The Smart Passive Income Blog » company finances

The Details Behind Starting an LLC For Your Small Business – Part 1

Pat — Wed, 17 Feb 2010 07:05:18 +0000

Did you know that February is National Start a Business Month?

Neither did I.

But, in light of the fact, I decided it might be nice to do a detailed post of some of the benefits behind starting a company and exactly what it entails.

I am a small business owner myself. In fact, I’m the owner of two companies: Flynndustries, which is my company that heads the websites that I create (including this one), and LOLer Apps, which is my iPhone app company. Additionally, I just helped a friend start his own company the other day, so the process is still fresh in my mind. I just wanted to make sure I could share as much as I could remember with you today.

In the past, starting a company was no easy task. Usually involving a lawyer, the process took much longer and was far more expensive. You can still hire a lawyer to setup a business for your today, but luckily for us, there are online services such as LegalZoom that can take care of everything in less than 30 minutes.

Before I go on, I must first write this quick disclaimer: I’m not a lawyer or a certified public accountant of any kind. Nothing I say or write should be held against me or my companies, and this information shouldn’t be taken as legal advice. If you’re looking for professional advice, I recommend consulting with a lawyer or CPA on your own.

Thanks!

Why Would You Want to Start Your Own Company in the First Place?

Great question!

There several different reasons why you might want to create your own business entity. For me, starting a business was a dream of mine ever since I was little, so there was some personal fulfillment involved in my decision, among other things.

Here are some other reasons why you may want to start a company:

Freedom: Probably the number one reason why people start companies is to break away from the rat race and the 9 to 5 lifestyle. By starting a company, you become your own boss and can finally make your own decisions.
Professionalism: In my experience, having my own company has made what I do online seem much more professional. It may not make a difference to you or even my customers, but it definitely makes a difference to other companies that I’ve worked and dealt with. Most established companies are far more comfortable and more willing to work with other companies, instead of just individual people.
Protection: Many people start companies for protection against their personal assets. If a company (not a sole proprietorship or general partnership, which I’ll talk about later), get’s sued or finds itself in debt, the owners’ personal assets would not be liable.
Tax Advantages: By starting a company, you grant yourself the ability to write off certain business expenses, which can save you a lot of money. As to what exactly you can write off, I recommend discussing this with your CPA / Accountant.

Why Would You NOT Want to Start Your Own Company?

As I always do here on this blog, I try to look at both sides of the equation.

The truth is, starting a business is not for everyone. Some of you may be comfortable in your 9 to 5 jobs, and for others, there are these things to think about:

It’s ALL You: As cool as it is to be your own boss, there’s a lot more to think about. Working a 9 to 5 job, you just have to worry only about the job you’re assigned to, and that’s it. As a business owner, you have to worry about every single aspect of the company, including financial, legal and all that jazz. For some, this can be too much.
Schedules are virtually non-existent: As much as I don’t like the 9 to 5 lifestyle, at least you know that by 5pm, you’re done. When you’re your own boss, it’s hard to keep steady hours because it just seems like there’s always more you can do to improve the business. It’s hard to turn off that switch, trust me.
Benefits: When you start your own company, you don’t automatically have access to a 401k plan, a health or dental insurance plan. You have to figure all of that stuff out on your own, and it sucks! Not only do you see exactly how expensive it is to really get insured (we don’t see really how much our employers are paying for us while at our 9 to 5 jobs), but we get to see exactly how cruddy the whole system is.

That being said, I still don’t ever regret going down the path that I’m on as a small business(es) owner, and if you’re still interested in possibly setting up your own company one day, I invite you to keep reading.

The Different Types of Business Structures

Before you start a business, you must first decide on which type of business structure you would like to form. I’ll briefly summarize the different types for you below, but I definitely recommend reading more about each type here on the IRS website.

Sole Proprietorship

A sole proprietorship is a business that is owned by a single individual, and it’s definitely the easiest and cheapest to create. No paperwork needs to be filed with the state, and all you basically have to do is register for a DBA (which stands for “Doing Business As”) so you can run your business under a name different from your own.

