February 16, 2012
By Jean L. Chou, Esq.
Too many new businesses dive into operations without planning ahead. Perhaps that’s the reason approximately 50% of start-ups fail within 5 years. With Valentine’s Day out of the way, you can start working on the anatomy of that business idea you placed on the back burner. Here are 6 key components to seeing your new venture to fruition.
(1) THE MIND BEHIND THE MATTER: Your Business Idea
Create a solid business plan before you begin anything else. Research. Analyze the market. What’s your mission? How much liquidity is required? Plan detailed budgets for 3 differing scenarios: (1) worst case; (2) base case (most reasonable); and (3) best case. Then plan backups for each. When will you hire employees? Do you need insurance? Will you operate online or through a storefront? Will you need specific licenses? Did you account for those fees? There are many business considerations and while professionals can assist and guide you through the process, the idea is your ultimate investment and yours only.
(2) THE SKELETON OF THE BUSINESS: Your Entity Structure
Successful business owners learn to identify and evaluate risks. A key to insulating your personal assets from your business is to form a business entity. When it comes to choice of entity, the most popular question we hear from our business clients is “should I form a limited liability company (“LLC”) or an S corporation (“S Corp”)? Therefore, let’s focus on these two competitors. Generally speaking, the LLC is more expensive to form, but provides owners with much more flexibility and less paperwork than an S Corp. The S Corp is less expensive to form but requires more maintenance and record keeping. It also has restrictions on the type of investors, which may pigeonhole future prospects. Below is a side-by-side breakdown of the formation requirements, control and tax aspects of the two entities.
Despite the greater start-up costs, the LLC is still the more desired choice of entity as it offers pass-through taxation and greater flexibility for operations and management. As a side note to the self-employed, however, when you place yourself on payroll, you may save more on self-employment taxes as an S Corp than as an LLC, which will pay 15.3%. The caveat to this notion is that NYC does not fully recognize an S Corp’s pass-through tax advantages and imposes a general corporation tax of 8.85% on an S Corp’s net income, in addition to any income tax you will pay on your individual salary. Regardless, you should conduct a financial analysis after your first tax year to better evaluate your entity choice. It’s also generally easier to change an LLC to a corporate form rather than the other way around. You should consult with a tax professional for additional information.
(3) THE HEART OF THE OPERATION: Your Operating Agreement
Once you’ve created your business entity (let’s say it’s an LLC), complying with the necessary procedures is key. There’s no point in spending the cash to form your business only to forfeit your liability protections by failing to adhere to legal formalities. The operating agreement is the heart of your LLC. It outlines how each member’s relationships play out in the operations, including, but not limited to, ownership contributions, roles, responsibilities, management, control, transferability, company governance, etc. A skilled business attorney can draft an agreement tailored to the exact needs of your business. Unfortunately, oral promises and agreements hold little weight in the judiciary system so be sure to document all your business decisions in writing. Even if you’re teaming up with your spouse, sibling, close friend or partner, word only binds in the legal world if it’s on paper. Plus, when that business dispute arises with your wife, it’s easier to reference “paragraph 6 of our agreement” rather than the dinner conversation you had last week.
(4) THE LEGS TO THE IDEA: Your Bank Account
With your business plan, entity choice and operating agreement established, you’ll want to set up the logistics of your finances. Get a federal employer identification number (“EIN”) for the business online. Open a separate bank account with your EIN and new entity name. Get new checks and a business credit card. Designate this account solely for your business operations. It may be tedious, but keep tabs on your business accounts and never mix your personal funds with your business funds unless you’re categorizing them as some sort of investment or a capital contribution. Commingling of funds is one of the fastest ways to terminate your limited liability protection and may expose your personal assets to business creditors and vice versa. Consult with an accountant to ensure you have all the proper bookkeeping tactics in place.
(5) THE FACE OF THE BUSINESS: Your Brand
Marketing and brand imaging often occupies the largest expense accounts in the books. Your brand is your uniqueness and you may want a trademark from the United States Patent and Trademark Office (“USPTO”) to protect your image. Trademarks can be words, phrases, logos, symbols or devices that are used to distinguish your goods or services from other goods or services. When you obtain a trademark, you essentially put the public on notice that any misuse or infringement of your particular mark may result in legal repercussions. Read: you have merit-based grounds to sue for relief.
The USPTO website offers extensive resources and information; however, it’s advisable that you consult with a trademark attorney to assist you in the process as specific requisites must be met to successfully obtain a trademark. Applications may be filed online and are not cheap. The non-refundable fees range from $275 to $325 per class of goods or services. For example, if the mark is used on goods in two different classes, such as computer software and t-shirts, then a filing fee for two classes is required. Finally, if you conduct online marketing, make sure you have the proper disclosures and privacy policies in place. Check out the Federal Trade Commission’s (“FTC”) website for additional information on the governance of e-commerce activities and web advertising. You’ll also likely need non-disclosure or confidentiality agreements drafted for any new hires or interns to protect your trade secrets and client information.
(6) THE MOVEMENT OF THE OPERATION: Your Expansion
Once the gears start churning on your business and you begin to grow, you may need to revisit your operating agreement and flush out a buy-sell agreement with any new partners, members or investors. Like its name infers, a buy-sell agreement allows you to contract procedures to purchase and sell interests of your company. We advise our clients to obtain a buy-sell agreement from the get-go for any multi-member business as the agreement also governs the distribution of interests in the event an owner becomes disabled or dies. If you chose the corporate form of entity, you’ll revisit your bylaws and establish term sheets and subscription agreements for shareholders and potential investors looking to support your venture.
Whether you decide to open a clothing store, restaurant, consulting firm or music production company, remember that any type of success requires patience, planning and a strong foundation. Optimism never hurts, but it’s important to remain realistic and hedge against unnecessary risks through the help of skilled professionals.