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Session 5: Business organization

OBJECTIVE: When you have decided which business is right for you, you will have three important decisions to make. In this session you will discover: whether to go into business alone or with a partner; the type of business organization to use; and what professional advisors to select.

      Business organization

Should You Have a Partner?

John Powers Attorney-at-Law John Powers
Attorney-at-Law
Play Video
Do you have any recommendations on how one should go about evaluating the pros and cons of taking on a partner?
It is best to make your decision concerning whether to have a partner by preparing a "for" and "against" list. The most common reasons for joining with another person to start the business:
  • There is safety in numbers. In other words, you have two heads instead of one to discuss and make decisions. In the words of Solomon: "Two can accomplish more than twice as much as one. If one fails, the other pulls him up; but if a man falls when he is alone, he's in trouble. And one standing alone can be attacked and defeated, but two can stand back-to-back and conquer. Three is even better, for a triple-braided cord is not easily broken."
  • You will not need to be at the business at all times. You will have someone else who will be there to share the load and permit you to take a vacation and have sick time.
  • You will also have a highly motivated co-worker, not just someone who is earning a paycheck.
  • Partners can also be advantageous when they have complementary skills.
  • It may be necessary to have a partner to contribute capital and share the risk when things do not proceed as planned.
  • A partnership should have provisions made for exit strategies and you will need experts experienced in succession planning. What happens if a partner dies or becomes disabled? Or if family members want to join or quit the firm? In our Building My Own Business course, Sessions 14 Selling your business and session 15 Considerations for family succession can provide important insights and who to call upon for advice.

Some of the arguments against having a partner:

  • You will have to share the rewards if the business is successful.
  • You will lose total control over the business, particularly if you and your partner have difficulty in making decisions.
  • You will have to share the recognition that will come if the business is successful.
  • A partner can be a disaster if his or her judgment is not good.
  • You run the risk of a falling out and perhaps the necessity of one partner buying the other out if dissention arises.

Some of the things to consider in deciding whether a particular person will make a good partner are whether you have similar work habits, similar objectives concerning how to run the business and whether your strong points are similar or complementary. For example, different capabilities permit you to spread the workload and provide better coverage for problems.

Different capabilities may permit you to give each partner a veto over important decisions in his or her area of expertise to help maintain stability and eliminate conflicts. Finally, you may want to consider whether you should have a buy-sell agreement in the event of a disagreement, and how the purchaser will pay for the portion of the business he or she is buying (and whether you should fund the buy-sell agreement with insurance in the event of the death of a partner).

What Type of Business Organization is Best for You?

Gary Hobday Secured Retirement, Inc. Gary Hobday
Secured Retirement, Inc.
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Looking to the retirement future is very important.
Whether you are going it alone or with another person, it is best to consult a lawyer to determine which form of business organization will be best for you. Your choices and the benefits of each form are essentially as follows:
  • Sole Proprietorship: A sole proprietorship is one person alone. He or she will have unlimited liability for all debts of the business, and the income or loss from the business will be reported on his or her personal income tax return along with all other income and expense he or she normally reports (although it will be on a separate schedule). Although proprietorship avoids the expense of forming a partnership or corporation, many start businesses this way because they are unfamiliar with the other forms of organizations.
  • General Partnership: In a general partnership, each of the two or more partners will have unlimited liability for the debts of the business. The income and expense is reported on a separate return for tax purposes, but each partner then reports his or her pro-rata share of the profit or loss from the business as one line on his personal tax return.
  • Limited Partnership: With a limited partnership, each of the general partners has unlimited liability for the debts of the partnership, but the limited partner's exposure to the debts of the partnership is limited to the contribution each has made to the partnership. With certain minor exceptions, the reporting for tax purposes is the same as for a general partnership.
  • Corporation: A corporation provides limited liability for the investors. Except as indicated below, none of the shareholders in a corporation is obligated for the debts of the corporation; creditors can look only to the corporation's assets for payment. The corporation files its own tax return and pays taxes on its income. If the corporation distributes some of its earnings in the form of dividends, it does not deduct the dividend in computing its taxes, but the shareholder recipients must pay taxes on those dividends even though the corporation has paid taxes on its earnings. A corporation has some tax benefits such as deductibility of health insurance premiums.
  • Robert ODell E-Information Strategies Robert O'Dell
    E-Information Strategies
    Play Video
    What kind of structure is right for a home based business?
  • "S" Corporation: A corporation that has made an election to be an "S" Corporation for federal income tax purposes is treated as a partnership for tax purposes, although it is treated as a regular corporation for other purposes.
  • Limited Liability: A limited liability company provides limited liability for all of its members, but typically can be treated as a partnership for federal income tax purposes. State laws may differ as to whether it is treated as a partnership or a corporation for state income tax purposes. It can be managed by all of the members or can have centralized management in one or more of the members. For details on all options available for federal income tax purposes, please visit the I.R.S. Web site page: www.irs.gov/businesses/small/article/0,,id=98359,00.html.

