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Smart accounting for growing companies
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- Rules Regarding Independent Contractors
In today’s free market world, more and more companies are hiring people as independent contractors rather than as employees. The big reasons? To save payroll taxes and benefit costs, which together can add an extra 20% to the cost of having an employee. If you’re considering using this strategy, keep in mind that the IRS has criteria for determining independent contractors vs. employees and that penalties can result if you don’t follow the rules. The following three criteria are generally considered to be the most important:
1) Behavior Control. Who decides when, where and how the work is performed? Who decides what tools/equipment to use? If additional staff is needed to help with the job, who hires them? If the worker has control over these decisions, then he/she may be considered an independent contractor. (Example: a case involving carpet installers found that they were independent contractors because they, not the flooring services company, determined the manner and sequence in which jobs were completed. They also used their own tools and hired their own “helper” work force.)
2) Financial Control. Who pays the operating expenses for the work to be performed (i.e. supplies, computer, travel expenses)? Is the worker free to perform services for other companies and/or the public? If the worker controls these decisions, then he/she may be considered an independent contractor. (Example: the carpet installers mentioned above were considered independent contractors because they purchased their own supplies, held the risk of profit or loss on their jobs, and were free to work without penalty for other companies.)
3) Relationship Factor. Who determines the working relationship of the parties? Is the worker provided with employee-type benefits such as insurance, vacation pay or sick pay? Obviously, these types of benefits are only paid to employees, not contractors.
As you can see, the rules are complex and leave some room for interpretation. If you want to increase your chances of convincing the IRS that a worker is in fact an independent contractor, you can take the following steps:
1) Create a simple contract documenting the independent contractor relationship (you can purchase a blank form from Nolo Press). You may wish to specify in the contract that the worker is responsible for his/her own insurance (including workers’ compensation).
2) Pay for work by the job instead of by the hour, the week or the month.
3) Have all workers submit invoices for work before paying them.
4) Don’t forget to complete IRS Form W-9 (Request for Taxpayer Identification Number) when you first start working with a contractor (you’ll need this info. for your year-end tax filings).(Sources: IRS, American Express Small Business, Quickfinders)
- Business Dashboards
How would it feel if you could turn on your computer every morning and immediately have a complete, real-time picture of your company’s financial performance? Not only that, but what if the information was presented in an easy-to-understand, visual manner (i.e. gauges and graphs) as opposed to the usual bunch of lifeless numbers? That is the basic idea behind business dashboards, a promising management tool that is gaining more attention in the business world these days.
In the realm of online accounting, NetSuite is leading the charge with a customizable dashboard that allows managers to view things like sales, new orders, even your daily calendar (part of the company’s mantra: One System, No Limits). Of course, you have to be a NetSuite customer to use it. If you are an accountant, Principa offers a powerful and easy-to-use dashboard that can help your customers monitor how they are performing against targets and cash flow projections, perform simple “what-if” analyses, and more. (Note: if you are a business owner and would like to learn more about this service, you can contact the ultra-friendly folks at Principa and they will be happy to help you find a member of their organization.)
Whether or not you have a business dashboard on your computer, the important thing to remember is this: the best way to improve your company's financial performance is to sit down and establish some basic financial targets, then consistently measure and monitor your progress toward those goals. That right there is the simple principle behind the dashboard concept. You don't necessarily need a computer program to do this, but you do need a disciplined approach. In our experience, approximately 90% of businesses never follow this basic "measure and monitor" strategy (either because they're too busy or because they don't know how). The 10% that do tend to be the companies that consistently outperform their peers in the same industry (i.e. the star performers).
- Advice For Selling Your Business
Thinking of selling your business? One of the first things you should know is that the process is far from a precise science. For example, business valuations can vary greatly depending upon the type of business, the valuation method used (there are several), and a variety of financial factors (which generally boil down to three things: assets, profits and/or cash flow). As if that weren’t enough, sometimes the most important factor in a company’s sale has nothing to do with the numbers- instead, it relates to the buyer’s motivation. (Case in point: eBay just paid $2.6 billion for Skype, the free internet phone service that has revenues around $60 million and isn’t expected to break even until the end of 2006. Why? The folks at eBay plan to use it to make buying and selling easier for their 157 million users.)
