Below is an excerpt from our book Startups Made Simple: How to Start, Grow and Systemize Your Dream Business. Learn more about the book here.
“An idea that is developed and put into action is more important than an idea that exists only as an idea.” – Buddha
All right, we’re getting close now. You’ve come up with your idea, you’re reasonably confident it will succeed, and you’ve at least done some basic testing and “back of the napkin” math. You’re ready to go! In this step, you’ll go through a checklist of items that may seem boring but are actually very exciting as the imaginary becomes real.
Formal Business Plan or Not
In Step 2, we went over a Startups Made Simple Business Plan, and that is going to be just fine for probably over 90% of startups. However, if there are complexities in your business or you intend to get funding from banks, angel investors, or venture capitalists, they’re likely going to require a more comprehensive business plan (of which there are dozens of free examples online) or at least a pitch deck presentation covering things like:
As I mentioned in Step 2, there are so many sources of funding these days and the market is moving so fast that if I covered all the ways to raise funds now, it would be outdated by the time this book was published. Also, less than 1% of companies ever get venture capital, so I don’t focus on VC in this book. That said, here’s a list of potential sources of funding and the chapter resources will also list specific sources:
Decide and Clarify Ownership Issues Before Starting
In the Founder Superpowers section of this book on making good decisions, as well as Step 2 in Top Reasons for Failure, I mentioned that nothing will sink a company faster than ownership issues if you have more than one founder. Fights, disagreements, misunderstood expectations, and more can paralyze or destroy your company, so let’s list out the issues that you should address in writing before you even form the company.
A good rule of thumb is that if you don’t want to work with these people forever, then don’t work with them at all. Sure, these may be uncomfortable to bring up now, but this could save a lot of grief later.
You can make your own document, have signed copies given to all founders, and that would be good, but this is one place an attorney could help greatly. For corporations, a Shareholders Agreement is typically what this called but basically it’s an agreement among owners. It can be simple or very complex covering issues like intellectual property, valuation, selling back shares, what happens when a founder dies, etc.
Decide on Stock Options or Equity Grants
Another thing I want you to consider before we go to file the official company paperwork is if you will ever want to grant stock options or ownership in your company. If so, then you should be aware of how much expense and complexity this will add to your company. There are services that assist with this now, and it’s much easier to manage than in the past, but adding a proper stock option program to your company definitely requires an attorney and is difficult to administer.
Stock option programs require fairly complex valuations, things like an 83(b) election with the IRS, vesting schedules, and more. It’s not something I’d recommend to your average self-funded startup, but if you need this, then you definitely want to have an attorney assist with the setup (and perhaps management) of the program.
What’s the alternative to complex schemes like that? First, you can give ownership away as a gift without paying the Federal Gift Tax (currently up to $15,000 year per person). For example, you could give 1% away per year to a valued employee. Also, so-called “phantom stock” plans are becoming more popular. Phantom stock plans are a simple agreement that if the company has a liquidity event (company is sold, acquired, etc.) or even a certain profit, that person X will receive Y percent of the total value; otherwise, they receive and are entitled to nothing. Now both of these options will also require an attorney to setup but they’re much simpler than a proper stock option program and don’t require constant management.
Select a Name and Legal Structure
Now that we’re clear on potential ownership issues and the complexity of various stock and ownership schemes, it’s time to file the paperwork to create our business. As mentioned in Step 2, don’t obsess about the business name, just pick one, and let’s file the paperwork. Read Step 2 to see more best practices in picking your business name and doing a preliminary name and trademark search. The name can always be changed and so can the legal structure, but let’s go over some of the basics so you can make the choice.
For the vast majority of entrepreneurs, you’ll choose one of the following three legal structures or business entities. Note that this information is relevant for forming a business entity in the United States (whether you’re a U.S. citizen or not).