Obviously there are variations in these rules, and you should consult with your attorney and/or accountant in each specific case to determine what form of organization best fits your needs.

One of the things to consider in making the final decision is, although a corporation has limited liability for its shareholders, if the corporation does not have sufficient assets various creditors may insist on personal guarantees from the shareholders. Examples are your landlord, some suppliers, and by law, liability for certain payroll taxes and liabilities to employees.

Laws That May Affect You

Stan Henslee CPA Stan Henslee
CPA
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What are some of the most common mistakes you see with people going into small business?
There are many laws that are applicable to owners of small businesses. It is best to consult with professionals to determine which laws will be applicable to you, what permits you will need to commence business and where to go to comply with the various rules. Your attorney should be able to assist you in complying with labor laws such as the employment of minors, illegal aliens and workplace safety rules. Your accountant should be able to assist you in filing:
  • Income tax returns
  • Franchise tax returns
  • Employment tax returns
  • The time for payment of withheld and employers share of employment taxes
  • Unemployment tax returns and payment

Sales Tax Reports and Payments Take a look at our Small Business Tax Center created in association with the I.R.S.

Your attorney may be able to help with requirements for business licenses, including special licenses for particular businesses as well as building codes and permits for remodeling and zoning laws, health department requirements and environmental laws.

How Can Your Professionals Help You?

B.J. Adelson Lawyer B.J. Adelson
Lawyer
Play Audio
If you get advice from a professional, listen to him or her. He or she probably knows better than you do.
Your Attorney
In addition to the above items, your attorney should draw your partnership agreement or form your corporation, including the issuance of stock and appropriate filings with the Secretary of State and the Department of Corporations. He or she will help advise on the best form of ownership, assist in negotiations to buy an existing business and review documents if you are buying a franchise. He or she will also advise on buy-sell agreements and draft appropriate documents.

If your business will require renting an office, store or factory, your attorney should review and approve your lease document. A lease obligation can become your biggest liability, and your attorney can help negotiate fair and protective terms. For example, if you anticipate growth, your lease should include a provision for how expansion requirements will be handled.

Your new business may require specialized legal advice to establish and protect your intellectual property rights. Intellectual property includes your ownership rights to your business name, trademarks, copyrights and patents. Intellectual property law is a specialized field, and you may need an attorney who specializes in these matters.

Your Accountant
Your accountant can be an important advisor in start-up decisions, such as

  • Deciding the appropriate division of the capital you contribute to a corporation between stock and loans.
  • Determining the best form of ownership.
  • Helping set up the books and records of the business.
  • Advising computer needs for accounting purposes.
  • Filing tax returns, advising on compensation of owners, preparing financial statements, helping forecast cash needs, including whether to expand, addition of employees and determining profitability.

He or she will have a continuing role in filing tax returns, advising on compensation of owners, preparing financial statements, helping forecast cash needs, including whether to expand, addition of employees, and whether you are really making money in this venture.

You will need to decide with your accountant what kind of financial statements are prepared. There are several audit levels that are described in our session one "Getting financial controls in place" in the Building My Own Business course.

Ken Blake CPA Ken Blake
CPA
Play Video
What are the benefits to outsourcing payroll?
Your Payroll Service Provider
All entrepreneurs face the dreaded question, "How am I ever going to handle my payroll, payroll taxes and comply with ever-changing state and federal laws?"

Thanks to efficiencies achieved through computer technologies, a huge industry has emerged to take over increasingly complex payroll issues. "Payroll Service Providers" now permit small businesses to outsource these functions at very low costs. Now the start-up entrepreneur, even with a payroll of one person, can "outsource" his or her Human Resources department.