Although the process may seem bewildering at the outset, all in all it’s a lot less confusing and stressful than the experience of starting a business in the first place. If you survived that, you can definitely handle this. As with many things in life, the first step is to focus on the big picture. To help you get started, here are a few simple suggestions:
1) Start early. If you can, start the process three years ahead of time. Business brokers report that 99% of the businesses they list for sale are not properly prepared to be sold. Starting early will give you time to fix problem areas (outdated inventory, unprofitable product lines, poor staffing, etc.) and clean up any possible tax/legal/ownership issues.
2) Systemize your business. A company with an owner’s manual (i.e. a well-documented set of systems and procedures) will always get a higher price than a company without one. Furthermore, a systemized business is less dependent upon the personal involvement of the owner(s) and thus more attractive to potential buyers.
3) Optimize your financial performance. When somebody buys a business, they’re basically buying a stream of earnings. Obviously, the numbers are an important part of the overall story. Make as many financial improvements as you can leading up to the sale and you’ll be able to paint a much better picture for potential buyers.
4) Think of business valuation as a starting point. It’s rare that buyers and sellers come up with the same figure for a company. Naturally, the buyer wants a lower price and the seller wants a higher one. Your goal should be to come up with a ballpark figure that can be used as a starting point for negotiation. The ultimate goal: to come up with a price that both sides can live with.
- Overview of Types of Financing
One of the biggest challenges that successful entrepreneurs face is: how to find money so that you can keep growing. For example, if you are a growing retailer you may need additional capital to open new stores or bring on new product lines. For companies who are just getting started, here is a basic overview of the different types of business financing.
Bank loan
What is it? A bank loan is usually the first step for business owners who need additional capital. Bank loans and credit lines are generally the most cost-effective ways to finance a business.
Getting started: Look for a lender who knows your business, industry and financial needs. Independent community banks are often more approachable than the big national banks. The bank will request a business plan that documents why the company needs the loan and how it will repay it.Line of credit
What is it? A line of credit is a type of loan (often called a revolving line) that allows the borrower to tap into money without having to file a new loan application each time funds are drawn. Credit lines are set for a fixed amount and may be either secured (no collateral) or unsecured (collateralized). They are generally established for one year and are reviewed by the bank on an annual basis.
Getting started: Lenders want to see a documented financial history of a company before issuing a line of credit. Before they grant lines of credit, banks want to see that a company is moving forward financially and has a game plan for the future.SBA Loans
What are they? U.S. Small Business Administration loans are federally backed loans for small businesses (i.e. the U.S. government guarantees between 70 percent and 90 percent of the loan, making it far less risky for the bank). The loans are normally repaid in equal monthly installments that include both principal and interest.
Getting started: While the SBA sets the guidelines for the loans it guarantees, businesses should go to lenders that offer these loans rather than to the agency itself. Choose the lender carefully- some have specialties. For a list of lenders, check out the SBA web site.Factoring
What is it? Factoring refers to the process of selling your accounts receivable to a third party lender (or factor) in exchange for cash. Factoring is often used by cash-hungry businesses who have a large portion of their working capital tied up in accounts receivable. Commissions typically range from one percent to ten percent, depending upon the particular service and risk.
Getting started: Go to one of several companies that specialize in factoring. Most traditional commercial banks usually do not offer it; however, they should be able to make referrals.Private Placements
What is it? A negotiated sale of stocks, bonds or other investments to institutional investors. The buyers are usually a select group of sophisticated investors.
Getting started: Develop an explicit business plan and gather the right team of professionals to help the firm find its way through the financing maze. Certain banks or investment firms that have experience in doing private placements can be good resources.Venture Capital
What is it? Venture capital is private funding supplied by professional firms who have a knack for ferreting out high-risk but potentially high-reward investments (often associated with technology-related companies). Venture capitalists are not lenders, but instead typically take an equity stake in the business and play an active role in its management.
Getting started: A variety of sources around the country continually seek out promising companies. Many large banks now venture capital divisions. Most venture funds are highly specialized to finance only specific industries and growth stages, so it's important to approach the right firm.(Hat tip: Cash Flow Blog)
- Understanding Your Total Business
Ram Charan is a well-known business advisor to CEOs and business executives in companies ranging from start-ups to the Fortune 500. He has a rare gift for translating complex ideas into simple terms that everybody can understand. Here is an excerpt from his classic book, What the CEO Wants You to Know. These basic questions are designed to help you step back and get a picture of your company's "total business."
