Chapter 2 - The Strategy
“A good mission statement becomes an out-of-bounds marker for your ideas. If your company builds lawn mowers, then is interior design really a good thought? Be real with yourself. Examine why you started the business, and don’t set yourself up for failure.” – Dave Ramsey
It is time to take your ideas out of your head and onto paper (or online document). The next step in your entrepreneurial journey is to write a business plan. What is a business plan? A business plan is a document that describes your concept, outlines your goals, and maps out your strategy to turn your idea into a successful business. Ellen Rohr, the founder of Bare Bones Biz says, “The primary purpose of a business plan is to help you gain clarity and hold yourself accountable for moving in the direction of what you want.”
Here are five reasons why you need a business plan:
A plan helps you avoid mistakes.
Organizations fail because they lack clear goals and focus. They run down rabbit trails and run out of capital or take on the wrong partners. They ignore their mission statement. Any long-term successful organization will have a rock-solid vision—clearly spelled out in the mission statement.
A plan takes the emotion out of it.
There are so many emotions when you set out to start a business. At first you are crazy passionate, to the point you lose touch with reality. Then comes overwhelming fear, doubt, and exhaustion. When emotions flare, a business plan helps you come back down to earth and look at things objectively. It reminds you what you are doing and why.
A plan puts everyone on the same page.
Whether you have mentors, partners, employees, or investors sharing your plan on paper keeps everyone informed and headed in the right direction. Having a clear plan is just good leadership.
A plan will help you execute.
When you have a solid plan in place, you are able to establish goals, measure performance, identify questions or concerns, and set your priorities. It will become your game plan.
A plan will help you raise money.
If you plan to raise capital or borrow money you will need to communicate your ideas on paper, in a clear and compelling way. Whether you are asking friends and family for money or bankers and venture capitalists, having a written plan will help you show whether or not your business has the potential to make a profit. By putting statistics, facts, figures and detailed plans in writing, a new business has a better chance of attracting investors.
So how do you write a business plan?
As a Startup Club Member, you have free access to a great business plan template. It will lay out the blueprint of a good plan and help you navigate each section to make your business plan look professional and presentable to lenders, partners and investors. Check it out: here.
A business plan is typically thirty pages long and is never quite finished. It is a living document, which means you are always reviewing, revising, and updating it as you grow your business and your plan evolves. In his book, Thou Shalt Prosper, Daniel Lapin says, “To begin a software design project or a business plan, you must focus on your ultimate goal. You must then break down that goal into intermediate phases, ensuring that each phase links seamlessly with those around it. Then, you need to break down each phase into specific tasks, each of which can be tackled without any distraction from the bigger picture. At regular intervals, you should glance up at the bigger picture to make certain that you are still on course.”
Stuck on your plan? That’s ok. Join THE STARTUP CLUB, our growing community of business owners are always happy to help.
Next Step: Paperwork
The stack of administrative paperwork that comes with the process of starting a business can be overwhelming. But don’t worry! We’re here to help. All of the below documents can be accessed on THE STARTUP CLUB. Let’s get started with the basics.
First things, first: Pick a Name
It’s time to choose a name for your business. A great way to do this is to sit down with a cup of coffee and brainstorm. Your company name should convey who your business is, what it does, and stick in customers’ minds. However, if you just aren’t able to come up with anything now, don’t let it stop you from continuing onto the next steps.
Keep in mind that you may want to sell the business someday or expand, so avoid naming it after yourself, or your region (for example, Alamo Ranch Furniture). You can always change your company name later, or operate under a different name with a Doing Business As (DBA).
2. Get your Employer Identification Number (EIN)
An EIN is a federal tax identification number to ID your business with the IRS. Having an EIN is required for LLC’s, partnerships, and corporations but even sole-proprietorships should consider getting one. Having an EIN is free, and only takes a few minutes to get. An EIN keeps you from having to use your Social Security Number on forms. Get one here.
