Business Start-Up: Choosing the Right Structure

One of the first questions that I pose to anyone who wants to start a new business is "What will be the structure of your company? Will you incorporate, set-up an LLC/LLP, or operate as a partnership or proprietorship?" The answer to this question will provide the basis for setting the company's legal status as an entity. Today, we will review the most common types of business structure, and we will explore the advantages and disadvantages of each.

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The most common types of business ownership are Sole Proprietorship (also includes Husband/Wife ownership), Partnership (various forms), and Corporation. LLC and LLP are other options, and include some of the benefits of a Corporation with some of the benefits of non-corporate structures. We will explore each of these in this issue.

Sole Proprietorships and Partnerships

By far, the easiest form of company set-up is the sole proprietorship. All you have to do is decide that you want to go into business, and then go through some basic set-up steps to legitimize it. If this will be a home-based business, you will file a name registration with your county (commonly referred to a DBA or "Doing Business As..."), publish it in a local paper, open a bank account in the business name, secure any licenses required (Home Occupation Permit, Business License, Resale Permit, etc.), and you are good to go! You will typically file your business income and expenses on IRS Schedule C and attach it to your Form 1040 at the end of the year.

While a sole proprietorship is easy to form, I generally don't recommend it as a business structure unless the business is never expected to ever grow larger than being home based, and it has minimal to no legal liability exposure. A partnership follows the same series of events as listed above, with the addition of the need for a partnership agreement. Partnerships can be either General Partnerships or Limited Partnerships.

A General Partnership has one or more General Partners, each of whom assumes full personal legal liability for the partnership. A Limited Partnership has one or more General Partners, along with one or more Limited Partners who may invest money, but who are not allowed to participate in the daily activities of the partnership in any capacity. A Limited Partner's liability for the partnership's actions is limited to the amount of money s/he has invested in the partnership.

Perhaps the single biggest disadvantage of a Sole Proprietorship or Partnership is the unlimited personal liability that attaches to the owners of either entity. If the business should go bankrupt, whether through mismanagement, a lawsuit, or other business reasons, the owner(s) must take personal responsibility for payment of the business' debts. Often, this causes the owner(s) to file for bankruptcy protection themselves. Another issue that can handicap either of these entities is the acquisition of credit. Since the business is not a separate legal entity from the owners, the owners usually wind up using their personal credit capacity to fund the business. This can make deduction calculations difficult, in addition to making credit acquisition difficult for the business.

A partnership will file an information report to the IRS every year on Form 1065. This form includes Schedule K, which details how the income and expenses of the partnership are to be allocated amongst the partners. Since a partnership is not a legal entity, it will not pay taxes directly to the IRS, but each member of the partnership will.

Each partner will receive a Schedule K-1 from the business, and will use this form to complete their income tax return. Note that the due date for Form 1065 is one month prior to the due date for the personal income tax returns of the partners. This is to allow the partners time to complete their returns by the standard tax filing day. The information from Schedule K-1 is reported by each partner on Schedule E, which is then attached to their Form 1040 and filed with the IRS.

Corporations and Incorporation

Incorporating can be a simple process, but the decision to set-up a corporation, as well as the continuing administrative requirements to keep a corporation legal, can be daunting. Setting-up the corporation does not take a lot of work, but you must follow some key steps in order to do it properly. A corporation may be set-up as a C-corp or an S-corp. S-corps are more common if you have a smaller company and/or a limited number of investors. An S-corp cannot sell shares to the public.

The first decision is to determine which of the fifty United States is most beneficial to the business as a home state. This does not have to be the same state in which the business operates, nor does the business have to have a physical presence in that state, other than a person who will agree to receive any court or legal documents on behalf of the corporation in that state. This is usually an attorney or accountant, but can be any person of legal age whom you authorize. They must have a physical presence (residence or office) in the state of incorporation, and they must be available to receive personal service of documents on behalf of the corporation.

When filing, you should have Articles of Incorporation and Bylaws to file with the Secretary of State of the state in which you will incorporate. You will also be required (in most states) to name the directors and officers of the corporation. In most states, these can all be the same individual. You will be required to keep corporate books and records. These records include Corporate Minutes, key decisions, Stock/Share records, and more. Today's sponsor has more information and guides available which can help you with this. Be sure to visit their site for more information.

