PATH TO Starting a Business
Why do I need to define my business in detail?
It may seem silly to ask yourself, "What business am I really in," but some owner-managers have gone broke because they never answered that question. For example, one watch storeowner realized that he spent most of his time repairing watches while most of his money was spent selling them. He finally decided he was in the repair business and discontinued the sales operations. His profits improved dramatically.
What should I name my corporation?
Choose the name of your corporation carefully. It is very important that you portray the image you want for your new corporation. Legally, the name you select must not be deceptively similar to any existing corporation in your state. For example, if a corporation named West Corp. exists in your state, you probably would not be allowed to name your business West Corporation. It is possible that the name you select will not be distinguishable; therefore, we ask for a second choice on the incorporation order form.
Additionally, the name you choose must show your business is incorporated. Most states require that the corporate name be followed by Corporation, Incorporated, or an abbreviation. Also, many states allow Limited or Company or an abbreviation of these words to be used as well.
What is a business plan and why do I need one?
A business plan more precisely defines your business, intended markets and markets avoided, competitive analysis with product/service differentiations, profit analysis including pricing and costing, operational procedures and requirements, and identifies your goals and time line forecasts. Its basic components will include a current and pro forma (known and best guess) balance sheet, income statement and cash flow analysis. It helps you allocate resources properly, better reveal or handle unforeseen complications, and make the right decisions. Because it provides specific and organized information about your company and how you will repay borrowed money, a detailed, well-stated business plan is a crucial part of any loan package. Additionally, it can tell your sales personnel, key suppliers and others about your operations and goals.
How do I develop a Business Plan?
A summary overview of the elements of a good Business Plan are:
1. Cover sheet
2. Table of Contents
3. Executive Summary - The executive summary should be the last element prepared when developing a business plan. Unfortunately, most entrepreneurs try to begin with this section. It should be a complete overview and refer to key attributes of the venture that will entice target readers, usually investors, to read on and learn more about your company's opportunity. There is a wide variety of opinions on what an executive summary should include and how long it should be. A good practice is to limit the executive summary to a maximum of three pages.
4. The Market - A product or service is nothing without a market. Regardless of how novel a product or service is, there must be a way to turn the need it satisfies into sales revenues. The Business (section 5) describes the need your products or services satisfy and how your company is uniquely suited to deliver its offerings. The Market section supports the ability and willingness of an outside party, a customer, to pay for the product. It also addresses how the company will make targets aware and interested in the product and how this interest will be converted into action. This section should address three areas: Industry; Market Size and Growth Rate; and your Target Market.
1) The Industry - This component should give a background or an overview of the industry and segments that your product or service competes in. A brief history of the market should be followed by trends that support management's, and outside analyst's, assertions that the market will grow in the near future.
2) Market Size and Growth Rate - The market size and growth rate are natural compliments of an industry description. Often a company's offerings compete in more than one market. For instance, a company that provides a system integration application will probably deliver consulting services. In such cases, it is essential that the size and growth rates for the services market be separately noted from the size and growth projections for the product market.
3) Target Market - After the size and rate of growth in the market have been addressed, the next step in a business plan is often to quantify and describe the segment, or segments, of the market that your product or service is targeted towards. This includes noting how many prospects there are, what they want and need, and any trends projected to drive the purchasing patterns in the future.
5. The Business
a. Description of the Business and Statement of Purpose
In this section, provide a detailed description of your business. An excellent question to ask yourself is: "What business am I in?" In answering this question include your products, market and services as well as a thorough description of what makes your business unique. Remember, however, that as you develop your business plan, you may have to modify or revise your initial questions. The business description section is divided into three primary sections. Section (a) actually describes your business, Section (b) the product or service you will be offering and Section (c) the location of your business, and why this location is desirable (if you have a franchise, some franchisers assist in site selection). When describing your business, generally
i. Legalities - business form: proprietorship, partnership, corporation. The licenses or permits you will need.
ii. Business type: merchandizing, manufacturing or service.
iii. A summary of what your product or service is.
iv. Is it a new independent business, a takeover, an expansion, a franchise?
v. Why your business will be profitable. What are the growth opportunities? Will franchising impact on growth opportunities?
vi. When your business will be open (days, hours)?
vii. What you have learned about your kind of business from outside sources (trade suppliers, bankers, other franchise owners, franchiser, publications).
A cover sheet goes before the description. It includes the name, address and telephone number of the business and the names of all principals. In the description of your business, describe the unique aspects and how or why they will appeal to consumers. Emphasize any special features that you feel will appeal to customers and explain how and why these features are appealing. The description of your business should clearly identify goals and objectives and it should clarify why you are, or why you want to be, in business.
Try to describe the benefits of your goods and services from your customers' perspective. Successful business owners know or at least have an idea of what their customers want or expect from them. This type of anticipation can be helpful in building customer satisfaction and loyalty. And, it certainly is a good strategy for beating the competition or retaining your competitiveness. Describe: C What you are selling. C How your product or service will benefit the customer. C Which products/services are in demand; if there will be a steady flow of cash. C What is different about the product or service your business is offering.
d. The Location
The location of your business can play a decisive role in its success or failure. Your location should be built around your customers, it should be accessible and it should provide a sense of security. Consider these questions when addressing this section of your business plan:
(1) What are your location needs?
(2) What kind of space will you need?
(3) Why is the area desirable?
(a) Why is the building desirable?
(4) Is it easily accessible?
(a) Is public transportation available?
(b) Is street lighting adequate?