There are many payroll service providers listed in the Yellow Pages and on the Internet (go to "payroll service providers" on search engines.) In recent years, payroll service providers have expanded their services to handle other personnel issues as well, such as managing retirement plans, workers compensation insurance and pre-employment verification. Many payroll service providers incorporate services such as

  • 401K and Simple IRA
  • Business Tax Protection & Payment
  • Health Insurance
  • Human Resources Help Desk
  • Human Resources Software
  • New Hire Reporting
  • Pay-by-Pay Workers Compensation Insurance
  • Payroll Tax Calculation, Deposit and Filing
  • Pre-Employment Screening/Background Checks
  • Reporting Solutions
  • State Unemployment Insurance Management
  • Time and Attendance Solutions

Your Pension Plan Manager
As a business owner, you can participate in the benefits of tax-deferred pension plans for yourself and your employees. Good pension planning will help you attract and keep good employees. Some payroll service providers now handle pension plan management.

Your professionals can also be of significant assistance in helping formulate your business plan by advising on

  • The appropriate form of organization.
  • Roles of each partner, such as the control of each party.
  • The areas in which each will have primary responsibility and the ownership of each party.

In connection with the acquisition of an existing business, they should advise on good and bad terms of the proposed deal and help negotiate with the seller and his or her attorney.

Finally, they should advise on your need for capital, both at the inception of the business and what additional capital will be needed if the business is successful and you decide to expand.

Your Pre-employment Screening Service
Pre-employment screening is especially important when you are starting because you don't have ongoing revenues to offset mistakes. Many start-ups skip screening because they're unfamiliar with it or don't know how to have it done at a reasonable cost. Unfortunately, this can open them up to resume fraud among other undesirable possibilities. A good example of a reputable and inexpensive source for conducting background checks is EmployeeScreenIQ. (Make sure to use this form to get $25 off for MOBI users). Also, many tips on how to go about the hiring process can be found through search engines by entering "hiring tips."

Consider Outsourcing
As an entrepreneur, your time should be focused on building up your business. A good way to do this is to outsource all the administrative and specialist tasks to external professionals. We recommend using a service like BPOVIA to help with this.

Suggested Activities

  • Before you start up, collect referrals to and references about lawyers, accountants and insurance agents so you can select the most appropriate professional advisors well before the time you will need their services. Perhaps they will provide you with initial free consultations for considering them as members of your professional team.

Top Ten Do's and Don'ts

THE TOP TEN DO'S
  1. Use a "For" and "Against" list when deciding if and whom you should have as a partner.
  2. If considering a partner, look for someone with complementary skills to your own.
  3. If you take on a partner, have a buy-sell agreement in place before you start.
  4. Consult with a lawyer when deciding on what form of business best suits your needs.
  5. Use an intellectual property lawyer to protect your intellectual property rights: your trade name, company name, logo, etc.
  6. Outsource your payroll responsibilities to a payroll service provider.
  7. Establish a tax deferred pension plan for yourself and your employees.
  8. Collect referrals about lawyers, accountants and insurance agents before retaining them.
  9. Use your attorney to assist you in maintaining compliance with changing labor laws.
  10. Join a local service organization such as the local chamber of commerce.
THE TOP TEN DON'TS
  1. Use a general partnership if you intend to limit your liability.
  2. Start a corporation without the help of a qualified attorney.
  3. Sell stock in a corporation without an attorney and governmental approvals.
  4. Fail to pay your payroll tax liabilities on time. You are personally liable.
  5. Sign a lease or important agreements without your lawyer's advice.
  6. Start your business without retaining an accountant and having an accounting system in place.
  7. Start a business with a handshake agreement.
  8. Become a general partner without understanding the unlimited liability incurred.
  9. Rely on your corporation as protection from personally guaranteed liabilities.
  10. Fail to take the advice of your lawyer and accountant seriously.

Business Plan for Session 5: Business organization

We heartily recommend that you download the individual business plan template for this session and complete it now:

Section 5: Organization
doc MS Word

Instructions on filling in the business plan template:

  1. Each box has a permanent title in CAPITAL LETTERS.
  2. Below each title is a sentence starting with an "Insert here" sentence. This will suggest information to insert. The boxes will expand as you take up more room so use all the space you need.
  3. After completing each box, delete the "Insert here" sentence, which will leave only the permanent title of the box and the information you have inserted.
We suggest that you fill in each section of the business plan
as you proceed through the course.

The full template for all sessions 1-15 can also be downloaded into your computer as a single document:

Section 1-15: (Full Business Plan Template)
doc MS Word

Include sufficient research findings and background materials. Make it interesting by the use of background data, your biography, charts, demographics and research data. When your business plan is completed, print off and assemble the 15 sections.

Many other business plan formats are available in libraries, bookstores and online.

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