Saturday, February 27, 2010

How to start a small business

The model shows the marketing process in 5 dif...Image via Wikipedia
Starting a small business is a major investment, not merely of money, but also of your time. So you'd want to do it right. Do you know ALL the issues that is involved in starting a small business?


I answer a lot questions on Yahoo Answers! and a lot of the questions seem to be "how do I start a business?"  So here's a summary, with a bit of help from Nolo Books... (Buy them!)
A. Evaluating your business idea 
B. What ownership structure will you choose? (SP, GP, LP, CC, SC, LLC)
C. Choose a name and register the name
D. Prepare the ownership structure paperwork
E. Find a business location and meet legal requirements
F. Apply for necessary licenses and permits
G. Get insurance
H. Setup Tax reporting and accounting
I.  Hire employees and know the relevant laws
A. Evaluating your business idea
A business idea is a bit more than "I'll open a shop selling _____". Can you answer all these questions honestly? Can you convince someone ELSE of your answers?
Does your business idea actually make sense? Not just to you, but to complete strangers in a few sentences lasting no more than 15 seconds?
Can you actually MAKE MONEY from it? Don't use "gut instinct" here. You have to perform a real "breakeven analysis". WHO would buy the stuff you sell (service or product)? How much would they pay for it? How much can you make per sale? How many can you sell per day? In a year?
Did you write a business plan yet? Did you perform a SWOT analysis? (SWOT=Strength Weakness Opportunity Threat)  How about profit/loss forecast, and cashflow analysis for the next 12-48 months?
Do you need to borrow money? You will need business plan, cashflow analysis, and so on to get a loan from a bank. Even if you only borrow from relatives, it is better to get a promissory note / loan document done, so you don't turn them into partners, dragging them into legal trouble should you run into problems.
How will you market your business? Do you have a marketing plan? Word of mouth can only go so far, and marketing is one of the most underestimated costs of a business.
B. What ownership structure will you choose? (SP, GP, LP, CC, SC, LLC)
While Sole Proprietorship (SP) is the simplest, it is also risky, because if you ran into several financial problems, you can lose MORE than you put in. General partnership is even worse, as you now have MORE points exposed to risk. Limited Partnership is useful in some circumstances. C Corporation and S Corporation are somewhat more traditional, and LLC is a relatively new organization you can choose that combines some of the best features of corporations and sole proprietorships.
This topic is a very complicated one, as each have their advantages and disadvantages, but mainly they differ in ownership, asset protection, and taxation. Please consult a book or a real corporate law expert before making any decisions. I'll just give a short summary:
Sole Proprietorship -- the default, one person business
General Partnership -- default if you have more than one owner
Limited Partnership -- special form of GP, more control to some partners, more legal protection for others
C-Corporation -- the normal corporation, stocks and stuff like that, profits taxed as corporate tax, then dividends taxed again as personal income
S-Corproation -- simplified, no corporate tax, all profits, if any, are "flow-through" as personal income
Limited Liability Company -- also known as a "limited", LLC combines aspects of both S-Corp and partnership
C. Choose a name and register the name
A CPA or attorney, or someone at City Hall, can help you find a suitable name with a local/state search. You should come up with a whole list of names, and have them checked one at a time until you get one that you can use. Keep in mind that if you want to go nation-wide eventually,  a local search may not be good enough, and you may need to get the full "trademark search". That cost more money. And even if you do NOT go nationa-wide, you may still run into a name conflict and be forced to change your name.
REAL STORY: An Alaska clothing store called "Out of the Closet" got on the news when it was revealed that ex-Governor Sarah Palin is their frequent customer. Normally, this is good... Except that a thrift store chain in California actually got the name first by years, and sent a cease-and-desist letter to the store in Alaska, that basically says, "Change your name or see you in court." The Alaskan store name was changed.
Once you find a good one, register the name as "dba" or fictitious business name first.  You may also want to incorporate the corporation or LLC for more legal protection. If you want to do business nationally, or regionally, you need to register trade mark or service mark. This topic is worth a book in itself. If you want investors, you will need to incorporate, just to protect the investors.
D. Prepare the ownership structure paperwork
All corporate structures needs paperwork to make it legal. Corporation, either C-Corp or S-Corp, need corporate bylaws, articles of incorporation, pre-incorporation agreement, and issue some actual stocks. LLC needs article of organization and operating agreement. Even partnerships need partnership agreement. Get a book to do it right, or pay someone else to do it right for you. If you do it wrong, it can be disastrous.
You also need to file these documents with your state's secretary of state with appropriate fees. If you do business across state lines, you will need to be "qualified" or "domesticated" in other states. Keep in mind that some states are better for busines sthan others. A frequent place to incorporate is Nevada, which has some of the most pro-corporation laws in the nation.
Remember, if you do it wrong, it may even be worse than NOT doing it at all, because you'd have filed all the taxes and other stuff wrong, and it would lead you to think you were protected when you are not.
E. Find a business location and meet legal requirements
While most people do start running a business from home, eventually you will want to move out and find a REAL place. Even if you *do* run the business from home, you will need some preparations.
What do you really need for the business? Space? Electricity? Water? Gas? Parking? Phone lines? Internet? What is the max you are willing to pay? (again, business plan!)
Talk to a commercial real estate lease broker, and see what's available. Which fits? Any room for negotiation? Is it a good location for your type of business? Can you negotiate for better terms? Would you know what to ask for?