(5) Are market shifts or demographic shifts occurring?
It may be a good idea to make a checklist of questions you identify when developing your business plan. Categorize your questions and, as you answer each question, remove it from your list.
Managing a business requires more than just the desire to be your own boss. It demands dedication, persistence, the ability to make decisions and the ability to manage both employees and finances. Your management plan, along with your marketing and financial management plans, sets the foundation for and facilitates the success of your business. Like plants and equipment, people are resources-they are the most valuable asset a business has. You will soon discover that employees and staff will play an important role in the total operation of your business. Consequently, it's imperative that you know what skills you possess and those you lack since you will have to hire personnel to supply the skills that you lack. Additionally, it is imperative that you know how to manage and treat your employees. Make them a part of the team. Keep them informed of, and get their feedback regarding, changes. Employees oftentimes have excellent ideas that can lead to new market areas, innovations to existing products or services or new product lines or services which can improve your overall competitiveness. Your management plan should answer questions such as:
1) How does your background/business experience help you in this business?
2) What are your weaknesses and how can you compensate for them?
3) Who will be on the management team?
4) What are their strengths/weaknesses?
5) What are their duties?
6) Are these duties clearly defined?
7) If a franchise, what type of assistance can you expect from the franchiser?
8) Will this assistance be ongoing?
9) What are your current personnel needs?
10) What are your plans for hiring and training personnel?
11) What salaries, benefits, vacations, holidays will you offer? If a franchise, are these issues covered in the management package the franchiser will provide?
12) What benefits, if any, can you afford at this point?
f. Marketing and Sales Plan
Marketing plays a vital role in successful business ventures. How well you market you business, along with a few other considerations, will ultimately determine your degree of success or failure.
For products or services that rely primarily on personal (face to face) selling, a summary of how these efforts will be directed should be included in a business plan. In cases where outside channels of distribution are expected to play a significant role, a separate component of the market section should be included to explain what the channels are and how they will interact with the company.
The key element of a successful marketing plan is to know your customers-their likes, dislikes, expectations. By identifying these factors, you can develop a marketing strategy that will allow you to arouse and fulfill their needs. Identify your customers by their age, sex, income/educational level and residence. At first, target only those customers who are more likely to purchase your product or service. As your customer base expands, you may need to consider modifying the marketing plan to include other customers. Develop a marketing plan for your business by answering these questions. (Potential franchise owners will have to use the marketing strategy the franchiser has developed.) Your marketing plan should be included in your business plan and contain answers to the questions outlined below.
(1) Who are your customers? Define your target market(s).
(2) Are your markets growing? steady? declining?
(3) Is your market share growing? steady? declining?
(4) If a franchise, how is your market segmented?
(5) Are your markets large enough to expand?
(6) How will you attract, hold, increase your market share? If a franchise, will the franchiser provide assistance in this area? Based on the franchiser's strategy? how will you promote your sales?
(7) What pricing strategy have you devised?
Advertising and Public Relations
How you advertise and promote your goods and services may make or break your business. Having a good product or service and not advertising and promoting it is like not having a business at all. Many business owners operate under the mistaken concept that the business will promote itself, and channel money that should be used for advertising and promotions to other areas of the business. Advertising and promotions, however, are the life line of a business and should be treated as such. Devise a plan that uses advertising and networking as a means to promote your business. Develop short, descriptive copy (text material) that clearly identifies your goods or services, its location and price. Use catchy phrases to arouse the interest of your readers, listeners or viewers. In the case of a franchise, the franchiser will provide advertising and promotional materials as part of the franchise package, you may need approval to use any materials that you and your staff develop. Whether or not this is the case, as a courtesy, allow the franchiser the opportunity to review, comment on and, if required, approve these materials before using them. Make sure the advertisements you create are consistent with the image the franchiser is trying to project.
Remember the more care and attention you devote to your marketing program, the more successful your business will be.
Competition is a way of life. We compete for jobs, promotions, scholarships to institutes of higher learning, in sports-and in almost every aspect of your lives. Nations compete for the consumer in the global marketplace as do individual business owners. Advances in technology can send the profit margins of a successful business into a tailspin causing them to plummet overnight or within a few hours. When considering these and other factors, we can conclude that business is a highly competitive, volatile arena. Because of this volatility and competitiveness, it is important to know your competitors. Questions like these can help you:
(1) Who are your five nearest direct competitors?
(2) Who are your indirect competitors?
(3) How are their businesses: steady? increasing? decreasing?
(4) What have you learned from their operations? from their advertising?
(5) What are their strengths and weaknesses?
(6) How does their product or service differ from yours?
Start a file on each of your competitors. Keep manila envelopes of their advertising and promotional materials and their pricing strategy techniques. Review these files periodically, determining when and how often they advertise, sponsor promotions and offer sales. Study the copy used in the advertising and promotional materials, and their sales strategy. For example, is their copy short? descriptive? catchy? or how much do they reduce prices for sales? Using this technique can help you to understand your competitors better and how they operate their businesses.
h. Pricing Policy
Your pricing strategy is another marketing technique you can use to improve your overall competitiveness. Get a feel for the pricing strategy your competitors are using. That way you can determine if your prices are in line with competitors in your market area and if they are in line with industry averages. Some of the pricing strategies are:
(1) retail cost and pricing
(2) competitive position
(3) pricing below competition
(4) pricing above competition
(5) price lining
(6) multiple pricing
(7) service costs and pricing (for service businesses only)
(8) service components
(9) material costs
(10) labor costs
(11) overhead costs
The key to success is to have a well-planned strategy, to establish your policies and to constantly monitor prices and operating costs to ensure profits. Even in a franchise where the franchiser provides operational procedures and materials, it is a good policy to keep abreast of the changes in the marketplace because these changes can affect your competitiveness and profit margins. Appendix 1 contains a sample Price/Quality Matrix, review it for ideas on pricing strategies for your competitors. Determine which of the strategies they use, if it is effective and why it is effective. You may also need to address the risks associated with your pricing policy as well as its benefits.
i. Operating Procedures
Describing the business' operating procedures is a good way to discover any key problems or omissions in the daily operations. The operating procedures should be a fairly good description of how the business will operate on a day-to-day basis. Each key process should be defined.
