So this post is the outline for a radio interview I recently participated in with Insight on Business the News Hour regarding start-ups. A lot of my clients are start-up businesses, generally these are folks that have been working in a particular field for a long time and want to try running their own business, or people who have been hobbyists and now want to see if they can make a living doing what they love (*cough cough* musicians *cough cough*).
The danger here is in not realizing that a familiarity with a job or hobby and starting and running a business are very different concepts. For this reason, you need to know the “Who, What, When, Where, Why, and How” of getting your start-up off on the right foot. So here’s your 30,000 foot view of successfully putting together a start-up business. This is general information so it can help everyone from the start-up band or promoter to someone who wants to make a sell custom instruments, it’s all applicable!
- There are different types of who- Who am I going into business with? Who is going to run it? Who is going to pay?
- Who am I going into business with? Well that’s up to you. It can be yourself, a few friends, some business partners, the money folks, just make sure it’s people you trust. Trust is key here, without trust there is no business.
- Who is going to run the operation? Once again, that’s up to you, but it’s a conversation you need to have with everyone involved, especially the folks who provide the cash. Different cash providers will have different expectations, but I’ll get into that a little bit more later on.
- Who is paying for all of this? There are different sources of funding and each one has its own pros and cons:
- Pay your own way–
- Pros- you don’t owe anyone anything and all of the payments stay in house, lowers the business’ debt to third parties and offers you the most freedom with organizing your business.
- Cons- This is easily most expensive and you may need to offer and sign personal guaranties against your personal property.
- Start-up loans (Banks/Government bodies)-
- Pros- These lower your burden and are generally low interest loans. The lending bodies usually don’t want any ownership or say in the business operations and they’ll have resources you can utilize, such as small business development officers.
- Cons- Set regular payments like any other loan, regardless of whether you’re turning a profit or not so there’s very little wiggle room. Also, they’ll still need to guarantee payment one way or another.
- Begin searching for these programs on your local small business development group’s website.
- Investors (angel investors; venture capitalists)–
- Pros- Payments made are based on interest, dividends, and returns of the business itself. They’re also putting a little more skin in the game than the other potential financial helpers. They often have wide support structures to help your business grow and have a true desire to see you succeed.
- Cons- you’re going to give up some ownership and organizational interest with outside investors, particular venture capitalists. It will limit how your business can be structured and will most likely impact the decision-making procedures of your business.
- You can find a list of angel investors and venture capitalist firms in your area with a simple internet search.
- Pay your own way–
The first question, should I form a business entity or operate as a sole proprietor? Well, I can’t answer that for you, but I can tell you a business entity relieves you of personal liability while a sole proprietorship does not. Also, there’s some serious tax benefits to forming a business entity.
What type of business entity should you form? (In general the basic forms are a Partnership, a Corporation, or a LLC?)
- Partnership– The default, actually the state of Iowa says if you neglect to form a business entity, but are two or more parties engaged in a for-profit enterprise, you’re considered a partnership by default. So . . .
- Two or more parties (can be other business entities) working together in a for-profit business.
- You can custom tailor your individual debt, equity, and distribution allocations, and net losses can flow-through to the individual, saving some individual tax burden and allowing loss deductions.
- Each partner is an agent to all other partners and each partner has an equal voice in formal decision making. This means that regardless of the amount of ownership each party has, each individual has an equal say in decision making and equal authority against third parties.
- Corporation– The traditional business entity, this is generally for bigger firms (think big record labels, folks doing international business)
- Two-tiered taxation (tax on corporate and individual level) unless you meet the S-Corporation election requirements (such as one class of stock, less than 100 shareholders) which allows for pass-through taxation. Note that you can have one class of stock which is divided into voting and non-voting shares and still be considered an S-Corporation, so long as no stock is considered “preferred” stock (as in, at some point in the future, one set of stock could or will be paid on before all the others).
- Corporations are probably the most customizable entity, you can outline different classes of stock and ownership, and it grants different tiers of authority (shareholders elect board of directors, directors make most business decisions and appoint officers, and officers run the day to day operations), and different voting value based on class of stock and number of shares held. It’s probably the most democratic of the business entities.
- Interest is freely transferable to other parties.
- LLC– The most popular entity these days. This is what most bands, small firms, and songwriters utilize. LLC stands for Limited Liability Company, and the goal is just that, to limit individual liability.
- Flexible in a different way than corporations, the LLC is basically made for small businesses, it’s like a starter set, a foundation from which to work.
- You can choose your taxation model so long as you fit the requirements of that business (note Partnership is the default), and you can change your operations to other models as your business develops.
- Primarily for parties that wish to own, operate, and work directly in the business (members and managers).
- Any profit the LLC makes is passed to the members as dividends at the end of the fiscal year and is taxed as regular income.
- You can form your business entity right now (if you have everything already outlined and have a good idea of your aims, goals, and how you’d like to operate) but remember that there are certain documents which will need to be updated from time to time.
- Now- Organizational and internal documents (articles of incorporation/certificate of organization; bylaw/operating agreement; buy-sell agreement; organizational minutes, EIN) basically all of the documents which state exactly how decisions are made, money is paid, and who is involved and in what capacity.
- Annually or otherwise– Documents which need to be renewed, reviewed, or drafted regularly (annual minutes, reports to the Secretary of State’s office; taxes; succession plan) which show you are a real business operating as a real business.
- Different states have different laws regarding business organization, recognition, and the local taxes. Most states are starting to adopt uniform laws and rules which get rid of many of these discrepancies and differences between the individual jurisdictions.
- If you’re doing business primarily in a state and the headquarters is in that state, you probably want to form in that state, it’s just going to be easiest. Now, you can do the run around and get a registered agent and an office in another jurisdiction (Delaware is quite popular), but for your start-up this is just the easiest plan and it makes sense.
- Another major consideration in choosing a location is not just where you’re doing business but where you’re going to get the most support. Look at the local business community resources prior to starting operations. It’s a lot harder to start a business in a climate where the community won’t readily offer you the support you need to be successful. It really does take a village in this case.
- Why form a business entity? To protect your personal assets and individual liability
- Why should I go into business for myself? If you know the business and have a passion for it, as well as a desire to go your own way, it just makes sense. There are risks involved but getting professional help and advice can mitigate those issues as much as possible.
- Why do we, at Kreamer Law Firm, care so much about this? Because we’ve been there. We’re an award winning small business ourselves with over 30 years of experience in business law. We want to get things done for entrepreneurs who want to make their dream business a reality.
- That’s the easiest question of all. Start by weighing your options, see what you have out there for interest and support, and then come talk to us and we’ll be happy to help you out with all your business law questions and needs. It’s our passion and it’s what we do.
Well there you go, folks! The who, what, when, where, why, and how of getting your start-up off on the right foot. Always remember, just because it’s work doesn’t mean it can’t be fun, explore your passions and see what you come up with! Keep on fighting the good fight, and let me help you start your new business of music.
Listen to the podcast from Insight on Business the News Hour below!