3. Get a business bank account
You absolutely should keep your business finances separate from your personal finances. Not keeping your money separate is one of the fastest ways to get into trouble. Not only will it make your business accounting very difficult, it can also forfeit your liability protection, as it will void your corporate veil. So open a business account using your EIN. It is free at most banks, and will help to give your business credibility when you have company checks, debit card, and account to give to vendors and customers. Select a bank or credit union that is convenient for you, and is also a local or regional bank. As you’ll see in Chapter 3, getting financing from smaller banks is considerably easier, and having a banking relationship with them early will help establish a track record with them.
4. Get a certificate of resale
Also known as a seller’s permit, a certificate or resale will allow you to collect state and local taxes on sales. You will need this permit if you plan to sell products or some types of services. You can access more information: here. For your convenience, THE STARTUP CLUB has an application for a San Antonio certificate of resale: here.
5. Obtain a business license, permits, and other documentation for San Antonio
THE STARTUP CLUB has all the forms you need to get your paperwork, permits, and licenses in order with the City of San Antonio, for free here.
6. Set up an accounting spreadsheet
Until you have sales, a simple accounting worksheet will be all you need to forecast costs, and budget for your business. Filling out this spreadsheet will help you become well acquainted with your numbers, before you start relying on software like Quicken or FreshBooks. These tools are great at tracking expenses, mileage, and payroll but forecasting your sales, expenses, and making those work within your personal income will be your responsibility. To help you really get to know your numbers, THE STARTUP CLUB has a Pro-Forma Net worth Spreadsheet that will help you track your personal balance sheet and income statements, while also tracking your net worth.
7. Register for a DUNS number
A Dun and Bradstreet or DUNS number is a unique 9 digit number assigned to each of your business locations and does two things: 1. It is required for business with the SBA, or bidding on Federal government contracts and grants. 2. It is the number that tracks your business’ credit score. The sooner you get a DUNS number, the sooner your business’ credit history can begin. The best way to get a DUNS number is to register for System for Award Management (SAM) at sam.gov. This will kill two birds with one stone, as you will also gain a CAGE code that is necessary for payments through the Government’s pay system, Wide Area Workflow (WAWF). For Startup Club members we have a walk-thru video that will show you step by step how to navigate the SAM registration and explain things like NAICS codes, entity representations and certifications.
8. Choose a Legal Structure
The next step is to choose your legal structure. One of the most important choices you will make when forming your new business is which legal structure to choose from. Also called a business ownership structure or business form, your choices include LLCs, partnerships, sole proprietorships, corporations, and non-profits. We’ll cover sole proprietorships, LLC’s, and corporations in greater detail.
What we see most often from newbies, is that they think starting a business is something very formal or regulated. The truth is you can officially start a business by doing nothing. If you got out of bed tomorrow and said alright I’m now a business, by default you become a sole proprietorship. The startup’s income would be reported on your taxes as your personal income, and legally speaking, you’re in business.
However, as easy as that sounds, there are drawbacks to being a sole proprietorship. For starters, you have unlimited liability for your business debt. This means you are personally liable for any deals gone bad, lawsuits, and mistakes. Even though you can setup agreements to limit your partners or employees individual authority, if anything happens you will still be held accountable. This means, you could not only lose the company, but also everything you own.
Other options for legal structure include Limited Liability Company or a corporation. These options limit your liability to just the investments you make into the company, but also come with drawbacks of their own including different tax rules.
Partnerships are nearly identical to sole proprietorships, except there are two or more people sharing the profits. For more info, check out the book LLC’s for Dummies.
Limited Liability Companies (LLC’s)
An LLC combines the tax benefits of a sole-proprietorship and the legal protection of a corporation. Most states did not adopt LLC’s until the mid-1990’s but since then they have become a favorite because of their flexibility. An LLC is a pass-through entity, which means that the profits, losses, credits and deductions flow through to the owners’ (called members) tax returns. The members of an LLC can be a single person, 2 or more individuals, corporations, partnerships, trusts, or other LLC’s. Members can use losses to offset other income, but only up to the “basis” which is the amount the member is invested. However, unlike a Corporation, the LLC can decide how income and losses are distributed to its members.