1) What were your company's sales during the last year?
2) Are sales growing, declining or flat? What do you think about this growth picture?
3) What is your company's profit margin? Is it growing, declining or flat?
4) How does your margin compare with competitors?
5) Is your company's cash generation increasing or decreasing? Why is it going one way or the other?
6) Is your company gaining or losing against the competition?If you can answer these questions, you will have a good grasp of the fundamentals for your company.
- Lame Tagline for Ernst & Young
Ernst & Young is featuring a new slogan in their advertising: "Quality In Everything We Do." Hmmm, that sounds eerily reminescent of a tagline that a major U.S. automaker used back in the 1990's. Maybe I'm missing something, but isn't the "quality" promise supposed to be a given? Plus, in typical corporate fashion the tagline says nothing about customers or their aspirations- it's all about the firm. Anyway, it's great to finally see some bold thinking from one of the Big Four CPA firms, as opposed to just recycling used marketing ideas from twenty years ago.
- WalMart's Pricing Strategy
In a recent program, PBS' Frontline examined the inner workings of WalMart. One of the most interesting revelations had to do with the company's pricing strategy, which was pioneered by legendary founder Sam Walton. The strategy is known as "opening price point," and here's how it works.
WalMart goes to great lengths to have an alluring and unbeatable opening price point item in each category- from TV sets to cosmetics to bathing suits. These are the "unbelievable" prices that the company has become famous for (for example, a microwave oven for $14.67). The psychological impact of this opening price point is huge- consumers are led to believe that all of WalMart's prices are this low. However, the reality is quite different. As confirmed in interviews with former store managers, WalMart does not have the lowest price on every item in every category. In fact, the company often has higher prices than other big retailers (i.e. you might get a better deal down the road at Target). However, in most cases the game is already over because consumers believe that WalMart's prices are lower across the board. Furthermore, evidence shows that most shoppers don't even buy the opening price point item. Instead, the low price lures them into the department, where they end up buying a brand name or higher quality item that they are more comfortable with.
So here's the point: as described in another post (Profit Drivers), pricing is one of the single most important factors that determine your company's profitability. In fact, price will always have an impact that is two or three times greater than the other drivers. As a result, this cunningly simple strategy is one of the major reasons that WalMart has become the largest retailer in the world. The moral of the story? Pay close attention to your pricing strategy, it has a huge impact on the bottom line.
- Blink Accounting
In his new book, Blink- The Power of Thinking Without Thinking, Malcolm Gladwell encourages readers to use less information when making decisions. The trick, he says, is to filter out the irrelevant and focus on the meaningful. What on earth does this have to do with accounting? Plenty. Here's why: one of the biggest challenges with accounting is not getting mired in all the details. The simple truth is that most companies don’t need more data and reports- they need less, so that they can focus on the big picture. That's why things like key performance indicators (KPIs) are much more useful to business owners than financial statements: because they provide at-a-glance feedback on how the business is performing. Blink.
- The Five Stages of Growth
Here is an amazingly simple idea that can help business owners figure out what it will take to help their company reach the next level of growth. It's called the Business Life Cycle.
The concept is relatively straightforward: there are five distinct stages that most businesses go through as they mature. Each stage of the cycle poses a different set of challenges and requires the owners to apply a different set of skills and resources in order to ensure the continued success of the business.
