Small Business Start-Up Guide
by Robert Sullivan
. . brought to you by The Small Business Advisor
you've decided you have the right stuff to be an entrepreneur and you're
anxious to get that new idea off the ground. Now let's ponder some of
the other considerations you'll need to look at. This chapter will give
you some recom-mendations about choosing a business that is right for
you. Then we'll look at the advantages and disadvantages of the types
of business legal structures (sole proprietorships, partnerships, corporations).
The last section looks at some of the legal requirements that can add
to the complexity of the process and of which you need to be aware before
you open your doors for business.
BUY, OR FRANCHISE?
are basically three ways to begin a business. You can start your own,
purchase an existing business, or invest in a franchise operation. There
are good reasons for each choice and each carries its own advantages
and risks. Most of us, however, will start our own because of the (usually)
small initial investment required. Purchasing an existing business or
a franchise can require a significant capital investment. The information
in this and other chapters is applicable regardless of the method you
choose for starting your business.
discussion of buying an existing business or a franchise is beyond the
scope of this book but considerable literature is available, some of
which is listed in the reference section at the end of this chapter.
However, a few words of caution are in order. You should have help from
an attorney and accountant who have experience with business purchases.
Do not do it alone no matter how good the deal looks or how much pressure
is being applied for you to "close the deal." Caveat Emptor ("let the
buyer beware") is what to remember when considering any purchase and
especially if it's a franchise.
are thousands of franchise opportunities, many of which are simply too
good to be true. Be cautious and get educated before you make any decisions.
Whether purchasing a business or franchise, the best advice is to investigate
EVERYTHING with great care. Once you have signed on the dotted line,
it's almost always too late for second thoughts. If you are considering
a franchise, look into the information that is available from the following
Franchise Association (IFA). 1350 New York Avenue, NW, Washington,
DC 20005. (202) 628-8000. Numerous books and pamphlets are available
ranging in price from $1.00 to $225.00. Website: http://www.franchise.org
Government Printing Office. Superintendent of Documents, Washington,
DC 20402. (202) 512- 1800. "The Franchise Opportunities Handbook."
$21.00. Ask for document #00300900649-0. You may pay with a credit
card. Website: http://www.access.gpo.gov Federal Trade Commission
(FTC). Bureau of Consumer Protection, Washington, DC 20580. (202)
326-2970. Free brochures covering franchise opportunities and questions
and answers about franchise operations. Website: http://www.ftc.com
fact that you're reading this book says that you probably want to own
and operate a business. In all likelihood you also have a good idea
of what that business will be. We'll give you some help to ensure you've
selected the business that's right for you.
Your business success will be directly proportional to how
much you love what you are doing.
the amount of effort you will need to expend as an entrepreneur to make
your venture successful, the business you select should be something
you love. There are lots of reasons why people choose to start a new
business. At the top of the list is dissatisfaction with their present
job. If this is your situation, try to understand why you don't like
your present job. This will help you select a business that will be
right for you.
a business because you have something to give, because you understand
the market and because you know you are going to do a better job than
anyone else. Don't pick one because you want to make a quick buck or
because the "deal looks just too good to pass up." If your heart and
soul are in the business, you have a much better chance of being successful.
business you choose should fit with realistic goals and an honest assessment
of yourself. The following checklist will help you decide on a business
that can be successful for you.
bought a fast food franchise because the opportunity looked too good
to pass up. It might have been, but Bruce knew nothing about the food
or restaurant business, and as far as I knew, didn't even like fast
food! Care to guess how successful he was? Or how long it lasted? Care
to guess what happened even though "all the details are taken care of
#2: CHOOSING A BUSINESS
THE BUSINESS LEGAL STRUCTURE
this the kind of work I really enjoy?
Look to your current interests. Many suc-cessful small businesses
grow out of hobbies because a hobby is chosen for all the right reasons
... you enjoy the task, the challenge, the time spent.
I have the required technical expertise?
Don't get involved in a business if you know little or nothing about
it. The story related above is a true one ... and one of many like
it. When you have the necessary technical expertise, you can ask the
right questions, make good business decisions and assess other "expert"
I make enough money in this business?
