What to Consider When Starting Your Business
Starting a business involves decisions on various crucial factors. It's imperative to carefully assess each of these aspects to ensure well-informed choices that are cohesive with your business goals and future aspirations. Here’s a comprehensive guide for entrepreneurs embarking on the journey of business entrepreneurship.
Define Your Goal
Clearly define the objective of your business and revisit this regularly. Whether your aim is rapid growth and ultimately selling your business as soon as realistically possible, or run it as a long-term “lifestyle” business, your initial actions will sharply influence your long-term trajectory and potential company liquidity events.
Prioritizing rapid growth and selling your business for a large valuation usually requires taking on multiple rounds of funding, leading to less ownership and control over time. Conversely, prioritizing a long-term lifestyle practice should focus on sustainable growth and profitability. This approach grants greater autonomy but may result in a lower company valuation when the time comes for an exit.
Various paths exist for steering your business towards success. Your goals should guide your operational decisions which are discussed below.
Business Structure
A limited liability company (LLC) offers a business structure that shields its owners from personal responsibility for the company’s debts or obligations. If a company becomes insolvent, creditors can not pursue the owners’ personal assets. Establishing an LLC is highly recommended for additional asset and liability protection for you and your potential co-founders.
The process for forming an LLC differs by state (more on that later), but there are a few common steps regardless. First, you will need to choose a name for your business and search to see if it’s available via online databases. Next, you will want (and usually need to) to create Articles of Organization. This document highlights the key information and responsibilities for each LLC member. Finally, you will pay the applicable fees and file for an EIN (Employer Identification Number), even if you don’t have employees. This is like your business’ social security number, and how the government will identify it. An additional recent requirement is filing a Beneficial Ownership Information report soon after you form your entity.
Corporations in Other States
Once you’ve decided to form an LLC, consider which state to incorporate in, as each state has advantages and disadvantages. Different states have different startup and ongoing requirements.
Corporations often elect to establish their LLC in Delaware, due to its laws that protect owners and investors. The common reasons they consider a Delaware corporation are no state corporate income tax, favorable and predictable court rulings that protect investors, and the privacy of LLC members.
With that said, there still are downsides. There are additional processes to which you must adhere to incorporate in Delaware and/or be able to transact business in your home state (California for example). In addition, if there are legal disputes, you might need to travel there regularly if you don’t live there already.
It’s important to understand the tradeoffs for incorporating in different states and how it may affect your business.
Taxation Election
Once you've established your LLC, you will need to choose how you want it to be taxed (Sole proprietor, partnership, S-Corp, C-Corp, etc.). Each election has its own unique characteristics, so you should carefully consider each option for your situation.
Tax Reporting
Partnerships, S- and C-Corporations require separate tax returns for the corporation. Sole proprietorships can be added on your personal tax return.
Sole proprietorships, partnerships, and S-Corporations allow your relevant business tax information to be reported on your personal tax returns either directly or through a K-1 from a passthrough entity. Taxation on your distributions will depend on how you're structured. For example, as an S-Corp, a distribution in excess of your basis is taxed on your personal return.
Tax Characteristics
Sole proprietorships and partnerships with ordinary income are subject to self-employment taxes. Once your business profits grow, filing an S- or C-Corp election could be beneficial.
An S-Corporation offers many tax benefits. As an S-corp, you can structure your compensation as a combination of salary plus distributions. Your salary will have the relevant payroll tax withholdings, but your distributions will be tax-advantaged, avoiding self-employment tax. However, you are required to maintain a ‘reasonable compensation’, so be sure you do not set your salary too low. In addition, your payroll wages are tax-deductible.
However, S-Corporations have several limitations. There can only be 100 shareholders and they can not be non-US citizens, partnerships, or corporations. Furthermore, an S-Corp can not issue different classes of stock, and the types of possible equity that can be issued are limited. Lastly, company stock can't qualify for QSBS that was issued when the business was an S-corp.
C-Corporations are subject to double taxation (at both the corporate and personal levels). However, the top corporate tax bracket is far lower than the top personal tax bracket. The higher your personal tax bracket is, the more beneficial it could be to structure your organization as a C-Corp.
Business Insurance
Although the LLC framework offers a degree of safeguarding your personal assets, it’s prudent to protect your company against various types of risk. Depending on your business objectives, operations, and entity structure, you may consider obtaining general liability and/or professional liability insurance coverage. General liability provides broad protection against lawsuits, injury or property damage. Professional liability coverage (also known as errors and omissions or E&O) addresses lawsuits stemming from financial losses due to your professional services.
Employees and Benefits
Depending on your goals and if you intend to hire employees, there are several operational services to consider. If you are making an S-Corp election or will have employees, you will want to set up payroll services. In addition, you will want to offer a benefits package to attract and retain the type of talented team members you are looking for. Whatever direction you go, it’s crucial to utilize a service that can be automated and integrated as much as possible.
Work with a Professional
Embarking on a business venture involves navigating complexities and managing numerous moving parts. Engaging with a professional early on is highly advisable to develop, execute, and sustain an effective business strategy. Ensure you collaborate with professionals that are well-versed in your specific circumstances and knowledgeable about the dynamic frameworks relevant to your industry. Consulting a team of financial planners, tax professional, and attorneys is essential to ensure comprehensive oversight at every stage.