Unfortunately, the major downfall of a sole proprietorship is that the business owner is personally liable for any debts that the business incurs. Additionally, it can be very difficult to get funding (loans from banks or investment capital) as a sole proprietor.

General Partnership

A general partnership is basically the same thing as a sole proprietorship, except it involves two or more people. A little bit more work needs to be done as far as dividing who is responsible for what and the percentages of ownership between all of the owners involved, but again – no paperwork needs to be filed with the state.

The scary thing about partnerships is that you are personally liable for any one of your partners’ wrongdoings. If one of your partners decides that it’s a good idea to drink and drive in a company car, if he gets into an accident, you could end up paying for the damages and medical bills that come as a result.

For both sole proprietorships and general partnerships, all income and expenses are simply reported on the individual’s personal tax returns.

Corporations

A corporation is a business entity that is recognized as a totally separate legal entity from its owners. Think of a corporation as a whole different person, with it’s own ability to conduct business, sue or be sued.

Corporations are far more complicated to setup and understand than the previous two business structures. There are shareholders involved, officers, board of directors, etc., most of which is stuff I honestly don’t know much about. There are “C” corporations, “S” corporations, Professional Corporations, and non-Profit corporations to consider, not to mention all of the paperwork that is required.

The primary advantage, again, is the limited liability that the corporation grants it’s members and shareholders. Additionally, a corporation can implement benefit and profit sharing programs for it’s employees.

Lastly, because it is a separate legal entity, it’s taxed as a separate entity as well, which can make things a bit complicated for those of us who are just starting out or doing small time business online.

Limited Liability Company (LLC)

The LLC is a fairly new type of business structure that takes the best of each of the above.

An LLC is not a corporation, but it can still provide that corporate-like protection that is important for many business owners. Also, an LLC can elect to be taxed as a Sole Proprietorship, Partnership, S Corporation or C Corporation, and income and expenses can simply be passed through to the members’ individual tax returns.

All of my companies are LLCs, and there is very little as far as extra paperwork that needs to be done. I’m quite happy with my decision to go with an LLC, however there are a few things to consider:

Because the LLC is so new, some states may not view a LLC as a separate entity and may end up treating it more like a sole proprietorship or partnership, which defeats the whole purpose of having an LLC in the first place. An owner of an LLC should do everything in his/her power to separate business from personal, especially when it comes to finances, in order to keep that separation and protection as best as possible.
Many states require a franchise tax in order to have an LLC. This tax is essentially the “fee” the LLC pays for the benefit of limited liability. In California, for example, I owe $800 per LLC each year, and this doesn’t include any taxation on my income.
Lastly, many investors still have mixed feelings about LLCs, so it may prove to be more difficult to raise any capital investments for your business if you have an LLC. That being said, since we work online, not very much money is needed to do what you want to do. I started my LEED exam website for less than $8 a month (domain and hosting).

Since this post is much longer than I had oroginally anticipated, I’ll be finishing up the details about starting an LLC in my next post. In it, I’ll go over, in detail, the process of setting up an LLC, including what you need to know before you begin, how much it will cost you, and what to expect after you setup your business.

Are any of you thinking about starting your own legal business entities, or have you already? What was your experience like when setting it up, and are you glad you did what you did?

I’d love to hear from you. Cheers!

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The Details Behind Starting an LLC For Your Small Business – Part 1

Why You Need A Business Banking Account, And How To Get One

Pat — Fri, 06 Feb 2009 08:00:25 +0000

After being all excited and getting over the fact that I could actually say “I, Pat Flynn, own my own business” (I can’t wait for my 10 year reunion), I soon realized that this is really serious stuff. There’s much more to it than just filing papers with the Secretary of State and having a really cool stamp thingy that has my company name on it.