You must also register your corporation in the states in which you will have a physical presence and conduct business. For example, you may decide to register your corporation in Nevada or Delaware, but actually operate your business in California. While your initial registration will be in Nevada or Delaware, you will also have to be a registered corporation in California. You do not have to register in every state in which you have customers (i.e. mail order), but you must register in any state in which you will have an office. There are exceptions to this, based on your line of business, so check with your attorney or CPA for additional requirements.

A corporation helps you to avoid the unlimited liability provisions of proprietorships and partnerships, but you must be careful to run your corporation as a completely separate entity from your person or your household. DO NOT pay any personal bills from the corporation. DO pay yourself a salary from the company, and use this money to pay your personal bills. If you don't truly run your corporation as a separate entity, then you run the risk of having your corporate status invalidated in court, and you could find that you are now subject to unlimited personal liability for the actions of the corporation.

Having a corporation also simplifies the process of procuring credit and trade lines in the business name. If done properly, you can avoid having these items appear on your personal credit report, and you can also avoid having to sign personal guarantees for these credit lines. If you would like more information on Business Credit, see future articles, or contact me by commenting on this blog. Since all comments are moderated by me, you don't have to worry about your personal contact information showing up on this site.

A corporation will file taxes on Form 1120 (c-corp) or Form 1120S (s-corp). A c-corp may issue dividends, and these dividends will be reported on a Form 1099-DIV issued to each shareholder. An s-corp will issue a Schedule K-1, just like a partnership, and the owners will transfer this information to Schedule E.

Limited Liability Companies (LLC/LLP)

An LLC/LLP works very similar to a corporation, but the recordkeeping requirements are less stringent, as you don't need to keep corporate books and records, but you must still ensure that you are running the business as an independent entity. An LLC/LLP has a manager and members. The manager is selected as the company's representative and the rest of the owners are the members.

An LLC/LLP can also get business credit, just like a corporation, and liability for the actions of the company is limited to the amount invested by the owners. Also, limited liability owners of an LLC/LLP ARE allowed to participate in the daily activities of the business (unlike a Limited Partnership), while maintaining their limited liability status.

An LLC/LLP is appropriate for many small businesses, and I highly recommend this business structure to most of my clients. As the business grows, you may eventually convert to a full corporation, but in most cases an LLC provides liability protection, access to business credit, and simpler administration.

Tax filing for an LLC is simple. If the LLC has only one owner, the owner can report all LLC income and expense data on a Schedule C, just as if the entity were a sole proprietorship. If structured as an LLP, or if an LLC with partners, then Form 1065 would be filed, and each manager and member would receive a Schedule K-1 and report on Schedule E. An LLC has the option to be treated as a corporation, in which case it would file Form 1120 instead.

Speak to an Attorney or CPA or Both!

Prior to setting-up your business, I recommend that you retain counsel and a CPA who will work with you and your business. The attorney can ensure that you are following the proper legal proceedures with respect to your business structure and set-up, as well as the ongoing administration of your status. The CPA will help you set-up your company books and records, and s/he will also be in charge of your annual audit and financial reporting.

We have not talked in detail about business credit here, but we will be speaking to these issues in future posts. Your CPA and attorney may play a pivotal role in assisting you with regard to business credit. In any event, you will (or should) find their guidance and counsel of help and comfort while operating your new venture. Your CPA will also help you with tax issues, if necessary. We will discuss some of the tax issues of each type of business structure in future posts as well.

Regardless of whether you set-up your new company as a proprietorship, partnership, corporation, or limited liability entity, you should be sure that you understand the pros and cons of each structure, and decide which provides the best combination of benefits for your type and scale of business. Working with your financial planner, an attorney, and an accountant will enable you to ensure that you are getting the most from your chosen business structure.

As with any of my posts, I urge you to speak to a licensed, qualified attorney or CPA in your area before acting on anything contained herein that speaks to legal or accounting issues, as I am not licensed to work in these areas. Any information contained herein is for informative purposes only, and should be verified prior to being acted upon.