Option 1: DBA/FBN
A DBA or FBN (also known as a sole proprietorship, Doing Business As, or a Fictitious Business Name; these names vary by state) is a business that is not separate from its owner, merely a different name that the business owner operates under. The owner is personally liable for the company and its debt; all income is added on the owner(s) personal tax returns (pass-through taxation). If there is more than one owner, then the business is classified as a General Partnership.
Taxation: Simple taxation. You add your income (or losses) to your personal 1040 tax return in a separate schedule (if more than one partner then each person gets their own schedule). Even TurboTax can handle the vast majority of DBA taxes.
Pros: Easy to set up, easy to maintain.
Cons: Owners are personally liable for the company and its debt (could lose their house, cars, personal assets, etc.) in a lawsuit. Usually not recognized at the state level, only in your city/county. No corporate “prestige” of having the “Inc.” or “LLC” attached to your name. LLC’s have primarily replaced DBAs as the entity of choice for even the smallest businesses.
NOTE: If you form a corporation or LLC, you can also file a DBA for your company, which means your corporation or LLC can do business under different names as well. This is ideal if you want to have one company that does multiple lines of business. For example, if you are ABC Services, LLC you can file a DBA as “Dave’s T-Shirts” and another DBA as “Dave’s Landscaping”.
Option 2: Corporation (“S Corporation” or “C Corporation”)
A corporation is a separate legal entity that can shield the owners from personal liability and company debt. As a separate entity, it can buy real estate, enter into contracts, and sue and be sued completely separately from its owners. Also, money can be raised easier via the sale of stock; its ownership can be transferred via the transfer of stock; the duration of the corporation is perpetual (the business can continue regardless of ownership); and the tax advantages can be considerable (i.e. you are able to deduct many business expenses, healthcare programs, etc. that other legal entities are not). Income is reported completely separate via a tax return for the corporation.
A corporation is set up in this structure:
In many cases (especially during the startup phase), you will be the 100% owner of the stock; therefore, you elect the directors (usually yourself) and then appoint yourself as an officer (or all the officers: CEO, treasurer, secretary).
The rules for operating your corporation are set in what are called corporate bylaws. This document sets the rules for the company and can be modified as the business grows and changes.
Operating a corporation involves, at the minimum, holding a yearly directors and shareholders meeting (the location is determined by you and the expenses are deductible), keeping written minutes of major company decisions, and maintaining general corporate compliance as dictated by the corporate bylaws.
A C-corporation is what all corporations are by default, you are automatically a C-corporation unless you specifically elect to be an S-corporation. You can choose to be an S-corporation by filing a form with the IRS (and some states require a separate form). “S” means “Small” corporation, which is restricted to U.S. citizens and a limited number of shareholders, currently under 100. S-corporations also may not own or be owned by other business entities (important to consider if you want to own “subsidiary” companies through one business entity).
Taxation: The most complex of the three options. Both an S-corporation and a C-corporation require a fairly complex separate tax return (separate from your personal 1040 return). Some simple companies can get away with using a service like TurboTax but most usually require the assistance of an accountant or CPA. C-corporations are taxed twice: You pay taxes on the profits, then you pay taxes again when the profits are given to each shareholder. The majority of small corporations are S-corporations because it means you do not pay a separate corporate tax on your profits, which is currently at 21%.
Pros: The oldest, most successful, and most prestigious type of business entity; provides personal liability protection; conveys permanence, can reduce taxes (lower tax rate on retained profits, items like healthcare, travel and entertainment are deductible).
Cons: More expensive to set up than a DBA; more paperwork and formality required than an LLC (holding shareholder/board meetings, keeping minutes and resolutions).
Option 3: Limited Liability Company (LLC)
A limited liability company can be best described as a hybrid between a corporation and a partnership. It provides easy management and pass-through taxation (profits and losses are added to the owner(s) personal tax returns) like a sole proprietorship/partnership, with similar liability protection of a corporation. It’s a relatively new form of business created in 1977 in Wyoming and now recognized in all fifty states and D.C.