Stage One- Existence
The first stage is known as the Existence phase. During this time, the major goal is simply to get the business up and running. Owners are required to be entrepreneurial and hands-on during phase one. They supervise everything directly and business systems are minimal to non-existent. The emphasis here is on producing products or services and selling them, period. (A sobering note: 75% of businesses fail during stage one.)Stage Two- Survival
During this phase, the business is experiencing moderate sales growth but is still in jeopardy of failing. The founders are still running the company and there is minimal emphasis on management systems, planning, etc. Problems that occur during this stage include conflicts between founders/partners in the business, working capital shortages, and temptation to diversify into unrelated businesses.Stage Three- Success
At this stage, the survival crisis has been solved and a leader has been chosen (usually a strong salesperson or inventor/designer). The company is profitable and more attention is being given to formalizing business functions. Companies in this phase often rely upon a small number of customers for most of their revenue. Problems that occur during this phase include the following: access to the leader becomes increasingly difficult, key employees become disenchanted and leave, reactionary planning is the norm, and financial reporting and control systems are inadequate for sales volumes.Stage Four- Take Off
At this phase the company has achieved a track record of sustained profitability and has resources for growth. There is a professional management team in place and a strong emphasis on organization. The company has a solid financial base. The problems that occur during this phase include the following: senior management feels they are losing control of day-to-day operations, increased vulnerability to inside factors (such as politics, bureaucracy, culture), slow reaction to new business opportunities, and increased threats from strong competitors.Stage Five- Resource Maturity
At this stage the company has extensive systems in place and the primary goal is maximizing the return on investment (or ROI). However, companies in this stage may have started to lose their competitive edge. There may be a lack of new ideas and a trend of eroding profitability. As a result, owners may feel frustrated or bored and may want "out" of the business. At this stage, the biggest challenge is for the company to innovate and renew itself (i.e. sort of like going back and becoming a stage three company all over again).Conclusion
So, what good does it do to know about the five stages of the business life cycle? One of the biggest advantages is simply psychological. Identifying what stage your business is in right now can help you understand that many of the problems and frustrations you're experiencing are typical. In fact, all growing companies face them. So don't worry, you don't need to start taking anti-depressants.Equally important, knowing what stage your business is in can help you determine what skills will be needed in order to reach the next level. If your company is struggling with the "classic" symptoms of one of the stages and is having a tough time breaking free, then it might be time to make an investment in new skills or start looking for external sources who can help. (Source: Principa)
- Key Performance Indicators
One of the keys to effective financial management is to regularly monitor the "critical factors" that determine the success of your business. Financial statements aren't great for this purpose because they can be complicated and time-consuming to prepare. Instead, what most companies need is a short list of key measures that they can look at on a regular basis (weekly or monthly) to see how the business is tracking. The way that many successful companies do this is through Key Performance Indicators (or KPIs for short).
What are KPIs?
KPIs are quick measures of your business' overall health and well-being. They focus on aspects of your company's performance that are vital to ongoing and future success. In essence, KPIs work like a report card to tell how the business is performing in crucial areas. As a result, they allow you to 1) quickly get a clear picture of what's happening with the business and 2) get an early read on trends and future profitability (i.e. while there's still time to take action that will influence the outcome).Examples of KPIs
KPIs vary greatly by company and industry. For example, big retailers (like Starbucks and WalMart) regularly track "same store sales growth" as a measure of overall sales performance. A company like Proctor & Gamble might monitor "revenue and/or gross margin by product line" to track the performance of its different products and divisions. A company like FedEx might track "average delivery time" to monitor its overall efficiency. Other examples of widely-used KPIs include things like: revenue/expense ratio, average age of receivables, total order shipped, days inventory on hand, marketing expense as % of sales, etc.Five Steps for Developing KPIs
Following is an overview of the basic steps involved in creating and implementing a basic set of KPIs for your company:Step one: communicate the purpose of KPIs within the organization.
Realistically speaking, KPIs that are not owned and accepted by the workforce will not succeed. In order for KPIs to be successful, you must first work on creating the right internal environment and getting buy-in from key stakeholders (employees, managers, customers, etc.) These are the people who will be the ultimate drivers of the project's success.One of the biggest challenges that companies face in developing KPIs is overcoming team members' fears and uncertainties. Most employees hold a long-standing suspicion of management-led forays into performance improvement (i.e. "Why are they doing this?" "Will the information be used against me?"). The best way to eliminate these fears is to explain the rationale for KPIs at the outset and include everybody in the process. When this is done openly and clearly, then all employees should at least believe that "we need to start doing things differently" and a core group of them should be very clear about what KPIs involve and how they will be used.
Step two: identify the "critical success factors" for your company.
These are the key areas in which things must go right in order for the company to remain competitive and succeed. Sometimes these factors are mentioned in the company's business or strategic planning documents. Other times they haven't been written down but the owners have an intuitive feel for what they are. Generally speaking, critical success factors come from one or more of the four broad areas that determine success for any organization: customer focus, financial performance, people, and innovation.Tip
Most companies try to begin the KPI process by identifying critical success factors. However, the best time to start building trust about the use of KPIs is at the initiation stage- that is, the first time the idea is raised within the organization. Therefore, we can't emphasize enough the importance of undertaking step one (communication) before step two in order to maximize the chance of success.Step three: select and develop KPIs.