Last week, I met with a CPA to help me with the finances of my business. I learned so much in that hour, but the most important thing I learned was that in order for a business to function properly, AND in order to maintain the protection of my personal assets (which is the main point of starting my LLC), I must separate my business finances from my personal finances.

Before I go on, I’d like to mention once again that…

Everything you read on The Smart Passive Income Blog, including this post, is just reflection on my personal experiences with making money online and owning a business. I am not a lawyer or financial advisor, and I’m simply just trying to make your job a little easier through my own experiences. I cannot guarantee anything and will not be held liable for any of the information I post on this website. Please remember that everything I write and comment about is my own formed personal opinion about the subject matter. You should always form your own conclusions and perform your own actions based on those conclusions.

Ok, back to “business”.

The Bad Financial Model for Running a Small Business

Here is a chart of what’s been happening since I started making money online, before I started my company (yay for charts!):

It may seem that this is the easiest way to do things – I mean, you just pull out money from the giant bank account that you and your business add to, but this is not good. An article I found on about.com by Darrell Zahorsky outlines 5 reasons why you should never mix personal and business banking:

The Business Deduction Rule: The law says only businesses can deduct business expenses. Let me say that again: Only businesses can deduct business expenses. If you have a business that runs out of your personal bank account, you’re going to have a very hard time convincing the government that you are indeed running a business. To them, it might just look like a hobby.
Tax Time Woes: When you file taxes for yourself and for your business, all of the transactions for each must be separated. If you don’t have separate accounts, going though each transaction is going to suck big time.
The Audit Trail: Note that it’s not a requirement to have a separate bank account for you and your business. The only thing that is required is that “all records be accurate, complete, permanent and show a clear record of income and deductions.” If you’re audited, your separate business statement and record provides a “clear audit trail” and will make your life much much easier.
Missed Deductions: With a giant bank account with both business and personal transactions, it’s going to be very easy to miss deductions that you can write off. Messiness equals wasted time and money.
Lack of Professionalism: If you were doing business with someone and they paid you with a personal check, you’d think they were a little unprofessional, or not even a real company – right?

The Good Financial Model for Running a Small Business

Below is a chart of what my business and personal finances should look like:

As you can see, the business is kind of like another person. It makes it’s own money, has it’s own bank account and it’s own expenses too. The only interaction between the two sides is when you get paid from your business. This can be hard to understand, but it’s like you’re working for your business – i.e. you’re an employee and you get paid. Money that goes to you gets recorded as a transaction and this again is really important to keep track of for both you and your business’ financial health.

There’s still a lot for me to learn, but I just wanted to break this down for you because I now understand the importance of separating business and personal finances – and it is all accomplished by first opening a business bank account…

My Experience Getting a Business Bank Account

As you know, I filed for my Limited Liability Company (LLC) with legalzoom.com. One thing I got in return was a federal tax ID number from the IRS (also known as an EIN, or employer identification number). Remember how I said your business is kind of like another person? Well, your EIN is pretty much the social security number of your business. Keep this in mind.

Anyways, I chose to get my business banking account for Flynndustries, LLC at Bank of America. You can get one at pretty much any bank, but I do personal banking with them, and I’m really used to their online banking system.

Just so you know, there are going to be fees involved wherever you go, but the costs are far less than the benefits to your business. At B of A, their fees for the account are waived if you use their check card (which is attached to the business checking account) at least once each month. If not, you get a $7.00 hit each month you don’t use it. I recur a $15.00 fee for one of my services which help me automate my business, so this will not be a problem.

Sole Proprietor or LLC?

At the bank, the first thing I was asked was if I was doing business as a sole proprietor, as an LLC, or a corporation. Of course, I said LLC, but you don’t need to be an LLC to get your own business banking account.

Sole Proprietor

You can be an individual person, or a sole proprietor who just wants your own separate business banking account for your business. That being said, you’ll need to provide two things:

YOUR social security number, and…
a DBA

Regarding the first item, please know that although you’ll have a separate bank account for your business as a sole proprietor, you’re not really protecting your own personal assets since your the one on the account, instead of a separate business entity, like an LLC or corporation. If your business were to be sued for whatever reason, both your business and personal assets would be in jeopardy. Again, this is why I started an LLC.