If a franchise, the operating procedures, manuals and materials devised by the franchiser should be included in this section of the business plan. Study these documents carefully when writing your business plan, and be sure to incorporate this material. The franchiser should assist you with managing your franchise. Take advantage of their expertise and develop a management plan that will ensure the success for your franchise and satisfy the needs and expectations of employees, as well as the franchiser.
k. Financial Management
i. Loan Applications
ii. Capital Equipment and Supply List
iii. Balance Sheet
iv. Break-even Analysis
v. Pro-Forma Income Projections (Profit & Loss Statements) Three-Year Summary Detail by Month, First Year Detail by Quarters, Second and Third Years Assumptions upon which projections were based
vi. Pro-Forma Cash Flow
vii. Key Risks and Time Schedule
viii. Supporting Documents - Tax returns of principals for last three years Personal financial statement (all banks have these forms) In the case of a franchised business, a copy of franchise contract and all supporting documents provided by the franchiser. Copy of proposed lease or purchase agreement for building space Copy of licenses and other legal documents Copy of resumes of all principals Copies of letters of intent from suppliers, etc.
Sound financial management is one of the best ways for your business to remain profitable and solvent. How well you manage the finances of your business is the cornerstone of every successful business venture. Each year thousands of potentially successful businesses fail because of poor financial management. As a business owner, you will need to identify and implement policies that will lead to and ensure that you will meet your financial obligations. To effectively manage your finances, plan a sound, realistic budget by determining the actual amount of money needed to open your business (start-up costs) and the amount needed to keep it open (operating costs). The first step to building a sound financial plan is to devise a start-up budget. Your start-up budget will usually include such one-time-only costs as major equipment, utility deposits, down payments, etc. The start-up budget should allow for these expenses.
1) Personnel (costs prior to opening)
2) Salaries/Wages and Employer Payroll Tax Expenses
3) Legal/Professional Fees
4) Occupancy - Rent, Upfitting, Displays, Security, etc.
5) Licenses/Permits, Incorporation
6) Equipment & Furniture
7) Insurances - General Liability, Facility, Workman's Comp, Errors & Omissions, etc.
8) Loan payments
11) Accounting and Legal
12) Computer Systems, Software, and Network
13) Accounts Receivables Income Collection
14) Utilities - Deposits, Hook-up Fees, Initial usage
An operating budget is prepared when you are actually ready to open for business. The operating budget will reflect your priorities in terms of how your spend your money, the expenses you will incur and how you will meet those expenses (income). Your operating budget also should include money to cover the first three to six months of operation. It should allow for the following additional expenses.
2) Miscellaneous expenses
The financial section of your business plan should include any loan applications you've filed, a capital equipment and supply list, balance sheet, break-even analysis, pro-forma income projections (profit and loss statement) and pro-forma cash flow. The income statement and cash flow projections should include a three-year summary, detail by month for the first year, and detail by quarter for the second and third years. The accounting system and the inventory control system that you will be using is generally addressed in this section of the business plan also. If a franchise, the franchiser may stipulate in the franchise contract the type of accounting and inventory systems you may use. If this is the case, he or she should have a system already intact and you will be required to adopt this system. Whether you develop the accounting and inventory systems yourself, have an outside financial advisor develop the systems or the franchiser provides these systems, you will need to acquire a thorough understanding of each segment and how it operates. Your financial advisor can assist you in developing this section of your business plan. The following questions should help you determine the amount of start-up capital you will need to purchase and open a franchise:
1) How much money do you have?
2) How much money will you need to purchase the franchise?
3) How much money will you need for start-up?
4) How much money will you need to stay in business?
Other questions that you will need to consider are:
1) What type of accounting system will your use?
2) Is it a single entry or dual entry system?
3) What will your sales goals and profit goals for the coming year be?
4) If a franchise, will the franchiser set your sales and profit goals?
5) Or, will he or she expect you to reach and retain a certain sales level and profit margin?
6) What financial projections will you need to include in your business plan?
7) What kind of inventory control system will you use?
Your plan should include an explanation of all projections. Unless you are thoroughly familiar with financial statements, get help in preparing your cash flow and income statements and your balance sheet.
Choosing a Business Structure
What legal aspects do I need to consider?
Licenses required, zoning laws and other regulations vary from business to business and from state to state. Your local city and county will have business license offices that can help you determine if any is required. The Small Business Administration (SBA) office and/or chamber of commerce will provide you with general information. To be thorough, you may need to consult a business attorney for advice specific to your enterprise and area. Also, you must decide about your form of organization (corporation, partnership or sole proprietorship) and tax status (e.g., should you select a Subchapter S status).
What are the most popular forms of business?