Like a corporation, it is a separate legal entity; unlike a corporation, there is no stock, and there are fewer formalities. The owners of an LLC are called “members” instead of “shareholders.” In essence, it’s like a corporation with less complicated taxation and stock formalities.
The heart of a limited liability company is known as the Operating Agreement. This document sets the rules for operating the company and can be modified as the business grows and changes.
Operating an LLC is less formal than a corporation, usually only requiring an annual members meeting and members’ agreeing to changes of the operating agreement and other major company decisions.
Taxation: Simple or complex. The beauty of the LLC is that by default it’s taxed just like a DBA/FBN: You just add your income or losses to your personal 1040 tax return, very simple. You can also elect to have it taxed like an S-corporation or C-corporation if you want a more advanced tax setup but this is pretty rare for small businesses.
Pros: Provides the liability protection of a corporation without the corporate formalities (board meetings, shareholder meetings, minutes, etc.) and extra levels of management (shareholders, directors, officers). Taxed the same as a sole proprietorship (one-member LLC) or partnership (two or more members) by default.
Cons: Usually more expensive to form than a DBA, requires more paperwork and formal behavior.
Options for Non-US Citizens
About 20% of our clients at MyCompanyWorks, Inc. are now international, so we specialize in their unique circumstances. There are some important details to be aware of if you’re not a U.S. Citizen.
Picking a State for Your Corporation or LLC
One of the unique features of incorporating or forming an LLC is that you do not necessarily have to form the company in the state where you do business. When deciding on which state to incorporate in, there are basically two choices:
Your Home State
For the vast majority of small businesses, incorporating or forming an LLC in your home state is usually the easiest and least expensive option. This is because virtually every state has laws that require you to re-register a Delaware or Nevada company in the state where it is actually doing business.
For example, if you form a Nevada corporation but your physical business is located in Colorado, the state of Colorado will want you to re-register as what’s called a “foreign corporation” (a company that was not originally incorporated in Colorado). This is especially true if you intend to get a bank account and business license or rent office space in your home state.
In most cases, registering as a foreign corporation or LLC will subject you to all the same taxes and fees as an in-state company, so you will probably have not avoided any taxes or fees, plus there is the added expense of registering as a foreign corporation in your home state and any annual fees in both states.
This is not to say there are not valid reasons for choosing another state, I just want you to be aware of the additional steps required when choosing a state outside of your home state. Further discussion with your attorney or other advisor is recommended.
Delaware, Nevada or Wyoming
Delaware is where most large corporations (Fortune 500, Nasdaq, etc.) are incorporated. The reason for this is that Delaware’s body of law is more business-oriented, and they have a large and advanced business court system (called the Chancery court) to handle complex legal litigation. It is the state of choice for both large corporations, foreign corporations, and many fast-growing or high-potential companies. For example, venture capitalists typically require a Delaware corporation before they’ll invest in your company.
Nevada has recently exploded in popularity for both large and small businesses. This is due to Nevada’s very pro-business climate, low-tax mentality, and the lack of an information-sharing agreement with the IRS (all other states share company information with the IRS).
Wyoming has also recently exploded in popularity for its very business-friendly climate and has been called the Switzerland of the Rocky Mountains by The Economist magazine. It features some benefits compared to a Nevada entity including:
Common Reasons for Choosing Delaware, Wyoming, or Nevada
The Lowdown on Picking a Business Entity and State
Much like obsessing over the business name, it’s not worth obsessing much over the business entity or state which can always be changed later (things are easier if you don’t have to change, but it’s not that hard). Facebook famously started out as a Florida LLC but is now a Delaware C-corporation (like most big U.S. companies).
Here are some basic guidelines to make your decision easier:
How to File Your Business Entity
Most people go to an attorney, an online service like my company or do the paperwork themselves. DBA/FBNs can typically be filed with your county clerk and they usually have the forms available online or in-person. Corporations and LLCs are typically filed with the Secretary of State and also have the forms available online or in-person.