Once the critical success factors have been determined, the next step is to start defining and selecting KPIs. If the CSFs are clearly defined, then it is a fairly straightforward process to generate ideas for KPIs. Key employees are actively involved in this process and the work is often done in teams. In fact, major KPI breakthroughs usually do not come from management but from local teams and workgroups themselves (from the factory floor, so to speak). Management's primary role is to provide the leadership and drive required to develop KPIs, and then provide the support and assistance needed to implement them.Tips
1) Focus on practicality, not perfection. Encourage teams to pursue KPIs that provide valuable information but do not require inordinate resources to collect.
2) Look for leading vs. lagging indicators. Lagging indicators reflect things that have already happened (i.e. sales). Leading indicators are helpful in predicting future results (i.e. product quality, customer satisfaction). Leading indicators give management and employees the opportunity to act quickly when results aren't being achieved and, as a result, impact the organization's overall performance.
3) Work with a limited, manageable number of KPIs. Most companies need only a few measures, in no case more than a dozen. Too many KPIs makes it difficult to focus.
4) Persistence pays off. Virtually no team will achieve a perfect set of KPIs on its first or even second attempt. Keep experimenting and you're bound to succeed.Step four: implement the KPIs.
Once KPIs have been developed and people within the organization are involved in the process, the next step is to implement a system that regularly tracks and reports the information to key individuals (for example, the business owner). In many cases, implementing a KPI involves two people: an employee in the department where the activity is being measured (ex. manufacturing, sales, customer service) will be given responsibility for gathering the data, and the manager of that department will be given responsibility for achieving the target and reporting results to the owner. Some types of data (i.e. operational data) may be collected weekly or monthly from the company's computer system. Other types of data (i.e. information about customers' satisfaction with the organization) may only be collected annually through a survey. Some other useful methods for collecting data include checklists (i.e. to analyze results over a period of time), visual inspections (i.e. for quality), and focus groups.Step five: monitor results and make improvements (i.e. take action).
In many respects, step five is the most obvious and the easiest to complete. The important thing is to monitor your KPIs regularly and compare them to past performance and established targets. If the desired results aren't being achieved, then management must discuss what action to take. Potential actions might include: taking a closer look at the problem area, revising the target, making operational corrections, or changing the company's strategy.Conclusion
It is important to point out that the real goal of building a KPI system is not just to provide a short list of indicators that shows what's happening with the business. Don't get me wrong, that's a wonderful thing. However, the greatest value of KPIs is that they can help you create a culture of continuous improvement and teamwork within your company. KPIs provide an opportunity to keep everybody (management, employees, suppliers) focused on what needs to be done in order to improve performance and keep the business on course. When teams understand where management wants the company to go, and how their job fits into the overall plan, they are enlightened and empowered to help the company achieve its objectives. And as most leaders of successful companies know, people are far and away the most important drivers of your business' success. (Source: Principa)
- Pros & Cons of Online Accounting
Updated October, 2005. Originally published February, 2005.
Online accounting has evolved a great deal in the past couple of years. According to a recent review, online systems now match or surpass desktop systems in many ways. If you're considering the switch to online accounting, here is a quick overview of the pros and cons.Pros
1) Low up-front cost. Unlike traditional client-server systems (which typically cost $25K-$50K just to get started), online accounting requires no up-front investment in hardware, software or maintenance contracts. Instead, companies pay a monthly fee (i.e. the "rent vs. own" school of thought).2) Quick set-up. Since there's no hardware/software to install, companies can start using the system immediately.
3) Greater security. Despite initial fears about the internet, most people now realize that online systems provide the best protection. The service providers- Intuit, Intacct, NetSuite, etc.- all use world-class data security technologies (far greater than most companies' in-house systems). Best of all, your data is automatically backed up and stored off-site (which is a lot better than carrying it around in the trunk of your car).
4) Anywhere access. Because it's web-based, online accounting allows business owners to access their accounting records from any location (home, office, road, wherever).Cons
1) Less customization. Generally speaking, online systems do not have as many features as traditional accounting packages (which have been around a lot longer). For larger companies who require customized capabilities (advanced reporting, complex inventory, etc.), online accounting may not be the best choice.