Now, what’s a DBA? You need a DBA, as a sole proprietor, in order to open a business bank account. Without it, it’s a no-go. DBA stands for “doing business as” and it’s a formal way to legally operate a business under a different name than your own. So, if your name was John Smith and you sell cucumbers, after you file a DBA you could legally do business as “Cool Cucumbers”. Legalzoom can also help you file a DBA for you for about $100. More info about DBAs can be found here.

LLC

As an LLC, I had to provide the following in order to get a bank account with B of A. They kept copies of each:

The LLC’s EIN (aka. Federal Tax ID) – The IRS provides you with a form with the EIN on it. They need to see this.
The “Articles of Organization” – this is a form that comes from the Secretary of the State that is signed and stamped and basically proves that you are indeed an LLC. It has a really long number in the upper right hand corner which they need.
The Operating Agreement (if you have one) – this is basically a formal statement about your company and it’s members.

It was a fairly simple process, and they just asked a few questions about what my business was about.

They set me up with an online ID so I could easily access my account online. I was also given a temporary checkbook which has the correct routing number and account number. This is important because I can immediately begin to connect my paypal account and other forms of business income to it.

Lastly, in order to open the account, I needed to deposit at least $25.00. I deposited $100 for good luck.

And that was that. I’ll be getting a check card in the mail in a few days, and I was actually approved for a business credit card as well, which will help my company begin to form a credit history, which is important if I ever want to take out any loans or lines of credit in the future.

In Conslusion

I apologize for the length of this post, but I believe it has some good information for you, even if you don’t plan on starting your own business anytime soon.

The most important thing to realize here, beyond the fact that you should separate business and personal finances, is that you should perform good business habits right from the start. Like a golf swing, if you start out with bad habits, it’s very hard to start over and get to where you really want to be.

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Thank you so much!

Why You Need A Business Banking Account, And How To Get One

What I Learned From My First Meeting With a CPA

Pat — Sat, 31 Jan 2009 08:00:17 +0000

Today I had my first meeting with a Certified Public Accountant. For those of you who aren’t too sure, a CPA is a person who has passed the Uniform Certified Public Accountant Examination whose primary function is to provide assurance services, or public accounting. In addition, they can help with business consulting, financial and estate planning, tax prep, and so on.

I had a financial planner once before who was actually very helpful in educating me about my future relating to retirement and larger purchases in my near future, such as a car and a house. However today, the CPA (let’s call him Dave) was pretty much focused on Flynndustries, LLC (my business), and my personal income with regards to taxes – something I am pretty clueless about. Remember, this is a learning process for me and if I tried to know and understand everything before diving into it, I would never have started my business in the first place.

Going Into The Meeting

I didn’t really know what to expect, but I did gather a whole lot of information before going into the meeting, which I’m thankful for. If you do ever meet with a CPA for the first time, for your personal or business affairs, I recommend bringing anything and everything you have that relates to your tax filing from the previous and current year, including your W-2s, any 1099s, expense reports, etc. and also any documentation relating to your new business. Dave examined a lot of the documents I brought and it helped him to understand my current situation a little better.

I walked into Dave’s office, was guided into a conference room, and sat down only to notice he had a folder with my company name on it with the emails we’ve been exchanging inside. Sweet.

Important Things I Learned

I won’t give you a play-by-play of everything that we discussed, but we did hit some important topics that I would love to tell you about.

For background, Dave understood beforehand that I work from home and run my own business after recently being laid off. I accept payments through paypal from my website which sells an eBook and an audio guide, and I also sell advertising space on my website too. Lastly, I made sure he did his best to educate me about anything and everything possible instead of just telling me to do this or do that.

As a disclaimer, this is my interpretation of what Dave told me, and you should take this advice as you may knowing that it may or may not be the best advice for you and your own situation.