First-Time Credit

People often ask me, "Randall, I don't know how to get started with credit. I know it causes problems for most people, but in this society, you have to have credit to exist. No one will issue me any kind of credit card. How do I get started?" Many people also ask me about how to re-establish credit, after they have already mucked it up before.

First of all, I caution everyone to be careful with credit. This is one of those, "Do as I say, and not as I do" kind of propositions, because I have had credit issues in my life at various times also. I will tell you how to go about setting-up stellar credit for the first time (or the next time), so that you can establish or re-establish a decent credit rating.

This article will focus on the personal side of credit, which I suggest you fix before you get to the business side of credit, which I will discuss in a future article (or many). Credit issues can get complex, and this blog will deal with a lot of credit issues, including setting up personal or business credit, managing and maximizing your credit score, repairing credit, protecting your identity, and exercising your legal rights as a consumer. This posting focuses on an easy way to establish or re-establish your credit. Ready? Here we go!

Step One: Find $500 to $1,000. I know, you don't have that much money. Everyone tells me that.

Rule #1: If you can't save money, you have no business borrowing money! Remember this, because it is the theme for every credit-related issue I will discuss from now until I stop breathing (or blogging, whichever comes first).

If you don't have the cash, open a savings account, and put 10% of your paycheck (or more) into it every payday. Do this before you pay any other expense, including your rent. If you pay your expenses first, you will never be able to save any money. You might question me on this, but you have always paid your expenses first, and you don't have any money, right? Trust me, I know what I am saying. You will automatically adjust your budget, so that you don't starve. If you lose some weight, you will be healthier anyway.

Once you have accumulated $500 to $1,000 cash in your savings account (I highly recommend $1,000 or more), you will set-up a meeting with the New Accounts Officer at your bank. I always recommend getting to know the manager, so if you can get your appointment with him/her, even better. At this meeting, you will explain to the officer that you have been consistently putting money into your savings account for the past (however many) months. You are happy that you have been able to save this money, but you need to access some of it, but you don't want to take it from savings. Tell them that you would like to borrow against your account on a 12-month basis. You would like to borrow $1,000 of the money you have in the account.

The officer should set you up with a Secured Loan against your Savings Account. You may have to relinquish your passbook, or they may just put a hold on $1,000 in funds. Since this is a Secured Account, your interest rate should be lower than a standard loan. Perhaps in the low double digits (i.e. 11.5%). Yes, you are paying interest to borrow your own money. You could pay a whole lot more for setting up your credit. Compare this to the hundreds of dollars you would spend in fees and interest opening up a new secured charge card or loan online. This is better, trust me!

You will take the $1,000 that you receive from the bank, and you will take it to a second bank. Note: Please deal with major banks, because they all report your loans to the Credit Reporting Agencies. At the second bank, you will deposit this money into a new savings account. About one week later, you will go back to the bank, and tell them the same story you told at the first bank about wanting to borrow against your savings. After they agree, take the $1,000 to a third bank, and repeat the process.

After the third bank gives you the $1,000, go back to the first bank, and open a checking account with the money. This should now be about two weeks since you opened the first credit line. The next week, pay $100 on each of the three loans. Two weeks later, pay another $100 on each of the three loans.

At this point, you have savings accounts (all encumbered) at three banks, which total $3,000. You have three credit lines, which now total $2,400 (plus a little bit of interest). You have $400 in a new checking account. Notice that if you add everything up, your net worth is still about $1,000.

Remember how you were saving money to build-up your initial savings. Now, instead of depositing this money into your savings account every week, you will use this money to pay your loans. Pay the loans down so that they are at $300 each by the end of six months. Pay $50 per month each from that point, until you can pay-off all three loans.

Yes, this process takes six months to one year. At the end of the process, you should now have three savings accounts with at least $1,000 in each. Hopefully, you have increased your income at work during this time through a promotion, raise, or job change as well. Wait 45 days after you pay-off all three accounts. Then, go back to each bank, and borrow the $1,000 again from each. Deposit this money into the first checking account. In two weeks, pay $250 against each loan. Two weeks later, pay another $150 against each loan.