First, your financial goals should be realistic. Then look around
at similar businesses to see how they are doing. Talk to the owners.
Most will give you enough information for you to decide if it's right
for you financially. This will help you to pick a business that can
satisfy your financial goals.
I get the help I will need?
If your business is not going to be a one-person operation, you need
to find out if the right kind of help is available in your immediate
area. Are there similar businesses in the area? Also check with local
I understand the market?
Will you be able to find customers? Do you have the knowledge required
to set prices appro-priately? Will you be able to direct a marketing
program? (You might not do this yourself, but you may have to manage
you've chosen your business. What next? No doubt, one of the most asked
questions by the prospective business owner is "Should I in-corporate?"
To answer this question, we need to examine what the options are and
their respective advantages and disadvantages. So as not to keep you
in suspense, it should be noted that most new small businesses will
not incorporate - but will operate as a sole proprietorship.
you have three basic business structures from which to choose:
1. Sole proprietorship
2. Partnership (limited or general)
3. Corporation (S, C or LLC)
Another possible business structure is the Non-Profit Corporation. Since
this is a very special case and something usually not of interest to
the small business owner we won't discuss it in any detail. Anyone contemplating
a not-for-profit business should discuss the matter with informed legal
council since the process is complex. For more information search on
the Internet. We've also included a reference at the end of this chapter.
There is no "best choice" for a business structure.
legal structure you choose depends on a number of things, including
your type of business, individual situation, goals for the business,
and a number of other personal and financial factors. Before deciding
what's best for you, discuss your plans with your accountant and attorney.
Make sure you are prepared to describe your business plans in some detail.
It will be money and time well spent. Making the right choice can help
you avoid a mistake that can cost you big in terms of possible future
liability (See Chapter 7, Get Professional Advice).
you have any discussions with your pro-fessional advisors, it is useful
to understand the basics of the various legal structures available to
you ... sole proprietorship, partnership, and various forms of corporations.
is the most popular form of small business and, as the name implies,
ownership is totally vested with one person. It is the easiest to establish
since no legal formalities are necessary. The only business requirement
may be a license from your local jurisdiction to allow you to conduct
the type of business you are planning. For example, you may need a license
to sell food to the public.
and quick and usually the least ex-pensive to establish.
have total ownership and control of the business.
the profits of the business belong to you, the owner.
additional Federal taxation on business profits (No double taxation).
periodic business reporting to the IRS or other government agency
tax filing is simply part of your annual personal tax return (Schedule
owner is personally liable for all business debts and the liability
is not limited to the value of the business. You are personally liable
for any and all business debt you incur.
is generally more difficult to borrow money or obtain outside investment
than with other types of legal structures.
the owner is incapacitated for any reason, the business is likely
management responsibility is with the owner which can be a heavy burden.
must pay self-employment tax on the business net income.
IMPORTANT NOTE A "home business" is frequently a sole pro-prietorship
and offers a number of unique ad-vantages. However, just because
you are con-ducting business from your home does not exempt you
from possible legal or other liabilities. See Appendix III for a
listing of the advantages of a home-based business.
type of business is just what the name implies: Business ownership is
divided between two (or more) partners. The general partnership is the
most common and is formed to conduct a business with two or more partners
being fully involved in the operation of the business. All the partners
share both profits and liabilities. A limited partner-ship, as the name
implies, provides for limited liability of the partners. (This liability
can be no greater than the partner's investment in the partnership).
In a limited partnership there must be at least one general partner
who remains liable for all the debts of the partnership.
a partnership is complex and legal advice is very important. The kind
of partnership and the type of partner you will be determines your po-tential
as a result of pooling partners' different areas of expertise.
partnership does not pay Federal in-come taxes. An informational tax
return (IRS Form 1065) must be filed which shows the pass-through
of income/loss to each part-ner.
may be spread among the partners.
can come from the partners in the form of a loan which creates interest
income for the partners and a business deduction for the partnership.
and subsequent changes in structure are complex.
with partner(s) as the result of misunderstandings, different goals,
etc., can weaken or destroy the partnership.
partners are liable for debt if they are active managers in the business.
