A frequent concern I hear from aspiring entrepreneurs is “I have invented a great product, but I have no idea where to start in setting up a company, to avoid all the tax and legal problems I hear about on the news.” In fact, this is a complex question, with answers that are different all around the world, but I have some general rules of thumb that apply here in the USA to get you started:
Create a business entity early to encapsulate your venture. To avoid the tax implications of co-mingling personal and business funds and assets, create your business entity before you hire anyone or spend money building the product. Don’t wait for that first investor or prototype. The primary business entity options include a sole proprietorship, Limited Liability Company (LLC), or a Corporation (B-Corp, C-Corp, or S-Corp). I recommend starting with the simplest, quickest, and the least expensive – the LLC. It can be done online, without a lawyer, often for less than $100.
Worried you won’t choose the right business structure? Since you can upgrade your business entity later as required, and you can’t foresee where your business is headed, don’t worry about whether you’re choosing the perfect structure today. Just focus on protecting yourself now by selecting the structure that makes the most sense for your present circumstances.
File founder stock election so no taxes are due until exit. File an 83(b) election with the IRS within 30 days of founding the company, while the market value of your startup is essentially zero. Failing to file or waiting to incorporate until a first investor arrives could lead to a nasty tax bill in the middle of startup rollout when you can least afford it.
Even though the initial stock has no value or market, it is imperative that you document the division of ownership immediately between co-founders commensurate with their investment, contribution, and role. Proper documentation will minimize later legal claims and issues.
Set up a separate records system for your new business. Many entrepreneurs follow old shoebox habits in managing expenses until the company launches. For legal and tax purposes, I recommend a formal system, like Intuit or FreshBooks, for the new venture. You’ll also need to save tax records, bank statements, canceled checks, and contracts.
Proper record keeping is especially important if you have employees and contractors, as you’ll need to manage W-2s, Form 1099s, employment agreements, attendance records, termination letters, and any settlement or ownership documents with former employees.
Don’t overlook business tax filing requirements and dates. For corporations in the US, the annual tax return due date is a month earlier than for individual tax filings, so be prepared. In addition, many corporations have quarterly filing requirements, or even monthly ones if you have payroll taxes, sales taxes, or state filing requirements.
Also remember that your tax entity election doesn’t have to match the legal entity. For example, any LLC or S-Corp can elect to be treated for tax purposes as a sole proprietorship (Schedule C), partnership (Schedule K), or as an S-Corp (Form 2553).
Upgrade your legal business entity to meet growth needs. You may start as an LLC but find that a potentially high-value investor insists on having preferred stock, which is only available with a C-Corp. Also, mergers, acquisitions, and alliances with other companies almost always drive the need to modify your organizational entity for legal or operational purposes.
Additionally, I recommend that you review and update co-founder ownership agreements annually. In these cases, you will typically use a business attorney to upgrade your corporate platform or modify contracts, as appropriate. You’ll likely need a business attorney on a regular basis. Consider vetting attorneys early on before you need one to find counsel that understands your type of business. This way you will have an established relationship with an attorney you trust when the time comes to get help.
If you need help in the beginning or along the way, I recommend a visit to your nearest Small Business Development Center (SBDC), your local SCORE office, or your local attorney. In addition, you can find a wealth of information online via the Internet, from tax experts and industry associations. But remember that the responsibility for legal and tax considerations is all yours.
All these organizational and operational considerations are one of the main reasons that an innovative solution alone does not assure a successful business. If you don’t feel that you have the ability to address them, I recommend that you find a co-founder who can complement your skills and balance the equation, as it frequently takes a well-rounded team rather than a solo owner to run a great business.
*** First published on CayenneConsulting on 01/20/2019 ***
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