Turning your small business ideas into a reality is exciting. You’ve invested the time to write a business plan, and you’ve thought carefully about how you’ll implement the idea.
But do you truly know how to start a business?
Before you sprint out of the gate and start operations, there are some items you need to address. Use these tips to make your business official, and get started right.
Why It Matters
If you glance through the steps to setting up a business, they may seem pretty mundane, but they’ll have an immeasurable impact on your business down the road.
To operate a business, and potentially grow your operations, you need to nail down these important steps up front. If not, you may have legal and tax issues in the future, and adding partners or new owners to your business may prove to be difficult.
What Is Your Structure?
When starting a business you need to first decide on the structure of your business. Here are some variables that may influence your decision:
- Simplicity: Sole proprietorships are the easiest to set up and operate, while a corporation requires a greater investment of time and documentation.
- Legal liability: C corporations offer the most legal protections, in the event of a lawsuit filed against your business.
- Adding owners: If you never intend to add more owners, a sole proprietorship structure can work for you. On the other hand, a corporate structure makes it easy to add new owners as your grow.
Here are the most common forms of business structure:
- Sole proprietorship: You are the only owner of the business, and setting up this type of entity is the easiest. However, you’re exposed to business legal liability, as there is no legal difference between you personally and your business. If you own a coffee shop, for example, and a customer falls and sues your shop for negligence, both your business and personal assets are at risk.
- Corporation: A corporation (or C corp) offers the most legal protection, because the business is a separate legal entity from the owner. A C corp also makes it easy to bring in other owners by issuing shares of common stock. However, setting up a C corp and meeting the regulatory reporting guidelines can be time consuming.
- Limited liability company (LLC): An LLC allows you to limit your personal liability for business risks, but not have to meet the same level of regulatory requirements as a corporation. There are several different LLC structures, based on your state’s tax laws.
When setting up a business, work with a CPA or attorney to consider the pros and cons of each structure. Most states will have forms you can complete to register your business.
Corporations, for example, complete Articles of Incorporation.
Once you choose your business structure, you need to apply for various tax documents:
- Employee identification number (EIN): An EIN number is used by the IRS to identify your business, you can apply online through the IRS website. Think of your EIN as a Social Security number for your business. It is important to use this number on business tax filings and other documents, so that you’re clearly reporting on business (and not personal) activity. Every business should use an EIN, including sole proprietorships.
- State tax identification number (State tax ID): Most states also require a state tax ID, and you need this number for state tax issues, such as income tax and payroll tax filings. You can apply for a state tax ID online, via your state’s department of revenue.
- Fictitious business name: In some cases, business owners choose to operate with a company name that is different than the name on the firm’s tax documents. You may notice companies that use the phrase “doing business as” or the abbreviation “DBA”. If a company operates multiple businesses under a common business structure, the firm may use fictitious names to differentiate their operations. You can register a fictitious name through the secretary of state’s office in your state.
If when starting your own business you choose to use a fictitious name, you’ll need to learn how to use that name on tax forms and regulatory reports.
Assume, for example, that Brentwood Construction is an LLC, and the company operates using the fictitious name Reliable Paving. Federal and state tax filings will typically be reported as “Brentwood Construction, LLC, DBA Reliable Paving”.
Work with an accountant who can help you correctly state the name of your business on tax and regulatory forms.
Starting your own business comes with some paperwork you may not be expecting. Your state, city, or county may have additional requirements in order to do business. Many municipalities require a business license to operate, so check with state and local websites to determine what you need to be compliant.
In addition, you may need a permit in order to perform certain types of work, and permits are common in the building and construction industries.
Check out Business Licenses & Permits to find more information on what business licenses and permits you will need to get started.
Business vs. Personal Records
It’s critically important for you to keep business records and personal transactions separate, and you need to implement this plan on day one of setting up a business . Here are some reasons why:
- Legal liability: As explained above, a corporation is considered a separate legal entity from the owner, and structure protects an owner’s personal assets from business litigation. If you don’t keep business and personal transactions separated, you may not have the same level of legal protection. Speak with an attorney about this risk.
- Business management: An owner needs accurate accounting information to monitor company performance, and to make changes to improve results. If personal transactions are mixed with business transactions, the accounting records aren’t useful.
- Tax reporting: If your business records include personal transactions, you’ll have to review your records and remove personal items before you can calculate your profit and your tax liability. Avoid this problem by keeping business records separated.
The best way to address this issue is to maintain separate bank accounts, and to exclude personal transactions from your business accounting software.
Bring your state business registrations forms, EIN, state tax ID, and any fictitious name registration forms to the bank, and set up a business checking account. To transfer your business profits, set up a process to move business profits into a personal account.
Your online bank statement is important, because it reports all of your banking activity through a reliable third party (your bank). It’s important to access your monthly bank statement and reconcile your bank account at the end of every month. A bank reconciliation is the faster way to find errors and to uncover any fraudulent activity in your account.
Get Paid 2x faster, get free ACH transfers, accept credit cards and use smart invoices with QuickBooks Online.
Smart Accounting Decisions
At this point, you need to consider how you’ll handle your company accounting needs. Accurate and timely accounting records allow you to monitor your finances and make informed business decisions.
Make the investment in an online accounting software package right from the start. If you purchase software and set up your system correctly, you’ll have accurate records on file from your first day of business. Here are some specific tasks you’ll perform:
- Chart of accounts: Your chart of accounts is a listing of each account and a corresponding account number. Your software package will start you off with a standard set of accounts, including cash, inventory, and accounts payable- the basics. You can add, change, and delete accounts, based on your company needs.
- Beginning balances: This step is the most important reason to hire an accountant. Once you set up a chart of accounts, you’ll input your beginning balances into the accounting system. If, for example, Julie invests $10,000 in cash into her Ridgeview Graphic Design business on June 1st, the accounting records need to include an increase of $10,000 cash and a $10,000 increase in owner’s equity (Julie’s ownership).
Don’t shortcut these steps! Many business owners start off keeping hard copy records, and then attempt to post data into an accounting system later. This process leads to errors, so use accounting software from the beginning.
Equity vs. Income
The most common accounting problem when starting a business is not documenting the differences between equity and income, and this problem is due to incomplete recordkeeping at the start of the business.
You have to clearly document the amount of cash, equipment and other assets you contribute to your business. These contributions are defined as your equity, or ownership in the company. You need to know your total equity, so that you can calculate a gain or loss if you sell your business years later.
There are two ways to create equity:
- Cash, equipment and other assets you contribute to your business.
- Retained earnings, or company profits that are left in the business and not distributed to the owner. Profits distributed to the owner are considered income, and income is taxable to the owner.
Assume, for example, that Julie contributes a total of $100,000 into Ridgeview Graphic Design over 12 years. Over same 12-year period, Julie leaves a total of $50,000 in annual profits in the business, and her total equity is $150,000.
If Julie sells her business for $300,000, she recognizes a $150,000 gain on the sale.
You can bet that there are hundreds of business owners who get an offer to sell their businesses, only to realize that they don’t know what their ownership equity is. They have to go back to the beginning and calculate equity from day one.
Avoid this problem by working with an accountant and tracking your equity properly.
As You Grow
As your firm grows and you develop your small business ideas you’ll need to find other experts and software to meet your needs. If you hire employees, you’ll need to add payroll capability to your accounting software. It’s a good idea to open a second business account to handle payroll. If you carry inventory, you can build effective systems to manage that process, as well.
Determining your structure, completing tax documentation, obtaining permits, managing your accounts are all large investment of time and resources.
The pay off being, the ability to start with the confidence, and focus to operate and grow your business.