· General Partnership
· Limited Partnership
· Limited Liability Company
· S Corporation
Proprietorship is the simplest form of business ownership since no formal legal action is necessary to establish it. Unfortunately, as a proprietorship the owner is personally liable for any debts and actions of the business and must pay taxes on all income as it is earned.
A General Partnership is a business with two or more persons (or entities) owners, usually all are active participants in the business. Legal documents need not be created to form a partnership. In fact, the law may construe a partnership when two or more are working together even if the entities do not intend there to be a partnership. However, a formal partnership agreement is usually used to document the division of responsibilities and benefits. Each partnership is fully liable for all debts and actions of the partnership by any partner. A General Partnership is taxed as a pass-through entity, meaning that each partner, and not the partnership, will pay tax on their share of the firm's income (or loss).
A Limited Partnership (LLP) is a hybrid between a partnership and a corporation. It has one or more general partners and one or more limited partners. The general partner(s) is fully liable for the partnerships debts and actions. The limited partner(s) is liable to the partnership or creditors for the amount of money the limited partner agrees to invest in their partnership interest. A limited partner does not have to be an active worker in the partnership. A Limited Partnership is taxed as a pass-through entity similar to the General Partnership.
The Limited Liability Company (LLC) is also a hybrid organization possessing characteristics of both corporations and limited partnerships. The owners are called "members" and are only liable to the company or creditors for the amount of money each agrees to invest in his/her membership interest, similar to limited partners in a Limited Partnership. However, unlike a Limited Partnership, no member is liable to the extend of a general partner. The members are bound by and the LLC is governed under an "operating agreement," similar to a partnership agreement. There are two basic types of LLC's: member-managed and manager-managed. In a member-managed LLC all members have management responsibility. In a manager-managed LLC the management responsibility is delegated to one or more persons, who may or may not be a member. Members and managers of LLCs are not liable for the obligations of the LLC unless they voluntarily agree to assume such liabilities. A LLC can be taxed as either a partnership or as a corporation, as determined by an election made by the founders. Usually, a partnership tax treatment is elected so the firm has both the limited liability of a corporation and pass-through taxation of a partnership. Recently, the Internal Revenue Service provided guidance on how to classify LLCs as partnerships. Care should be taken in structuring the operating agreement so that the LLC will lack certain "corporate characteristics," thereby allowing it to be treated as a partnership. An LLC will be the preferred entity only if it can be classified as a partnership. A single member LLC can be taxed as a corporation or as a proprietorship. The North Carolina Limited Liability Company Act was adopted in 1993. LLCs have become increasingly popular alternatives to partnerships and S corporations. To form a LLC an Articles of Organization is filed with the Secretary of State and usually an operating agreement is established.
A Corporation (often referred to as a "C" corp.) is owned by any number of shareholders. Their liability is limited to the amount that each invested for their stock. Shareholders elect directors, who, in turn, hire or elect officers. Shareholders pay taxes on the dividends that are paid by the corporation out of its after-tax profits. Thus, income taxes are paid twice - first by the corporation (possibly at a lower rate than the personal income tax rate) and then by the stockholders for their dividends. Losses of the corporation are not passed on to the shareholders for tax purposes. A corporation may retain earnings to fund future growth and not issue dividends, creating the possibility that lower income taxes may be incurred overall. To form a Corporation an Articles of Incorporation must be filed with the Secretary of State.
An S Corporation is a "small" Corporation that the IRS has agreed to treat all of the owners as partners for tax purposes. For purposes of state corporate law it has the characteristics of a regular or "C" corporation. However, to satisfy special treatment by the IRS, it must have 75, or fewer, stockholders, generally only one class of stock, and must elect to be treated for tax purposes under the terms of Subchapter S of the Internal Revenue Code as a pass-through similar to a partnership. Stockholders may be certain trusts, estates and charitable organizations but cannot be a nonresident alien.
Do you need an attorney to incorporate?
No, an attorney is not a legal requirement to incorporate. You can prepare and file the articles of incorporation yourself; however, you need to be thoroughly versed in the laws of your state.
You can incorporate and save money on attorney fees. However, if you are unsure if incorporation will benefit your business, consult an attorney or accountant.
What are some of the key considerations in choosing between the various business structures?
(Click Here) for an Excel Spreadsheet that compares a Sole Proprietorship, LLC, Corporation, and a Subchapter S Corporations.
Comparison of LLCs to Partnerships
While an LLC is typically taxed as a partnership, there are some important differences between them. General partnerships offer no protection from liabilities. In limited partnerships, the general partner or partners are subject to unlimited liability. Moreover, if a limited partner substantially participates in the management of the limited partnership, he/she may risk being treated as a general partner and be exposed to unlimited liability. To achieve limited liability, limited partnerships are often structured by having the general partner be a corporation. However, such a structure may be too burdensome for a small business.
Unlike limited partnerships, participation in management by members of an LLC does not expose them to personal liability. While members of an LLC are not subject to the liabilities of the LLC, a creditor of an LLC (or partnership) may require as a condition for making a loan that the members (or partners) guarantee the debt. The LLC is more attractive than a limited partnership where there is a risk of non-creditor liability, such as tort liability, as no members would be at risk, whereas the general partner of a limited partnership would be exposed.
Comparison to S Corporations
An "S corporation" is a corporation that meets certain requirements and whose shareholders file an election with the Internal Revenue Service under which the net income of the corporation will be taxed to the shareholders themselves. Thus S corporations and partnerships (and LLCs) are similar in that income is allocated to and taxed to the owners. As with any corporation, S corporations offer the advantage of limited liability for its shareholders, except to the extent a creditor may require the shareholders to guarantee a loan to the S corporation.