Pay $100 per loan after this, until paid. Be sure that you keep each loan open a minimum of six months before you pay it off, or it won't help you as much.

It is now 18-24 months since you began the process. You have six trade lines of credit history, all for $1,000 or more, and all paid in full. Hopefully, you do not have any other debt. You also should have at least $4,000 to $6,000 in total savings (you didn't stop saving, did you?).

At this point (and you probably could have done it sooner), you should have no problem opening unsecured credit accounts with Visa, Mastercard, American Express, or anyone else you like. If you had bad credit, these new accounts should help make up for some of that.

This whole process probably did not cost you more than about $100 in interest payments, it caused you to save a few thousand dollars, which you had been unable or unwilling to do before, and it has helped you establish or re-establish a good credit rating. Hopefully, you have learned some discipline as well with regard to building savings and managing your expenses along the way.

By the way, be sure that you continue to deposit money into your first savings account during this process. Just because you are only paying $150 - $300 per month on the credit lines does not mean that you should stop putting the excess from your 10% paycheck contribution into savings. Even though the account is encumbered, you can still make deposits to it.

Look for future articles on credit repair, and read them before paying any money to a collection account or other aged balance that is negatively reporting on your credit report. Other credit-related articles on the way will be dealing with debt management, staying out of debt, proper uses of debt, and a whole slew of articles regarding business credit, mortgages, and investment financing. Stay tuned!

Have a great day!

Welcome!

Hello World and Reader:

I have finally relented to pressure from family, friends, colleagues, and others, and I am making my vast body of knowledge available to the rest of the world.

First, allow me to welcome you to "Personal Finance for Real People." This blog will attempt to provide useful financial planning tips that almost anyone can employ immediately, in order to improve their financial future.

Some of the topics planned for discussion include:

1. Income Generation (Ways to increase income, reduce taxes, and supplement income)
2. Debt Management (Consolidation techniques, credit enhancement and repair, ways to avoid debt)
3. Personal Savings (Emergency Funds, Goal Setting, Priorities)
4. Long-Term Savings (College Funds, Retirement, Major Purchases)
5. Risk Management (Proper Insurance Protection, Scam Avoidance)
6. Estate Planning (Wealth Transfer, Minimization of Death Taxes, Probate)
7. Real Estate (Your First Home, Income Property, Commercial Investments)
8. Mortgages (Saving Money, Choosing the Right Mortgage)
9. Business Topics (Incorporation, Funding, Managing, Planning, Business Credit)
10. Other Topics (Chosen by Readers or Dictated by Current Events)

Of course, each of these subjects has sub-topics, and each sub-topic provides many areas for discussion. Over the next few weeks, I will be posting a large number of informational articles touching on these points. These articles will provide a starting point for discussion, and I want your comments, so please feel free to contribute.

Once I get the core topics posted on this blog, I plan to submit at least one weekly post that deals with current issues. As of this writing, the sub-prime dilemma has touched almost everyone in the world, either directly or indirectly. Many people wonder how to take advantage of the situation for their own planning, while some just wonder how to get back to zero. Topics such as these will be fodder for this blog.

My goal is to set this up as a resource that will provide ideas for you to improve your financial life for the long haul. Having said that, I must request some things from you. Your willingness to read and participate in this blog are subject to the following disclosures, acceptances, and restrictions:

Anything that I have written on this site is copyrighted by me, unless stated otherwise. Rights to my content are mine alone, but I will authorize limited usage of this information:

1. By currently-enrolled students at no charge, as long as they provide proper credit to me.
2. If a student posts their work online, they must include a link back to the source of the material in addition to giving proper credit.
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Furthermore, you agree to indemnify and hold me harmless for any use of the information that you read here, as it is offered for entertainment purposes only, and carries no guarantee, warranty, or other representation.

Having said all of this, I hope that you will bookmark this page, subscribe to my RSS feeds, click on my sponsors' links, and enjoy this blogsite for years to come.

I sincerely thank you for your visit and your support!

Randall Parker, MBA