Typically the forms are pretty easy to complete after you search the name for availability, which is somewhat of an art itself. You’ll pay a filing fee to submit the form then wait anywhere from a day to several weeks depending on the county or state.
The form will either be accepted or rejected. If it’s accepted, you’re basically in business and it’s time to continue doing the other checklist items below. Some states have requirements that your new business be published in a newspaper and will provide those instructions with your filing.
Obtain Your Federal Employer Identification Number (FEIN)
If you are setup as a corporation, LLC, or partnership (or a sole proprietorship with employees), apply for a Federal Employer Identification Number (FEIN) from the IRS by filing Form SS-4 or filing it out online. A FEIN will be necessary to open a bank account or process payroll. Think of your FEIN as the Social Security Number for your company.
Open the Company Bank Account
It’s important to separate your personal and business expenses (for proper accounting and legal compliance), so select a bank and open the company bank account. Most people just choose the same bank where they have a personal account. If you’re going to get a loan or otherwise have specific needs from a bank, do your research and select the right one for your business. Typically, to open the account, you will need your filed company paperwork, your FEIN paperwork, and perhaps an application or written document authorizing the various owners, officers, etc. to make transactions.
Tip: Contact the bank prior to opening the account to see what their specific requirements are to open a business checking account. Some banks’ requirements are fairly simple whereas some banks’ requirements are extremely complex.
Organize and Capitalize the Company
Now that you have a company bank account, it’s time to put money into the company so you can capitalize the company and start paying for business expenses through a proper business bank account. Note that you can reimburse any expenses incurred by the founders before the account was established. How much money you need to put in the company depends on how much you are capable of, (some states have a $1,000 minimum), but the general rule of thumb is to put enough cash in the company to get you operational and cover your startup expenses for a while. You can always inject additional cash later.
If you are setup as a DBA/FBN and are a sole owner, this process is very simple; simply move money into your business account and that’s your startup capital. If you are a DBA/FBN with more than one founder, the same basic process applies but you’ll want to get in writing who has contributed what and who owns what percentage of the company i. Typically, this is called a Partnership Agreement and can be very simple, even one page. Search online; there are many examples.
If you are setup as a corporation, you will exchange money (and sometimes services or past expenses used in the formation of the company) for stock. Put money in your company bank account, and the company will issue stock to you as proof of your ownership in the company. You will keep track of stock ownership using what’s called a Stock Ledger (basically a spreadsheet). Even if you’re a one-person company, this process still applies. It’s how you’ll prove ownership of your company and even transfer or sell it later.
Corporations should hold what’s called an Organizational Meeting where they will issue this stock and also complete the setup of the company including electing directors and officers, adopting the corporate bylaws, and other post-formation tasks. Whomever handled the filing of your corporation will typically provide you with forms or templates for all of the above and some guidance on completing these important steps. Note that these steps are important. Don’t just file your paperwork to form the company and then not properly organize the company afterward; this could have severe consequences later. Finally, if there are multiple shareholders, consider having them all sign a Shareholders Agreement as mentioned earlier in this chapter.
LLCs should hold an Organizational Meeting as well. The main difference is that LLCs are typically set up to exchange ownership percentage instead of stock. This means that the process is very similar to a DBA/FBN: Put money in the bank and track who owns what. LLC’s typically have what’s called an Operating Agreement that also details ownership percentage and has various rules on transferring ownership, meetings, how to handle disputes, etc., which is important especially if there are multiple owners. Some LLCs can be set up to use units of ownership, which are similar to stock but are somewhat complex and beyond the scope of this book. (Talk to your advisor if you want this option.) You will keep track of LLC ownership using what’s called a Member Ledger (again, basically a spreadsheet).
All of the documents mentioned above should be organized centrally in a company binder. Corporations and LLCs can get what’s called a Minute Book that has the forms and Ledgers mentioned above as well as proper Stock or Member Certificates and a Seal to stamp official company documents.