An S corporation may have no more than 75 shareholders; there is no such limit on members of an LLC. Limitations are placed on the types of shareholders an S corporation may have. For example, an S corporation may not have a corporate shareholder; there is no such limitation in the case of an LLC. An S corporation may have only one class of stock, whereas an LLC can be structured so that members have varying rights such as to distributions and allocations. An S corporation may not own more than 80% of the stock of another corporation; there is no such limitation on LLCs.
If an S corporation or an LLC incurs losses, such losses will flow through to the shareholders or members. However, the ability to deduct such losses by the shareholders and members may differ. A shareholder of an S corporation may deduct losses up to his tax basis in his shares plus the sum of any loans made by him to the S corporation. Loans from third parties, however, are not included. In an LLC, the member may deduct losses up to his tax basis, including his loans to the LLC and his allocable share of all third- party debts. Thus, where it is anticipated that there will be substantial third-party debt, the LLC may offer the advantage of greater deductions by owners. There is also greater flexibility in allocating losses among the members of an LLC than among the shareholders of an S corporation.
S corporations are limited in the types of income they may receive. If an S corporation earns a substantial amount of passive income, such as dividends and interest, it may risk the loss of its S corporation status and the imposition of a corporate level tax. Generally, an LLC may receive passive income without adverse tax consequences, although special limitations are placed on LLCs (and partnerships) on investing in marketable securities.
Choosing between a S Corporation and a LLC
It's smart to protect personal assets from business debts and liabilities. Both owners of S Corporations and LLC's enjoy limited personal liability. By contrast, sole proprietors and partners have unlimited personal risk.
Traditionally, business owners who chose to form an entity to protect personal assets but allow income/losses to be reported on a personal tax return had to create an S Corporation. Today, that can also be accomplished with an LLC. All 50 states and the District of Columbia recognize LLC's, and their popularity has soared. Nolo's Legal Guide for Starting and Running a Small Business states, "For the majority of small businesses, the relative simplicity and flexibility of the LLC make it the better choice. This is especially true if your business will hold property, such as real estate, that's likely to increase in value."
Both S Corporations and LLC's allow owners to avoid "double taxation" and to pay income taxes on a flow-through basis like sole proprietors and partners. However, LLC's are quickly becoming a preferred entity among small business. Here are some key examples of the benefits of an LLC verses an S Corporation:
· An LLC is simpler and faster to form. It may be formed in one step, while an S Corporation election with the IRS, by filing a simple form #2553, can only be made after a General Corporation is formed first.
· An LLC is not required to hold annual meetings or to keep formal minutes, while an S Corporation is required to do so.
· LLC members can split profits/losses in any way they choose. In an S corporation, shareholders must receive dividends according to the number of shares that they own, regardless of the amount of effort put into the business.
· An LLC can be owned by any combination of individuals or business entities. Only United States citizens and resident aliens may own an S Corporation. Other entities generally may not own an S Corporation.
While many business owners are enjoying the simplicity and flexibility of the LLC, it may not be the best choice in every case:
· Most states allow single-member LLC's, however Massachusetts requires two members. Married owners often accommodate this by naming a spouse.
· Enticing or compensating employees with stock options or stock bonuses requires forming a corporation since LLC's do not issue stock.
· S Corporation shareholders pay Medicare and Social Security tax only on money received as wages or salary, but not on profits received as dividends or that stay within the company. Under certain conditions, LLC members may need to pay Social Security and Medicare taxes on the entire amount of LLC profits. In particular, LLC's that provide professional services such as health, law or engineering should consult a tax advisor on this issue.
How do I select a business structure based upon succession planning?
One of the most important decisions a business owner must make in estate planning is selecting the appropriate business entity. That decision will affect the income and transfer tax consequences to the owner and the family and the ease with which the business can be shifted from one generation to the next.
Gift Giving and the Business Entity
An immediate consequence of the choice of business entity is the ability of the owner to make lifetime gifts to the next generation. Making lifetime gifts of interests in the business is an essential part of the estate plan for three reasons:
1) the interest given away is removed from the owner's estate, thereby reducing the overall estate tax;
2) all appreciation in the value of the interest after the gift, is removed from the owner's estate; and
3) all income earned by the interest after the gift, is removed from the owner's estate.
C Corporation - Estate Issues
A C corporation, unlike a sole proprietorship, is a separate legal entity. As such, a C corporation has the right to sue or be sued, enter into contracts, and hold and dispose of property in its own name. More importantly, a C corporation is a separate taxable entity. Therefore, the major disadvantage of a C-corporation is double taxation. In other words, a C corporation pays income tax at corporate level on its earnings and then the shareholder pays income tax at the individual level on the after-tax earnings distributed as dividends.
Making gifts of stock of a C corporation is relatively simple. Usually, the business owner wants to maintain control over the business while making gifts to the younger generation. One way to accomplish this is to create two classes of stock- preferred stock and common stock. The only difference between the two classes is that the preferred stock has voting rights while the common stock does not. The owner can then make gifts of the nonvoting common stock to the younger generation and, by retaining the voting preferred stock, maintain control over the corporation.
Because the owner is giving away a minority interest, a discount from the value of the interest is available for gift tax purposes. The discount is based upon both the lack of control and the lack of marketability of the stock that the donee receives. A discount of 30% to 40% for both the minority interest and lack of marketability is generally considered reasonable.