General partners have unlimited liability. You may also be liable
for the commitments of your partners.
are three major types of corporations, the C-corporation ("regular corporation"),
the S-corporation (or "S-Corp"), and the Limited Liability Corporation
(or "LLC"). All of these forms of the corporation are complex legal
entities. Their detailed structure may vary from state to state (incorporating
a business in a given state allows you to conduct business only in that
state). It is essential for you to obtain legal advice if you are thinking
about forming a corporation. (See Chapters 7 and 11). Since each state
has its own set of corporation laws, you should contact the appropriate
state office in your state (usually the office of the Secretary of State)
for additional material and procedures. A listing of these offices for
all 50 states is included at the end of this chapter. Most offices can
provide a guide for new businesses to follow for incorporation and doing
business in their state. Call or write for a copy.
people immediately think of incorporating in order to minimize their
personal liability. Indeed, the liability of stockholders (owners) in
a corp-oration is limited under certain and complex conditions. Today,
with the Tax Reform Act of 1986 and other legislation, there are really
few good tax reasons to incorporate (with the exception of dividing
corporate profits as noted below). The best reason for incorporating
is, in fact, the limited liability. However, there is no such thing
as total insulation from liability resulting from doing bus-iness as
keeping and tax matters with a corporation are difficult and time-consuming
tasks usually requiring the services of an accountant. You need to keep
this in mind when considering operating costs for your business.
the "do it yourself" incorporation guides. Incorporating is a complex
process and you should not take on the task yourself. You cannot afford
any mistakes at this point in your new business, so if you decide incorporation
is for you, do it right and spend the money required to have it done
professionally. Legal fees for setting up a corporation can run between
$350 and $1,500 (assuming it is relatively straightforward). See Chapter
corporation is a taxable entity and, as such, pays taxes. This results
in the "double taxation" you may have heard about. The corporation pays
corporate taxes on its profits, and then, you the owner (shareholder),
pay personal taxes on the dividends your corporation pays you. (The
dividends are not deductible by the corporation). This is one of the
biggest disadvantages of a corporation.
other hand, incorporating your business usually makes it easier to establish
credit with suppliers and borrow from banks. If you expect to use outside
investors for business capital, a corporation is a must.
(the owners) enjoy personal limited liability.
is generally easier to obtain business capital than with other legal
may be divided among owners and the corporation in order to reduce
taxes by taking advantage of lower tax rates.
corporation does not dissolve upon the death of a stockholder (owner)
or if owner-ship changes.
tax treatment for employee fringe benefits including medical, disability,
and life insurance plans.
of any dividends received by the corporation from stock investments
are deductible (unless you purchased the stock with borrowed money).
expensive and complex to set up than other legal structures.
tax returns usually requires the help of an accountant.
taxation on profits paid to owners (corporation pays corporate taxes
on profits and owner pays personal taxes on dividends from the corporation).
annual corporate fees.
rates are higher than individual rates for profits greater than approximately
accumulated earnings tax on profits in excess of $250,000.
losses are not deductible by the corporation.
The S-corporation offers the limited liability advantages of a corporation
but does NOT pay Federal taxes. All the earnings and losses of an
S-corporation are passed through to the share-holders. It is a popular
form of incorporation in the startup years of a business but there
are some subtle disadvantages that need to be taken into account
as you grow. Again, because of the complexities involved, talk with
your attorney and accountant.
enjoy personal limited liability as in a regular corporation.
No Federal income tax liability, and in most cases, no state income
Profit/losses are passed to owners ... no double taxation.
The S-corporation does not dissolve if one of the owners dies
or otherwise leaves (like a regular corporation).
Wholly owned subsidiaries are permitted.
LIABILITY CORPORATION (LLC)
Legal assistance is required to set up.
Maximum of 75 shareholders.
Only one class of common stock is permitted (no preferred stock).
This type of corporation blends the tax advantages of a partnership
and the limited liability advantages of a corporation. Owners of
an LLC are referred to as "members." As you might expect, it also
has some limitations but is definitely worth con-sidering. Ask about
the LLC when you contact your appropriate state office for incorporation
infor-mation as suggested earlier in the chapter.