Shameless Self Promotion
If you know the type of company you want and where you want to file it you can spend hours doing the previous tasks I’ve mentioned above or you can go to my company’s website at www.mycompanyworks.com and spend about ten minutes on an order form and let us handle it like we’ve done for over 50,000 clients since 2001. We form companies in all 50 states and D.C. We search the name with the state, file your paperwork (correctly!), provide a registered agent (if necessary), provide the post-formation organizational documents ready for signature, provide a Minute Book and even guidance on the bank account, business licenses and an interactive checklist called the Startup Wizard to help you do the remaining setup tasks. The only thing we can’t offer is financial, legal or tax advice so if you need any of that, ask an advisor first.
Arrange Office, Warehouse, Retail Space
Now that you have a proper company and bank account, you can pay vendors with the company account for your office, warehouse or retail space (assuming you’re not home-based). Some of this work can be done before your company is filed and bank account is open (especially for complex leases or build-outs) but ideally after so you can track expenses in the company properly.
Contacting a commercial real estate broker in your area can be helpful. Make sure to arrange for utilities and office furniture. Also, remember that home office expenses can usually be deducted, so keep careful track of your spending on home offices and supplies.
Obtain Licenses and Permits
Forming the company is the first step. Now, you typically will need to get a license or permit to operate in your local jurisdiction (and sometimes at the federal level) as well as register for various local taxes. The easiest way to determine what you need is to call the local government office where you will operate and ask; they’ll typically provide some kind of checklist. If you live within a city you would call city hall; if you live outside the city, then call your county government and ask for the business license division.
If you will be opening a retail location or renting office space, it’s important you clear the location for zoning and other issues by contacting the government before signing any lease or other documents.
Federal Permits: Most businesses do not require a federal license or permit. However, if you are engaged in one of the following activities, you should contact the responsible federal agency to determine the requirements for doing business:
State Licenses: Some occupations and professions require a state license or permit. Laws vary from state to state, however, if you are engaged in one of the following professions, you should contact the responsible state agency to determine the requirements for your business:
Tip: Most people engaged in the types of business that require a special state license or permit are already aware of the requirements (e.g. an accountant is familiar with the licensing requirements for accountants).
State Licenses and Permits (based on products sold): Some state licensing requirements are based on the product sold. Contact your state licensing authorities to determine the licensing requirements of your business. For example, most states require special licenses to sell:
Sales Tax Permit: If your company sells physical products, you may have to collect and pay sales tax. This is usually accomplished by obtaining a state seller’s permit or resale permit. You can usually register or find the forms online.
Tip: Many service businesses that do not sell a physical, tangible product are not required to collect sales tax, so ask your state taxation agency for details/clarification.
Business License: Most cities or counties require you to obtain a business license, even if you operate a home-based business. This is a license granting the company the authority to do business in that city or county. You can usually find the forms online.
Hire Employees (if applicable)
If you intend to hire yourself (typically required if you are set up as a corporation) or others as a full or part-time employee of your company, then you will have to register with the appropriate state agencies to obtain workers compensation insurance or unemployment insurance (or both).
Employee payroll and laws are so complex that I always recommend people use one of the many payroll services that can be found online (see the Chapter Resources). Not only will they help you register your business properly to hire employees, but they will calculate payroll, pay appropriate taxes, file quarterly forms, track vacation/sick time, and more for as little as $10/month or less per employee. Trust me, it’s silly to even consider doing payroll yourself in this day and age. I guarantee it’s not worth your time or the risk.
Set up an Accounting and Record-Keeping System
Set up your accounting and record-keeping system and learn about the taxes your new company is responsible for paying. Accounting is important, not only for tax purposes, but for you to know your cash position, profit and loss and more.