S Corporation - Estate Issues
An S corporation is a corporation, which has made an election under the Internal Revenue Code to be treated as a pass-through entity for tax purposes. All income and losses are passed through to the shareholders, and there is no corporate level tax. The principal disadvantage of an S corporation is the strict requirements for making and maintaining the election.
One of those requirements is that an S corporation may have only one class of stock. However, differences in voting rights are disregarded so long as all of the outstanding shares have identical rights to distributions and liquidation proceeds. Therefore, an S corporation may be re-capitalized to create preferred stock and common stock if the only difference is the voting rights of the shares.
Another requirement is that an S-corporation may have no more than 75 shareholders. More importantly for estate planning purposes, with certain limited exceptions, a trust is not an eligible S corporation shareholder. That restriction challenges S corporation owners who wish to make lifetime gifts of stock to the younger generation.
Generally, the same valuation discounts that are available for gifts of stock of a C corporation are also available for gifts of stock of an S corporation.
Family Limited Partnership (FLP) - Estate Issues
Use of family limited partnerships has become an increasingly popular means of transferring the family business to the younger generation. In a limited partnership, the general partners have unlimited liability for debts incurred in the business and complete control of the management of the business. The limited partners are not liable for the debts and liabilities of the limited partnership in excess of their capital contributions and generally have no control or management rights. Consequently, the business owner can transfer earnings and appreciation to the next generation by making lifetime gifts of limited partnership interests while maintaining complete control by retaining a small general partnership interest. Again, valuation discounts of 30% to 40% for gift tax purposes may be appropriate. There are certain assets which should not be placed into a family limited partnership, including:
1) the family home;
2) individual retirement accounts and other qualified plan interests;
3) stock in an S corporation;
4) stock in a professional corporation;
5) risky assets, such as cars, planes, and boats that are likely to attract liability in the form of large lawsuits; and
6) personal use assets, such as art, jewelry, antiques, or other collectibles.
Incorporating your Business
What is the organizational structure of a corporation?
The organizational structure of a corporation relies on three basic groups: shareholders, directors and officers.
A corporation is owned by shareholders; however, they do not directly manage the corporation. Instead, they influence corporate decisions through indirect methods such as electing and removing directors, approving or disapproving amendments to the articles of incorporation and voting on major corporate issues.
The board of directors are responsible for managing the affairs of the corporation. Usually, directors make only the major business decisions and supervise and appoint the officers who make the day-to-day business decisions of the corporation.
Officers are responsible for the everyday management of the corporation. Typically, officers are appointed directly by the board of directors.
It is important to note that a shareholder may serve on the board of directors and as an officer. In fact, in most states one person is enough to form a corporation.
How many directors do I need to form a corporation?
Illinois requires three directors
Where should I incorporate my business?
One of the first decisions a business must make after deciding to incorporate involves selecting the proper state of incorporation. A corporation is not required to incorporate in the state of its operations; however, often the best decision is to incorporate in your home state.
Two issues must be weighed to determine the proper state: (1) a dollars and cents analysis comparing the costs of incorporating in the state of operation versus qualifying to do business as a foreign corporation in the state under consideration and (2) determining the advantages and disadvantages of each state's corporate laws and tax structure. The decision usually falls between the state in which the business is located or Delaware.
If the corporation is a closely held corporation and does business primarily within a single state, local incorporation is typically preferable. The cost of local incorporation will usually be less than incorporating in another state and qualifying to do business as a foreign corporation in the state. A foreign corporation that qualifies to do business in another state is subject to taxes and annual report fees from both the state of incorporation and the qualifying state. Another disadvantage of incorporating outside of your home state is the possibility of having to defend a law suit in another state. If you have any questions concerning where to incorporate consult an attorney or an accountant.
Steps to incorporate your business
1. File your company's Articles of Incorporation or Articles of Organization.
Being revised for ILLINOIS
2. Obtain your corporations tax identification numbers from the IRS and the Illinois Department of Revenue.
For IRS, go to http://www.irs.gov/formspubs/lists/0,,id=97796,00.html and get form # SS-4. Complete and fax to number shown in instructions. An Employer Identification Number (EIN) will be sent to you within 7 days.
3. Once you have an EIN from the IRS, go to http://www.irs.gov/formspubs/lists/0,,id=97796,00.html and get form # 2553 to elect to be taxed as a Small Business Corporation. Complete and send to the IRS. (This will allow you to pay taxes only once like an S corporation, instead of twice on income like a C corporation.) By March 15 each year, you must file form 1120S (or 1065 if LLC) with the IRS and form CD-401S with the state.
4. Check with the Illinois Secretary of State for information regarding a Business License.
5. Purchase a company seal. They are about $25 - $30 from most any stationary or office supply store.
6. If Incorporated, purchase a blank stock certificate to create your "no par" value certificate(s) of shares issued. ("No par" is recommended to minimize personal exposure to the corporations liabilities. e.g. A stock with $5 par value means that the owner is personally liable for the debts/liabilities of the company up to $5 for every share owned.
If LLC, develop a Organization agreement to establish whether the LLC will be member-managed or manager-managed and other important items. There is good software available (e.g. NOLO's LLC Maker) to assist you in doing that. It generally costs less than $50.
7. Contact county and local agencies to see what regulations and restrictions may apply to your business. Your attorney will usually be able to guide you through this process. You are not, however, required by law to hire one.