Limited personal liability for the owners (like a corporation
and unlike a partnership).
No Federal taxes (like a partnership).
No limit on the number of stockholders (un-like an S-corporation).
More than one class of stock is permitted (unlike an S-corporation).
Business losses may be deducted on your personal tax return (like
Legal assistance is required to set up. The paperwork is complex.
No "continuity of life" as in a regular corp-oration. The LLC
dissolves if one of the owners dies or otherwise leaves. However,
other formal agreements between the owners can overcome this.
Some states require than an LLC have more than one member.
As already noted, it is difficult to give specific advice as to
the choice of legal business structure since every situation will
be unique. The ad-vantages and disadvantages noted above should
be assessed based on your particular situation. In any case, it
is important to discuss your plans with advisors including both
an attorney and an ac-countant prior to making your final decision.
The various tax consequences for corporations and partnerships are
complex and must be carefully considered for each specific situation.
When discussing your plans with your advisors, keep in mind the
LLC is well worth looking into.
taxes is one of the most important reasons to consider when selecting
your structure. Keep in mind that there are generally few tax advantages
with a corporation if your total taxable business income is more than
select the corporation structure based on possible tax advantages
of profit-sharing plans since the Keogh, SEP, and IRA plans available
to a sole proprietorship are equally beneficial.
you consider a partnership, be certain to have a complete partnership
agreement drawn up by your attorney. (See Chapter 5).
an S-corporation if you expect business losses for the first year
or two of your business. These losses can be passed through to the
owners as tax relief whereas they provide no current benefit in a
There are a number of other items that must be addressed when starting
your business regardless of its structure and type. Before conducting
any business activity, review the following listing lest you get
yourself into legal trouble or, at the very least, become liable
for various fines. Once again, it is a good idea to review these
items with your attorney and get help where required.
checklist of business legal requirements is excerpted from "Starting &
Operating a Business in [state]" and reprinted here with permission from
The Oasis Press® and M. D. Jenkins. It provides an excellent summary of
those items that need to be considered when starting a business in a specific
state. (The chapter numbers shown in parenthesis refer to chapters in
this guidebook where additional information on that item may be found.)
Some of the material below duplicates the requirements listed in the IRS
publication checklist shown above.
licenses and permits.
Depending on your type of business, Federal, state, county, and local
business licenses and/or permits may be required. It is impossible
to list all the specific requirements by business or jurisdiction.
You should first check on your state's requirements by contacting
the appropriate state office or agency. (See the listing at end of
this chapter). They may also be able to assist you with the local,
and possibly the Federal requirements. Then check with your local
city or county government offices (usually in the courthouse) for
information about local requirements. Don't overlook this, since heavy
fines are usually associated with conducting a business without proper
licenses and permits.
Give some careful thought to the name of your business. You should
select more than one possibility since you may not be able to use
your first choice. You cannot and should not use a name already in
use. Most states will allow you to "reserve" your desired name for
a short period of time in order to allow you to complete other required
paperwork. The state office can tell you if your selected name is
in use and suggest you pick another one, if necessary. You should
also check with your local county clerk to see if the name you picked
is being used locally. In any case, you do not want your business
name confused with another for a variety of obvious reasons. Some
states require you register for a "fictitious name" if the name of
your business is something other than your own full legal name (e.g.,
"Robert Sullivan Consulting Services"). The cost to register varies
but is generally between $10 and $100. Check with your local government
for specific requirements.
You will be required to make periodic estimated Federal and sometimes
state tax payments regardless of your business legal structure. The
requirements vary and you should discuss the matter with your accountant.
Don't be late in filing since penalties accrue.
IRS reporting requirements.
There are a large number of IRS reporting requirements that you need
to be aware of since penalties can be severe. These include such requirements
as the filing of different types of Form 1099 for payments to individuals
and reporting different kinds of income. It is very important for
you to discuss what requirements must be met with your accountant.
of sales tax.