Even if you are just running business from home, you should check...
1) Does your homeowner's insurance actually cover your home-based business? If it doesn't, how much more will you need to pay for the coverage? If you rent, will your renter's insurance cover that?
2) Does your current lease or local bylaws/rules/restrictions allow you to run a home-based business? Even if you own your home, there may be homeowner's associations and such that have rules that governs your area. And if you rent, there may be provisions in your lease that says you can't run a business out of the unit. Violation of those terms may subject you to penalties or eviction!
3) Does your local area have zoning restrictions? CAN you operate business from your zone? If not, can you get a "home occupation" permit, if that is possible?
4) Did you calculate the taxes properly based on IRS rules? Home office must be "separate" for the IRS rules. Deductions and depreciations are some of the benefits of a home office, but only if you do it right, else you will owe IRS back taxes!
F. Apply for necesary licenses and permits
If you need employees, or if you are forming a partnership or corporation, you will need to get a Federal Tax ID number, also known as EIN, Employer ID Number.
Almost every jurisdiction require a business to register a "basic business license", often at city or county level.
If you plan to go retail, and your state collects "sales tax", you will need a reseller's permit, so that when you buy things, from wholesalers, you are not charged sales tax, and you have to periodically report and pay sales tax to the state. You will then need to know which products are charged sales tax and which are not.
If you deal with the public a lot, you may need special business licenses, such as alcohol, food, firearms, and so on. Almost all thing that involve food requires health department inspection and safety permits.
Some specialist occupations also need special registration, such as physicians, pharmacists, and so on.
Other states may have other requirements. For example, California requires all "sellers of travel" to register as well. Others may require you to be bonded, as well as insured (building contractors, locksmiths, plumbers, etc.).
Finally, your state may require special permits, esp. in regulated industries, such as taxi, restaurant, bar, and such.
There should be a state "Small Business Developement Center" that you can consult for what permits and licenses are needed for your business.
Please don't assume that you don't need one. If you do need one, and you don't have one, you will be in big legal trouble.
G. Get insurance
While insurance is not "required", it is best to buy some "just in case". They generally fall into three categories:
business Insurance (covers yourself) -- insures all business owned assets for loss or theft or damage (may need special coverage for flood, earthquake, and so on). Remember, homeowner's insurance probably does NOT cover home-based business. Check with your insurance agent!
liability insurance (covers other people) -- insures your business, so if you or your employees or products injured / damaged others, your insurance pay for it. Make sure you buy the right policy!
medical and other labor insurance -- worker's compensation insurance, unemployment insurance, medical insurance, and so on, covers medical needs, often tax deductible
Other insurance -- some industries, such as bus charter or taxi, have additional requirements and may require more coverage
Consult an insurance professional that specialize in your business area and see what coverage you will need.
H. Setup Tax reporting and accounting
Do you know how your business is taxed? It depends on what business entity you chose... SP, GP, LP, CC, SC, or LLC? Single taxation or double taxation?
Do you know what expenses are actually deductible for your business (i.e. can spend pre-tax dollars)? Do you know how to depreciate the business assets?
Are you using cash accounting or accrual accounting?  (if you don't know what that means, find out!)
Are you using calendar year or fiscal year?
Are you going to use a bookkeeper, or software like Peachtree or Quickbooks? Did you set them up yet?
If you sell things, how will you track and pay sales tax, if any?
How about state, county, and city taxes, if any? (San Francisco charges a city payroll tax)
I. Hire employees and know the relevant laws
Do you know the difference between employees and independent contractors? Keep in mind that just because you SAY they are contractors does not necessarily make them so. They have to qualify under IRS rules and your local employment board rules. Beware, as you'll owe a LOT of back taxes and penalties if you misclassified employees as contractors.
Did you get EIN yet, and setup the business bank account yet? Nowadays IRS take the money straight from your account. Really. And if you mingle the business funds with yoru personal funds, you may lose the corporation protection completely (known as "piercing the corporate veil")
Did you pay unemployment tax, and worker's compensation? How about withholding and payroll taxes? Did you keep all the records?
Do you know what OSHA and Department of Labor requires for your industry? Required posters, training, plans, and such? Can you document all the compliance stuff?
Do you know about the "New Hire Reporting Agency"? It's for chasing after deadbeat dads (and moms, technically) for child support. Did you report to them?
How about USCIS (formerly known as INS) requirements that all workers must show permit to work in the US? Did you document everybody? (ID, Social Security card, etc.)
Did the employee fill out a full employee application, and get an employee handbook? Oh, you didn't write one? You better get started!
Does your city or county have their own employee laws? San Francisco have its own sick leave and minimum wage laws, among other things.
Does your industry have its own employee laws? Commercial drivers are required to meet Federal USDOT regulations, state PUC regulations, and so on.
Yes, that is a LONG list of items you need to be aware of even before you open the door for business. And we're only scratched the surface because each of these areas deserve several books to explain them in detail. Please make sure you *have* considered all the factors before starting your business. It is better to find out now than realized you missed something later.
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