8. Set up a bookkeeping system. Many firms have found Intuit's QuickBooks to be very easy to use and handles most of their requirements. For more sophisticated small firms, Peachtree is another popular accounting system. Most corporations hire an accountant to oversee this part of the incorporation process and check the company's books on a regular basis. An accountant can also help prepare your company's tax filings.
Cash Flow Management
Understanding Cash Flow
Failure to properly manage cash flow is one of the leading causes of small business failures. Understanding the basics will help you with your cash flow management. Your business's monetary supply can exist either as cash on hand or in a business checking account available to meet expenses. A sufficient cash flow covers your business by meeting obligations (i.e., paying payroll and bills), serving as a cushion in case of emergencies, and providing investment capital.
The operating cycle
The operating cycle is the system through which cash flows, from the purchase of inventory through the collection of accounts receivable. It measures the flow of assets into cash. For example, your operating cycle may begin with both cash and inventory on hand. Typically, additional inventory is purchased on account to guarantee that you will not deplete your stock as sales are made. Your sales will consist of cash sales and accounts receivable credit sales, usually paid 30 days after the original purchase date. This applies to both the inventory you purchase and the products you sell. When you make payment for inventory, both cash and accounts payable are reduced. Thirty days after the sale of your inventory, receivables are usually collected, increasing your cash. Now your cash has completed its flow through the operating cycle, and the process is ready to begin again.
Cash and other balance-sheet items that convert into cash within 12 months are referred to as current assets. Typical current assets include cash, marketable securities, receivables and prepaid expenses.
Cash flow analysis
Cash-flow analysis should show whether your daily operations generate enough cash to meet your obligations, and how major outflows of cash to pay your obligations relate to major inflows of cash from sales. As a result, you can tell if inflows and outflows from your operation combine to result in a positive cash flow or in a net drain. Any significant changes over time will also appear. Understanding this will lead to better control of your cash flow and will allow adequate time to plan and prepare for the growth of your business.
It is best to have enough cash on hand each month to pay the cash obligations of the following month. A monthly cash-flow projection helps to identify and eliminate deficiencies or surpluses in cash and to compare actual figures to past months. When cash-flow deficiencies are found, financial plans must be altered to provide more cash. When excess cash is revealed, it might indicate excessive borrowing or idle money that could be invested. The objective is to develop a plan that will provide a well-balanced cash flow.
Planning a positive cash flow
Here are the basic ways that a business can increase cash reserves: Collecting receivables: Actively manage accounts receivable and quickly collect overdue accounts. You stand to lose revenues if your collection policies are not aggressive. The longer your customer's balance remains unpaid, the less likely it is that you will receive full payment.
Tightening credit requirements: As credit and terms become more stringent, more customers must pay cash for their purchases, thereby increasing the cash on hand and reducing the bad-debt expense. While tightening credit is helpful in the short run, it may not be advantageous in the long run. Looser credit allows more customers the opportunity to purchase your products or services. You should measure, however, any consequent increase in sales against a possible increase in bad-debt expenses.
Taking out short-term loans: Loans from various financial institutions are often necessary for covering short-term cash-flow problems. Revolving credit lines and equity loans are types of credit used in this situation.
Increasing your sales: Increased sales would appear to increase cash flow. However, if large portions of your sales are made on credit, when sales increase, your accounts receivable increase, not your cash. Meanwhile, inventory is depleted and must be replaced. Because receivables usually will not be collected until 30 days after sales, a substantial increase in sales can quickly deplete your company's cash reserves.
Employees or Partners
Would a partner(s) make it easier to be successful?
A business partner does not guarantee success. If you require additional management skills or start-up capital, engaging a partner may be your best decision. Personality and character, as well as ability to give technical or financial assistance, determine the ultimate success of a partnership. In most partnerships one is always the "boss". Trying to share management works for only a short while. Eventually one will "rise to the top" or the partnership disbands. In general, avoid a partner if you don't have to have one.
How can I find qualified employees?
Choose your employees carefully. Decide before hand what you want them to do. Be specific. You may need flexible employees who can shift from task to task as required. Interview and screen applicants with care. Remember, good questions lead to good answers-the more you learn about each applicant's experience and skills, the better prepared you are to make your decision.
How do I set wage levels?
Wage levels are calculated using position importance and skill required as criteria. Consult your trade association and accountant to learn the most current practices, cost ratios and profit margins in your business field. While there is a minimum wage set by federal law for most jobs, the actual wage paid is entirely between you and your prospective employee.
What other financial responsibilities do I have for employees?
You must withhold federal and state income taxes, contribute to unemployment and workers compensation systems, and match Social Security holdings. You may also wish to inquire about key employee life or disability insurance. Because laws on these matters vary from state to state, you probably should consult local information sources and/or SBA offices.
What kind of security measures must I take?
Crimes ranging from armed robbery to embezzlement can destroy even the best businesses. You should install a good physical security system. Just as important, you must establish policies and safeguards to ensure awareness and honesty among your personnel. Because computer systems can be used to defraud as well as keep records, you should check into a computer security program. Consider taking seminars on how to spot and deter shoplifting and how to handle cash and merchandise; it is time and money well spent. Finally, careful screening when hiring can be your best ally against crime.
Do I need a computer?
Small business today faces growing inventory requirements, increased customer expectations, rising costs and intense competition. Computers can provide information that leads to better returns on investment. At the same time, they help you cope with the many other pressures of your business. Computers are not cure all's, however, and considerable care should be given to: deciding if you need one, and selecting the best system (or personal computer) for your business.