As an example, one member can take all of the losses but then distribute profits to all members based on their ownership interest. This provides some interesting liability strategies (more on that in our blogs and other books).
Several cautionary notes:
LLC members cannot separate income earned and passive investment income, so the LLC’s profits are subject to Social Security and Medicare taxes on top of income taxes.
Liability protection is not absolute. Creditors may be able to “pierce the corporate veil.” The “veil” being the legal distinction between two entities. It’s called a veil because it is an imaginary separation between you and your business. A judge may rule to pierce the veil in cases of fraud, failing to follow legal and reporting requirements, and when entities are too intertwined.
Luckily all of these are avoidable, and we’ll talk about intertwining in the money chapter.
How to file an LLC
After choosing your name, you must file articles of organization with the state of Texas. THE STARTUP CLUB has provided a template articles of organization to use: here. Next, you must create an Operating Agreement. Though not required by law, an Operating Agreement defines the by-laws of the LLC, stating the basic rights and responsibilities of the LLC’s members. This is crucial because it will be the document the judge relies most on in a trial. THE STARTUP CLUB has also provided an excellent template and example of an Operating Agreement: here.
A C Corporation is the most basic form of an American corporation. A corporation is an entity that is completely separate from its owners because its ownership shares (stocks) can be traded among an unlimited number and type of owners. The C Corporation is most commonly used to offer an Initial Public Offering (sometimes called taking the company public). This is when you begin selling shares to investors or on the stock market. The benefits of a C Corporation is the ability to offer shares to employees and professional investors. However, most small businesses stay away from this structure because of the “double taxation” and strict requirements for reporting, and board & shareholder meetings.
C Corporations file their own tax returns and pay the corporate tax rate (currently 20% as of the new 2018 rules, see more about these changes in our blog). Profits are distributed to shareholders as dividends, and those dividends are taxed again at the shareholder’s income tax rate.
With that said, sometimes the individual tax rate is higher than the corporation tax rate, and it makes sense to form a corporation, especially if the corporation is reinvesting profits. Because, unlike an LLC, a C Corp can distinguish between active and passive income and pay employment taxes only on the salaries of the active shareholders.
Another strategy to avoid the C Corporation double taxation, is to form an S Corp. An S Corp is limited to no more than 100 (U.S.) shareholders with one class of stock. Unlike an LLC and C Corp, an S Corp cannot own other companies, nor be owned by another company.
The S Corp is a good choice for banks or insurers who can’t legally form LLC’s, and companies that may face higher taxes than LLCs. Texas allows S Corp income to flow down to its owners (shareholders) and pay federal tax at the owner level only. Owners can pay themselves “reasonable” salary before profits and pay the individual tax rates on that income, and then share in the profits as dividend distributions which is free of employment taxes. Keep in mind, if profits are reinvested into the company, owners still must pay taxes on the profits, despite not receiving any of the money.
B Corporations are for entrepreneurs who wish to “do good” as part of their for-profit business. Essentially what a B Corp does is allow its owners to pursue social good goals without being sued by shareholders for not maximizing profits. Corporations in Texas can meet the legal requirement for B Corp certification by amending their articles to become a Social Purpose Corporation and then including further language designed to create stakeholder consideration. For more information on how to certify as a TX Social Purpose Corporations (SPC) click here.
How to Incorporate
Once you have selected your name, you must file Articles of Incorporation, which in Texas means completing a registration form. (Filing fee of $300 applies) Next you must appoint directors and create the company’s bylaws, which describe how the business will operate.
Finally, new corporations must distribute stock certificates to shareholders. If you need help or more information go to LegalZoom.com.
What’s the most common type of legal structure for a small business?
According to the National Association of Small Business’s 2015 Economic Report, the majority of small businesses surveyed are S-corporations (42%), followed by LLCs (23%).
Now that we’ve outlined some early steps for your startup, next we’ll talk about the crux of any young business: money.