2) Switching costs. For companies that are heavily invested in an on-premise enterprise accounting system (Great Plains, MAS 90/200, etc.), the benefits of switching may not justify the costs of learning a new system for a while.Conclusion
All in all, online accounting seems best suited for small to mid-sized companies who are a) ready to upgrade to a new system, b) don't want to make a large investment in hardware/software, and c) have relatively straightforward accounting (i.e. minimal customization). In particular, online accounting seems like an ideal fit for companies with multiple locations (franchisees, etc.), business owners who travel a lot, and entrepreneurial companies who want to outsource their accounting and/or work with an outside CFO. - Road Trip Wisdom
One of the things that distinguishes successful entrepreneurs from the rest of the world is their ability to think “outside of the box.” If you haven’t stumbled across an episode of Road Trip Nation yet, I encourage you to visit their web site, which features dozens of off-the-cuff interviews with entrepreneurs, leaders and everyday people who are doing what they love. One of my favorite snapshots:
Howard Schultz (Founder & Chairman, Starbuck’s): After a life-changing trip to Europe, he fell in love with the romance of the Italian espresso bar. He talked to over 200 investors to raise the finances to build Starbucks, but 99% of them said no. Quote: "I think that sometimes the difference between winning and losing, success and failure, is this grey line between will, passion, and self-belief that, I'm going to do this." Thousands of Starbucks later, Howard is living proof of what happens when you "have the courage to dream big."
- Microsoft Targets Small Business Accounting
In case you haven't heard, the software giant is currently in the midst of launching Microsoft Office Small Business Accounting. This is Microsoft's effort to re-enter the low-cost accounting market. The primary distribution medium will be the OEM channel, which means that it will come forced (I mean, pre-loaded) onto your PC if you order Microsoft Office Professional. They have also hired a former Intuit (QuickBooks) executive for a big push on CPAs. Proof positive that Microsoft is still... Microsoft.
- Comparison of Business Entities: Sole Proprietorship, Partnership, Corporation, LLC
Most companies have a tough time figuring out the right type of business entity for their business. Partnership? Corporation? LLC? Following is a brief overview of the different entity types along with some basic advice. (For those who like to cut to the chase, refer to the "Rules of Thumb" at the bottom of this post.)
Sole Proprietorship
A sole proprietorship is the simplest business entity to form. No paperwork needs to be filed- a sole proprietorship generally comes into being when an individual begins conducting a new business (unless you form another legal entity, such as a corporation or LLC). The business may be conducted under an assumed name, which is commonly referred to as a DBA ("doing business as"). Note: there can be only one owner of a sole proprietorship (any more and you'll need to form a partnership, corporation or LLC).General Partnership
A partnership is a business with two or more owners that has not formed another type of entity (i.e. corporation or LLC). No paperwork needs to be filed to create a partnership, although drafting a partnership agreement at the outset is recommended. There are two types of partnerships: general partnerships and limited partnerships. Typically speaking, general partnerships are relatively simple to set up and run. Income and expenses pass through to partners and all partners are treated equally. The main drawback of partnerships is that the partners bear personal liability for the debts and obligations of the partnership. As a result, partnerships are not suitable for businesses that engage in inherently risky activities (construction, machinery, food service, environmental risks, etc.).Limited partnership
Limited partnerships are more complex to create and maintain than general partnerships. There are two types of partners in a limited partnership: the general partner (who controls day-to-day operations and is liable for business debts) and limited partners (who are not responsible for business debts or claims). The most common example of a limited partnership is a real estate partnership in which one individual (the general partner) solicits investments from other individuals (the limited partners) in order to purchase property. The general partner then manages the business while the limited partners serve as passive investors. Limited partnerships generally involve the preparation of a written partnership agreement, which can be complex because some partners may be treated differently than others. In particular, limited partnerships provide the ability to allocate income/gains/losses/etc. differently among different partners (called "special allocations").C Corporation
A corporation is a business entity that carries its own legal status, separate and distinct from its owners. As a result, the primary advantage of corporations provide owners with limited liability against business claims (often referred to as the "corporate shield"). There are two types of corporations: C corporations (often called "regular" corporations) and S corporations. The primary disadvantage of C corporations is what's known as double taxation: profits are taxed first at corporate tax rates (around 35% for federal and 9% for California) and then again at the individual level (i.e. when owners receive profits from the corporation in the form of dividends, that income is fully taxable on their personal tax return- hence, double taxation). C corporations are formed by filing articles of incorporation with the Secretary of State.S Corporation