What about telecommunications?
All small businesses share some common functions: sales, purchasing, financing, operations and administration. Depending on your individual business, telecommunications can support your objectives in any or all of these areas. In its basic form, the telephone (the terminal) and the network (local or long distance) make up the basic components of telecommunications. It is an effective tool that can easily change with seasonality and growth. How you use telecommunications can affect how efficiently and profitably your company grows in the future.
Where can I go for help?
The NACC-IL is a great resource for American Indians to use to start their own business or to improve an existing business. The NACC-IL has many experienced members that can assist you with your business problems. If your business is stagnant the NACC-IL can help you decide what is the most cost-effective decision for your organization. Between all of our services you should be able to get your company running successfully and profitably.
The U.S. Small Business Administration has offices in nearly every major city in the country. SBA's operates the toll-free "Answer Desk" at 1-800-8-ASK-SBA (1- 800-827-5722), to give callers direct referral to appropriate sources of information.
Sponsored by SBA are a variety of counseling, training and information services including the Service Corps of Retired Executives (SCORE), Business Information Centers (BICs), Small Business Development Centers (SBDCs) and Women's Business Centers (WBCs). In addition, procurement center representatives can be found at each major military installation. More than 2,700 chambers of commerce are located throughout the country to provide additional assistance.
Service Corps of Retired Executives (SCORE)
Retired executives from all walks in business provide personalized and free counseling to assist you in making the right decisions for your business. Take advantage of this free service for specific advice pertaining to your business and your financial needs. http://www.score.org/
Small Business Investment Companies
The SBA or your local Chamber of Commerce may be aware of Small Business Investment Corporations operating in your area. These organizations are interested in reviving depressed portions of your community, bringing employment to places with high unemployment, or even helping certain minority groups. They will work with new businesses if you meet the criteria they expect. You can visit the International Economic Development Council for a list of organizations in your area: http://www.iedconline.org/
How much money do I need to get started?
Once you have taken care of your building and equipment needs you also must have enough money on hand to cover operating expenses for at least a year. These expenses include your salary as the owner and money to repay your loans. One of the leading causes of business failure is insufficient start-up capital. Consequently, you should work closely with your accountant to estimate your cash flow needs.
What are the alternatives in financing a business?
Committing your own funds is often the first financing step. It is certainly the best indicator of how serious you are about your business. Risking your own money gives confidence for others to invest in your business. You may want to consider a partner for additional financing. Banks are an obvious source of funds. Other loan sources include commercial finance companies, venture capital firms, local development companies and life insurance companies. Trade credit, selling stock and equipment leasing offer alternatives to borrowing. Leasing, for example, can be an advantage because it does not tie up your cash. Ask your local SBA office for information about these various sources.
What do I have to do to get a loan?
Initially, the lender will ask three questions: How will you use the loan? How much do you need to borrow? How will you repay the loan? When you apply for the loan, you must provide projected financial statements and a cohesive, clear business plan which supplies the name of the firm, location, production facilities, legal structure and business goals. A clear description of your experience and management capabilities, as well as the expertise of other key personnel, will also be needed.
What kind of profits can I expect?
Not an easy question. However, there are standards of comparison called "industry ratios" which can help you estimate your profits. Return on Investment (ROI), for example, estimates the amount of profit gained on a given number of dollars invested in the business. These ratios are broken down by Standard Industrial Classification (SIC) code and size, so you can look up your type of business to see what the industry averages are. These figures are published by several groups, and can be found at your library. Help is also available through the SBA and the trade associations that serve your industry.
What should I know about accounting and bookkeeping?
The importance of keeping adequate records cannot be stressed too much. Without records, you cannot see how well your business is doing and where it is going. At a minimum, records are needed to substantiate:
· Your tax returns under Federal and State laws, including income tax and Social Security laws;
· Your request for credit from vendors or a loan from a bank;
· Your claims about the business, should you wish to sell it.
But most important, you need them to run your business successfully and to increase your profits.
How do I set up the right record keeping system for my business?
The kind of records and how many you need depend on your particular operation. The SBA's resources and an accountant can provide you with many options. When deciding what is and is not necessary, keep in mind the following questions:
· How will this record be used?
· How important is this information likely to be?
· Is the information available elsewhere in an equally accessible form?
· What is my market potential?
The principles of determining market share and market potential are the same for all geographic areas. First determine a customer profile (who) and the geographic size of the market (how many). This is the general market potential. Knowing the number and strength of your competitors (and then estimating the share of business you will take from them) will give you the market potential specific to your enterprise.
Are some locations better than others?
Time and effort devoted to selecting where to locate your business can mean the difference between success and failure. The kind of business you are in, the potential market, availability of employees and the number of competitive establishments all determine where you should put your business.
Can I operate a business from my home?
Yes. In fact, experts estimate that as many as 20 percent of new small business enterprises are operated out of the owner's home. Local SBA offices and state chambers of commerce can provide pertinent information on how to manage a home-based business.
Illinois Minority Supplier Development Councils
State of Illinois
IL Historically Underutilized Business (HUB)
How do I find out about suppliers/manufacturers/ distributors?
Most suppliers want new accounts. A prime source for finding suppliers is the Thomas Register, which lists manufacturers by categories and geographic area. Most libraries have a directory of manufacturers listed by state. If you know the product line manufacturers, a letter or phone call to the companies will get you the local distributor-wholesaler. In some lines, trade shows are good sources of getting suppliers and looking over competing products.