If you initially only have a handful of transactions per month, then you can probably handle bookkeeping yourself at first. Eventually, when it becomes more complex, I recommend you use one of the many online accounting programs and hire a bookkeeper, accountant, or CPA to manage your books (unless this is already a skill you have). Recently, there are online services that will actually do your books (including receiving receipts, invoices via email/scan), reconcile your accounts, provide reports, and even provide access to a CPA for advice for a very low monthly rate that is based on your number of transactions (or similar, see the Chapter Resources). Regardless of how you do it, it’s critical that you reconcile your books monthly so you can stay on top of your finances especially in the critical startup phase.
You’ll want to maintain a list of all owners and addresses, copies of all formation documents, financial statements, annual reports, amendments, or changes to the company. All tax and corporate filings should be kept for at least three years. Scan and keep everything just in case.
Obtain Business Insurance
There are many types of insurance for businesses, but they are usually packaged as “general business insurance” or a “Business Owner’s Policy.” This can cover everything from product liability to company vehicles. A decent policy can run as little as $300/year and offers a great extra level of protection and can help you sleep easier at night.
If you provide advice or a complex service, consider an “Error and Omissions” policy. If you are providing a digital service, they even have policies to protect you against claims of lost data or hacking. I recommend you contact a local insurance agent and discuss your needs with them.
Develop a Business Identity
In Step 2, we discussed picking the name and even colors and fonts. A professionally created logo can make your business look professional and established. After your company has been officially filed, now’s the time to consider having a professional create a business identity for your company. This has become very inexpensive over the years and a decent logo package can be purchased for under $100 in many cases. You can then order business cards, letterhead and promotional materials for your business from one of the many online vendors (see the Chapter Resources).
A trademark is a name (or phrase), symbol or design identifying and distinguishing a product from goods and services provided by other companies. Unlike registering your business name with the county or state, a federal Trademark offers you nationwide protection of your mark. Well-known trademarks include the Nike Swoosh, the AT&T blue planet, or the phrase “I’m lovin’ it®” from McDonald’s.
Filing a Trademark:
Trademark law is complex, and many applications to the USPTO are rejected. That’s why we highly recommend that if you want to file a trademark you have a firm that specializes in trademarks perform a comprehensive search and prepare the application.
Tip: If you are reasonably certain you are the first to use a trademark in the US (you would have already done searches at USPTO.gov, online, etc.) then you can add the ™ symbol to your mark to indicate that you are claiming this as yours. This doesn’t require a filing at all but is usually the first step in claiming your mark before you file the official trademark.
Advisors: Accountant and Lawyer
Many of the steps above will be made easier if you start a relationship with a good accountant and lawyer. Now, many startups simply cannot afford these people at this time in their company’s life cycle, but I encourage you to search online and use one of the many of the “pay as you go” services that are quick, available almost instantly and reasonably priced. There are also legal plans you can buy for a few hours per month of advice as well as the aforementioned accounting services.
Again, having a local trusted advisor is ideal, but consider these services until you can afford this. Finally, I’m a big fan of a regular legal review and financial review of the company top to bottom: contracts, employee manuals, terms and conditions, overall risk profile, etc. that, depending on your finances and risk tolerance, you may want to consider before launch or later on after you’re generating income.
If you’ve made it this far and have actually pulled the trigger, I want to just take a moment and offer you some congratulations. (If you’re not there yet and are still researching, don’t despair, we’ll get there). A lot of people these days talk about starting a business, the “wantrepreneurs” I’ve previously mentioned, but you actually put yourself out there and took the risk to start. That’s to be admired, and, as I wrote in the introduction to this book, is the greatest source of progress and wealth in the world. In the next few sections of our Six-Step system, we’ll go over Growing, Managing and ultimately Systemizing this business we’ve created.
Visit http://www.startupsmadesimple.com for Chapter 7 Resources and to download the Startups Made Simple Startup Checklist.
This was an excerpt from our book Startups Made Simple: How to Start, Grow and Systemize Your Dream Business. Learn more about the book here or see our previous excerpts here.
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