If your business will be selling goods to end-user customers (the
public), it is likely you will have to collect sales tax for the state
and/or local government. Check with your local government offices
on this one ... every state is different. You will probably have to
apply for a sales tax identification number that will identify you
to the local and state government as a seller of goods. The process
is easy and usually no cost is involved. There can also be monthly
NEW BUSINESS LEGAL REQUIREMENTS
reading over the previous list, you'll have a better understanding
of why it's important to talk with both your attorney and accountant.
Remem-ber, also, that there may be additions to this list for certain
states. You should check with your own state (see listing below) for
specific compliance requirements necessary for your type of business.
Also refer to Chapter 12 for additional requirements if you are going
to hire employees.
local business licenses.
Check on local zoning ordinances, regulations, and other land
Determine if your particular business requires a state license
to operate (3).
Determine if any Federal permit or license is required (3).
Be prepared to make estimated income tax payments almost immediately
after starting business or incorporating.
Apply for a sales and use tax seller's permit if you will sell
tangible personal property.
File sales and use tax returns, if sales or use tax must be collected
on your sales.
File with the county clerk and "publish" a fictitious business
name statement, if the business operates under a fictitious name,
and then file an affidavit of publication with the county clerk
(in most states).
Locate a good insurance agent or retain and meet with an insurance
consultant regarding fire, accident, liability, theft, and other
types of commercial insurance you need. Then obtain the necessary
insurance coverage (11).
If you purchase real estate, you must withhold up to 10% of the
purchase price and remit it to the IRS if the seller is a foreign
individual or foreign owned company, under the Foreign Investment
in Real Property Tax Act. Otherwise, you should insist upon receiving
an affidavit that the seller is not a non-resident alien, with
his or her taxpayer identification number, unless you are certain
that he or she is a U.S. citizen or resident.
For a sole proprietorship, report any self-employment income on
Schedule SE of Federal Form 1040, and report income or loss on
Schedule C of Form 1040.
A partnership files Form 1065, to report partnership income. Each
partner reports their portion of the partnership's income on Schedule
SE of Form 1040 and income and loss from the partnership on Schedule
E of Form 1040.
For a limited partnership, file a Certificate of Limited Partnership
with the Secretary of State and copies in counties where the partnership
will have places of business or real estate (in most states).
For a corporation, file articles of incorporation, adopt bylaws,
and observe the necessary corporate formalities. File Federal
income tax return Form 1120 (or 1120-S for an S-corp). If property
is transferred to the corporation tax-free under IRS Section 351,
report required information relating to the transfer on the corporation's
income tax return for that year.
For a corporation or a partnership, apply for a Federal Employer
Identification Number on Form SS-4, even if the business has no
File annual tax information returns, Forms 1096 and 1099 series,
for payments of $600 or more for items such as rent, interest,
and compensation for services, and send 1099's to the payees.
File Form 1098 for mortgage inter-est of $600 or more your business
receives in a year from an individual. Also, report any cash payments
or cash equivalents of more than $10,000 that you receive to the
IRS within 15 days. Such filing may have to be done on computer-readable
If your business is a corporation, be sure to ob-tain an adequate
supply of Federal tax deposit coupons in time to make your estimated
OFFICES FOR INCORPORATION INFORMATION
or call the office in your state and request their guide or brochure
covering corporation registration. The literature you receive will most
likely contain other information about doing business in your state
such as Federal Employer Identification Numbers (EIN), various tax liabilities,
and other licenses and permits that may be required.
Also refer to Appendix VII, State Specific Infor-mation, which lists
a number small business related organizations in each state.
your business with care and do it for the right reasons. You will be
working hard at your new venture and love of your work is important.
Obtain professional advice before selecting a sole proprietorship, partnership,
or corporate structure for your business. Ask your professional advisor
(attorney, CPA, etc) questions like:
do not begin any business activities until your business legal structure
has been formalized and you've attended to the requirements discussed
in the previous sections.
What legal structure is best for me? Why?
What is my worst case personal liability?
How complicated is it to form this structure? How much will it
What is required in terms of Federal and state tax returns?
What are the tax consequences for me personally?
How will the structure affect hiring of personnel?
How will the structure affect the raising of capital?