1. Entity selection - I am asked about this a lot. It is always wise from a cost-saving perspective to run as a sole-proprietor when you first get started. However, it is not wise to remain that way for too long. Some of the potential triggers to incorporate or organize an LLC include:
- bringing on partners or investors
- gaining your first and subsequent customers
- adding employees and/or contractors
- protecting intellectual property and personal/other assets
- planning for taxes.
One other point to make in entity selection - creating an entity is about setting up a legal structure and, in my opinion, does not mean you have created a business. Getting customers to accept your promises and then receiving payments from those customers when you keep or deliver upon your promises constitutes a real business. Focus on getting customers, then you should spend more time worrying about your legal entity.
2. Record Keeping - There are plenty of software options for record-keeping, but we need to be clear about what we are after. Why are we bothering to keep records? Is it to be compliant with taxes, our bank, or some other entity, or is it so that we can review and use our financial performance strategically - to improve our performance and build competitive advantages?
A start-up must first focus on record keeping for compliance. This may mean an outsourced bookkeeper or your CPA looks over and corrects your information quarterly or annually. My recommendation is to move towards establishing your record keeping system for strategic reasons. You may need to have someone working on this information daily. Depending on your volume, number of transactions, and overall complexity, the most economical but highest impact structure can be designed for your business.
3. Banking - Yes, please set-up a separate bank account from the first day of the business, even if you are a sole-proprietor. This makes record-keeping much easier and it helps you initially manage your business cash flow better. I recommend a bank that has a high-level of online banking features to keep you or your staff from going to the bank very often. Once you set-up the bank account, you may not need to ever return. With remote deposits, online bill-pay, and so many other services available, your time can be focused on more important things, like getting your start-up going.
In addition, have a separate credit card for your business purchases. This simplifies tracking your expenses. You may also get a credit card in the name of your business, but it will based on your personal, not business, credit score and you will have to personally guarantee it.
4. Billing & Collections - Be very careful to whom and under which terms you extend credit to your customers. Resist the temptation to extend your customers an extra 30 days to pay at their request. You are running a business and your cash flow is your life-blood.
Establish your invoicing practices under the premise of receiving payments from your customers as early as possible, even before you deliver your products or services, if possible. Why do you think so many monthly subscription companies are willing to discount their subcription fees if you pay for an entire year in advance? Because they know that cash flow is the life-blood of their business and 10 months of subscription cash in their hands today is worth more than receiving small monthly subscriptions over the next 12 months.
If your customers are delinquent, cut them off from your product or services. This is hard to do, especially if they are a large and/or very profitable customer. However, the risk of not getting paid is potentially far more damaging than trying to keep that customer happy. Stick to your guns. If they still don't pay, then charge them late fees and send them to collections. Yes, collection agencies are expensive, but they will report the delinquency to the credit bureaus as well as give you your best chance of getting paid.
All of this implies having a policy and procedure for invoicing and collections. For more information on establishing these, you can refer to a prior blog post I wrote Collections - The Pleasant Nuisance Theory.
5. Payroll - Do you have employees or independent contractors? If you answered yes to the independent contractor part, then you need to know about a potential liability you have. Are they really independent contractors? I will not go into detail here, but I have seen companies assessed penalties in excess of $200,000 for improperly classifying their contractors.
Payroll compliance is complex and, in many instances, it makes sense to outsource it. First, you need to be aware of it. I know several companies that, when they started, were unfamiliar with the payroll tax laws and codes. It did not take long before they got in trouble and one of them went out of business because they could not cash flow the back-payments, penalties, and interest. The IRS is the worst and most expensive potential creditor for your business. Second, there are many on and off-line companies capable of the task for reasonable fees. If you run payroll in your company, I recommend you seriously consider outsourcing this task.
6. Taxes - Most start-up companies have losses initially. While a start-up experiences losses for tax purposes, it is beneficial to have those losses off-set income from the highest tax bracket possible. This may be beneficial to you, or it may be able to benefit someone else, like a close relative, even more. There are some strategies worth exploring in the early days of your start-up.
Once the business becomes profitable, a few issues arise. First, how you and the other owners are paid. You can be paid through payroll, profit-taking (aka distributions, dividends, draws), and reimbursements. There are critical tax consequences to each, and they should be explored to keep as much cash in the business as possible. Second, the entity type will become crucial to taxation. And third, business deductions and credits should be maximized that might include: home-business deductions, section 179 for equipment purchases, R&D credits, hiring credits (thanks to President Obama), and many others.
7. Staff - I have written in detail before on staffing accounting and finance for start-up to medium-sized companies. Outsourcing usually makes sense at first, and then every start-up reaches a point in growth, volume, and complexity that merits bringing the function in-house and building it into a core strategic competency. Every business has to deal with this, and when it is handled correctly, it can be a tremendous competitive advantage.
8. Professionals - You will need a good tax CPA, a business attorney, and other professionals to help you be compliant. You will also need professionals to help you strategically grow and succeed in your firm. One example of professional services are the CFO services we offer to our clients. I recommend three things for you to consider as you engage and work with professionals in your business. First, interview at least two or three to find the right fit for your business. Do they have experience in your industry? Do they have contacts or other connections that could help your business? Do you get along with them? Do they listen well and help you understand things in a way with which you are comfortable? Interview and find the one you like.
Second, remember that you are their boss, and not the other way around. They work for you and you pay their bill. You need to question their recommendations and, ultimately, the buck will stop with you even if something bad happens because you followed their advice.
Third, you want to work with professionals who have the right blend of hunger, experience, empathy, energy, initiative, and honesty. This is tough to find, but they are out there.
9. Financing - The very best way to finance your business is to bootstrap it and use your internally-generated cash. Besides watching expenses, you can improve cash flow through vendor credit/trade terms, customer pre-payments, and other strategies. If you do not have enough cash and you are sustaining operating losses, you will need to finance those losses with personal credit cards and signature loans/HECLs or equity. When the business needs to make capital expenditures, these can be financed with leases and loans secured by the equipment. If the company needs capital to fund an aggressive growth trajectory, then some debt and most equity instruments will do the trick. Remember that most forms of debt require a personal guarantee from the owner(s).
10. Benchmarking - In my recent blog post 5 Ways Entrepreneurs Improve Cash Flow with Benchmarking, I identify that benchmarking is usually free but few business owners utilize this powerful concept. Compare your performance to yourself, your industry, and to other businesses as well. The accounting/finance function usually facilitates this, but in a start-up it is usually the owner that initiates and follows-through on benchmarking. Your benchmarking should include both quantitative and qualitative data. Make this a regular part of your business, and you will quickly find competitive advantages to improve your cash flow and profitability.
11. Payment Priorities - BONUS TIP! I recently spoke with a man who started his business 26 years ago. He has been through many cash flow "valleys" wherein he did not have enough cash to meet the financial demands of payroll, vendors, etc. He taught me his payment priorities when such emergencies come. First, he pays his employees. Second, he pays the government. Third, he pays the landlords of all of his locations. And finally, he pays all other loan payments, vendors, suppliers, and others - including himself. This is not a bad way to prioritize.