Starting My Own LLC to Protect Myself was SMART

Dave immediately told me that if I hadn’t started my own LLC already, he would have told me to – especially now that I’m getting married and I want to protect my personal assets from any debts my business may happen to incur.

I told him that I was pretty clueless about how to handle money with regards to my business, and so far nothing has changed from before I started my company up until now. Dave said this was okay and meeting with him was the first step in the right direction to make sure my business runs smoothly and financial matters are kept in tact, since I’m a newbie.

First Things First: Keep Your Business and Your Personal Assets Separate

The first thing I must do is separate my business from my personal accounts. Guess what…the IRS requires it. Right now it’s all mixed up, which happened because I was running my website as a sole proprietor before starting the business.

I have to open a business checking account, which can be done at any of the nearby banks. Since I received an EIN (employer identification number) from the IRS, which was done automatically for me by LegalZoom, this shouldn’t be too hard.

Any payments I make should be through this checking account, either by writing a check on an online transaction. This will ensure that all money coming out of my business really did come out of my business accounts. Dave advised me that I can make payments for my business using my personal accounts, but I would have to then reimburse myself and literally pay myself back with my company’s money. It sounds kinda funny, but this again ensures that all transactions for my business are kept in record on my business accounts, which will help when tax season rolls around.

Any money that I earn from selling anything online, or any payments from eHow or Google must be brought into my business checking account. Right now, it’s all in my Paypal account. The Paypal account can still accept payments, but I must forward any income into the business checking account.

Track Everything I Do

An important thing I learned is that as long as I keep track of every major decision I make regarding my business, and every piece of income and expense is kept track of neatly in software such as QuickBooks, I will provide myself with maximum protection.

If I write something on paper and date it, such as a decision to partner with someone, if I were to be audited or sued later on, the fact that it is on paper will help tremendously. If I just say “Oh yeah, we partnered on this date…”, it won’t really fly.

Dave also recommended that I get really involved with QuickBooks to track my income and my expenses for the company and also for my personal finances as well. I have to discipline myself to spend a few hours each week to enter transactions into Quickbooks to make sure that I have a record of each and every thing I do. This way, I can make sure I save the maximum amount of money on tax write-offs and also if I ever wanted to sell any part of my business, having easy to read QB files, rather than shoeboxes full of receipts is much more professional.

Dave said this to me:

“Start your company off with good habits. You are the owner, the CEO, and how your company is run from the inside will reflect how it performs on the outside.”

Nice.

Doing Business As

One last thing I learned in today’s meeting was that I can have my own company, Flynndustries, LLC, and have other entities or “projects” that work under it that do business under a different name. For instance, my intheleed.com website is now Flynndustries, LLC “doing business as” intheleed.com. It’s still the same company, just a different “face” for a different “project”.

This isn’t just said – it must be done formally depending on your state. Here is a helpful website that explains how to do this in the state you are doing business in.

Very Pleased

Overall, I was very well pleased with my initial meeting and I told Dave I would love to have him be my CPA for my business and for my family. He mentioned that he was definitely interested to work with me because it excited him that my company is brand new and he wants to help it grow just as much as I do. I will report to you the next time I meet with him if I learn anything new and helpful.

Free Consultation

This was a free consultation, and as you can see – I learned quite a bit. Most CPAs will do a free consultation and help you figure out what you’re supposed to do or where you may need help and can use their services. I recommend that if you need to straighten out your finances at home, or you just started your own business – to find a CPA or accountant of your own.

I found Dave online after searching for “San Diego CPA” in Google. I read some reviews and heard some good things about Dave, which is why I emailed him for a consultation.

On Deck

Well, it’s the end of the month, which means my monthly reports are coming up. My next post will be my January Income Report, and I’ll have another eHow report for you eHow writers too, don’t worry.

I also wanted to get into more of the details behind how I automated my business and how I handle purchases, transactions, and delivery of my eBook and audio guide. This will be highlighted in some of the February posts.

Cheers to all!