a government entity do this, because I do not have confidence in the SEC to do this in a way that is meaningful, given the regulatory capture that has occurred at the SEC, I would say cut the government out of it. David Leary: [00:52:55] And I think we'll have to cover it next week. But I think I saw the SEC charged the accounting firm for the tingo failures. Yeah. Blake Oliver: [00:53:03] Yeah, that's follow up. We can talk about that. The firm that audited Tingo. One of them anyway. Yeah. Um, here's a message from John Doe. Anonymous. I'm going to assume, considering that advisory revenue is so much bigger than tax Nordic combined, what are the advisory service lines that you think are going to grow the most? Advisory is a massive umbrella, but has so many different services inside. It is insane to just have it as one whole thing. Yeah that's right. I mean advisory, it includes consulting, right? And so obviously AI consulting is going to massively grow because we're going to figure out ways as consultants to leverage AI inside of all these midmarket businesses. Public companies and the managers of these companies are not capable of figuring out how to implement it themselves. So they're going to hire consulting firms to do it. And when you can go into a company, you can say, look, you've got 100, you got 1000 people doing this thing, you've got 10,000 people doing this thing. And we can use AI to automate it. I mean, this is the new offshoring. So think about all the consultants that came into all these companies in the 80s and 90s and helped them offshore jobs. That's going to happen with AI now. And they're going to make a killing doing it. David Leary: [00:54:16] Um, or even on a smaller business model, if you can. Most small businesses are having they all have an open rec, right? They all have a body they cannot seem to hire or fill at their company. And if you can come in and be like, hey, here's how I'm gonna help you not hire that somebody, that's a valuable to charge for. That's the. Blake Oliver: [00:54:33] Positive view. David Leary: [00:54:34] $100,000. You could extract value out of that. Yeah. Blake Oliver: [00:54:39] Um, the other area, of course, is client accounting services, outsourced accounting in in accounting firms like, that's a really fast growing, um, and related line of service. And that's more towards like helping companies grow without having to hire. Why hire and staff your own accounting department as you grow when you can simply outsource that to us, your accounting firm, and we do your taxes as well. It's a win win. So those are two areas I would definitely look at going into. Um, and you know tax is going to grow. It's not like the tax code is going to get any simpler. The one thing that isn't really growing is audit right. Audits have become commoditized. They are low value. How many companies would actually get an audit if they weren't forced to do it? Is the question I like to ask. So it's also getting carved out. You see all these accounting firms that are taking private equity investment. What's the first thing they do? They separate the firm into two entities. You put the auditors in this entity over here, and you put all the really profitable, lucrative stuff in this non CPA firm entity over here. And that's where you take the private equity investment. So it's like the auditors are getting sidelined. If we don't do something about, you know, the quality of audits and the quality of financial information that we are producing. Blake Oliver: [00:56:00] Like it's all going to just become irrelevant over time, just very slowly irrelevant. And go back to the last episode and you'll hear me rant about that. Uh, here's a question about technology. This is from Kevin. Kevin says I am the CFO of a general contractor, a custom home builder in Scottsdale. Our company uses QuickBooks Enterprise Desktop. Uh oh. I have been researching various merchant service offerings in order to receive credit card or ACH payments from our customers, and to find one that offers an autopay feature The merchant service offered by Qube has that option. However, there is no way to set up an auto payment through their system for the full invoice amount option. Well that's stupid. The only, uh, they only have an option to select enter a fixed amount on a recurring frequency. So this is when the invoice amounts are changing and you want the customer to be able to set up autopay. Are you aware of any merchant service system products that have the capability of our customers? Setting up an automatic payment for the full invoice amount that varies from month to month? Well, wait, didn't we have a sponsor this week that could do that? Ignition. But it doesn't integrate with QuickBooks Enterprise Desktop, right? Or does it? David Leary: [00:57:15] I don't that I don't know if it does or not. Um. Blake Oliver: [00:57:19] So this is kind of an interesting question. Um, and it would normally take a lot of googling to figure this out. Right? But like, what if you just took that question and you pasted it into perplexity? And the first recommendation is consider switching to QuickBooks online. This is the problem when you're stuck on desktop software, right? Is there's not that many new apps that want to integrate with enterprise desktop. David Leary: [00:57:50] And the other possibility is, you know, when you migrate up, if you do like QuickBooks online and then a construction app like Builder Trend, and those are a lot of times going to have these use cases like this solved in the industry niche app. Yeah. Because like if you're a payments company you're not going to solve this. You're just not you're it's it's too hard to figure out and solve. But if you are a construction company and every one of your clients, your construction app and every person that uses your app has this need, you're going to build it into your app, right? And that's why, um, Cleo Law Firm software built special billing software to handle all the trusts inside of Cleo law firm software build their trend I'm sure has ways to these change orders and bill for these changes automatically inside of the product. I'm actually looking at the website now, but I really suspect looking at a niche app is probably the way to go. Blake Oliver: [00:58:43] All right, we've got more. We've got more listener mail, but we're also getting towards the full hour. So I'm going to save this for next time. Thank you so much everyone who joined us live today. If you are listening on the podcast feed, you can subscribe to us on YouTube The Accounting Podcast. Join our 25 000 plus subscribers on YouTube and hit that subscribe and notification icon and you'll get notified when we go live and you can join us and chat with us. Uh, and don't forget, you can earn free continuing professional education for having listened today. Download the earmark app or go to earmark Dot app. Earmark app in your web browser. Sign up for free and find our channel. We put up courses for every episode nasba CPE courses and you can do one a week for free. Or you can subscribe to the earmark app for $150 a year and support our mission of making CPE accessible and affordable for all. David Leary: [00:59:44] I think you have, what, 12 weeks now to the end of the year to get your. Yeah. Blake Oliver: [00:59:48] It's time, right? So if you've been listening to our show, you can go and take the quizzes for the episodes that you've listened to and you can get your CPE. I know that some states have a limit on how much on demand CPE you can get, but some don't. So you could potentially do all your CPE. We've got ethics courses. If your state allows general behavioral ethics courses, you can go into our search function and just search for behavioral ethics and get that taken care of. We are going to work on adding those state specific courses in the future. And and there's all sorts of great shows on this app. Oh my. Fraud federal tax updates. We just added a new one. What was one of the new channels that we added this week? Jackie Myers, concierge, CPA, just joined earmark, and, uh, we're doing our earmark expos there. You can get demos of amazing products and you can get CPE for that as well. So sign up for that. Let me know your thoughts and send us your messages. Oh, and don't forget you can join the earmark community. Earmark community. Go there in your web browser and you can chat with me and David and our other listeners on whatever we talked about on the show or anything that is of interest to you. Have a great weekend, David, and enjoy Mexico and I'll see you here. After that, we'll try to. David Leary: [01:01:11] Try to not really work where it's hard. Wear lots. Blake Oliver: [01:01:14] Of sunscreen. David Leary: [01:01:15] Yes, we're two shirts. Blake Oliver: [01:01:17] Two shirts. All right, take a break. Thanks, everyone. See you later, David. Bye.