An S corporation is a regular corporation that has special tax status (under Subchapter S of the IRS code- hence the name). The main advantage of S corporations is that they do not pay federal income tax. Instead, income and/or losses from S corporations pass through to shareholders in the same manner as partnerships (that's why partnerships and S corporations are both referred to as "pass-through entities."). In other words, S corporations avoid double taxation. Note: S corporations have certain restrictions that do not apply to C corporations (i.e. maximum of 100 shareholders, all shareholders must be U.S. citizens, and only one class of stock is allowed). S corporations are formed the same way as C corporations- by filing articles of incorporation with the Secretary of State. Important note: to elect S corporation status, you must file Form 2553 with the IRS within approximately two months of your incorporation date- check with your lawyer or CPA for the details.LLC (Limited Liability Company)
Over the past few years, LLCs have replaced S corporations as the most popular form of business organization for new companies. The reason? LLCs combine the best attributes of corporations and partnerships: limited liability, pass-through taxation, and flexibility in allocating profits and losses. Furthermore, LLCs aren't subject to many of the same restrictions as S corporations. The biggest drawback of LLCs is that their legal treatment varies by state, making them a questionable choice for businesses that operate (or plan to operate) in multiple states. Much like limited partnerships, LLCs are formed by filing Articles of Organization with the state and governed by an operating agreement that looks a lot like a partnership agreement.LLP (Limited Liability Partnership)
LLPs are a special type of partnership designed to provide individual partners with protection against malpractice by other partners in the business. LLPs are primarily designed for professions such as doctors, lawyers and accountants. As a result, they're not really applicable to anybody else.Rules of Thumb
1) Legal protection. No doubt about it- the need for limited liability is the single most important factor in choosing a business entity for most companies. Rule of thumb: businesses that engage in risky activities should be conducted through a limited liability entity- a corporation, LLC or (to a much lesser extent) limited partnership.
2) Tax issues. When it comes to taxes, sole proprietorships, partnerships and LLCs come out about even (they're all pass-through entities). As far as corporations are concerned, S corporations have a distinct advantage over C corporations because they avoid double taxation. Rule of thumb: S corporations are the preferred choice for most smaller companies (in particular, start-ups that expect to lose money for the first few years- because the losses can then be passed through to shareholders' personal tax returns).
3) Cost and administration. Sole proprietorships and partnerships are the easiest to form and least expensive to maintain. Corporations and LLCs are almost always more expensive to create and difficult to maintain. Rule of thumb: if your business does not need limited liability protection and you want to "keep it simple," consider sticking with a sole proprietorship or partnership.
4) If you're considering forming an S corporation: take a look at an LLC instead (for all of the advantages mentioned above).
5) When to choose an S corporation over an LLC: if your company plans to issue stock or stock options, or if your company plans to operate in multiple states.
6) When to choose a C corporation over an S corporation: if the corporation has more than 100 shareholders, has shareholders who are not U.S. citizens, or intends to file a public offering in the future.
7) Be wary of changing from one entity type to another. A lot of people think they can simply convert to a different entity in the future. While it is possible to do so, it's never easy and can cause considerable headaches. In particular, trying to convert a C corporation or S corporation to an LLC can trigger some very unpleasant tax consequences.
8) Last but not least: never put appreciating assets (such as real estate or liquid investments) into a C corporation. When you sell them, you'll pay double taxes. Go with a partnership instead.(Sources: Nolo, Micromash, Quickfinder)
- Ben & Jerry's vs. Amazon
If you have a start-up company, one of the major issues that you face from day one is this: how much do you want to grow? According to entrepreneur Joel Spolsky, there are two basic models and you absolutely must decide which one you're going to follow (and gear everything accordingly) or you're going to have a disaster on your hands. The choice? Whether to grow slowly and organically (which he calls the Ben and Jerry's model) or whether to have a big bang with very fast growth and lots of capital (which he calls the Amazon model). This is one of my favorite manifestos of all time: Strategy Letter 1: Ben & Jerry's vs. Amazon. You can find this and many other thought-provoking ideas at ChangeThis.
