By: Ben Forbes
There’s an old saying that “an ounce of prevention is worth a pound of cure.” This saying rings especially true when you are starting a business. Entrepreneurs are problem solvers by nature. They develop innovative solutions that create value in their business. As an entrepreneur, it is your business to address the problems that have already occurred, but you can save yourself a lot of headaches and late nights by preparing to address certain issues before you actually go into business. The purpose of this post is to provide would-be entrepreneurs with a brief overview of some issues they should consider before starting their business.
The Planning Phase
An entrepreneur should conduct research and develop a plan long before starting the business. Even a great idea can fail due to insufficient planning. Developing a business plan is a great start. A business plan can make you more marketable to lenders and investors when you are seeking investment. Investors are more willing to buy in when they can see the projected course of the business. The Small Business Administration’s (“SBA”) and the Pennsylvania Business One-Stop-Shop have some helpful tools to assist you in starting your business and developing your business plan.
It may be tempting to just jump right in and start doing business without formally creating an entity through the Pennsylvania Department of State (“DOS”), but doing so leaves you open to personal liability for the business’s debts. An individual who begins doing business without filing has created a sole proprietorship (“SP”) if they are acting alone and a general partnership (“GP”) if they are carrying on business with one or more partners. These entities provide no liability protection, so the owner(s) can be sued directly for the debts of the business. To avoid personal liability, you should consider one of the many entities that have built-in liability protection such as a limited partnership (“LP”), limited liability partnership (“LLP”), or a limited liability company (“LLC”). For more information about entity types and personal liability you should consult DOS’s “Guide to Business Registration.”
The type of entity you elect to create also has substantial tax implications. The owners of SPs and GPs are not viewed as separate entities from their business. This means that owners of SPs and GPs must report their share of the income from their business on their own tax filings and can also use the business’s losses to offset other reported income. This scenario is referred to as “pass-through taxation.”
These tax consequences can also affect the profitability of a business. Some entities may elect to utilize pass-through taxation. Pass-through taxation allows an entity to pass its tax obligations on to its owners so it can reinvest its income into growth. The owners of pass-through entities may also claim the losses of the business to offset their income from other sources. LLCs and S-corporations are common examples of entities that may elect pass-through taxation.
Certain entities, like C-corporations may not elect to use pass-through taxation. These entities are taxed on their income and then shareholders are also taxed on any distributions they may receive. This is commonly referred to as the “double tax.” You should consider your goals for yourself and for the business when deciding which tax scenario is most beneficial to you and your business. For more information about the taxation of business entities, see the Internal Revenue Service’s website.
funding and raising capital
Every business needs a certain amount of capital to get started. The first step is determining how much capital you believe you will need. You consider factors like equipment, facilities, supplies, research and development if you are selling a product, filing fees, and legal fees. Each business comes with its own unique expenses that you consider when assessing your capital needs.
The second step is how. Small businesses that do not require substantial amounts of capital may want to consider debt financing. Debt financing is just that: financing a business through bank loans. For new businesses with little or no credit, the bank will likely require one or more owners to sign a personal guarantee for the loan. Some small businesses may have trouble obtaining loans, and those businesses should consider applying for loans guaranteed by the SBA. The SBA guarantees loans from certain lenders to make capital more available to small businesses. To learn more about these loans, the qualifications for borrowers, and for help finding a qualified lender, visit the “Funding Programs” portion of the SBA’s website. Small businesses can also seek loans from private investors such as friends and family members. Finally, a small business can seek capital by adding partners or offering equity in exchange for investment.
Larger businesses with more robust capital needs, such as businesses that need a substantial amount of capital for research and development of a product, should consider investment from venture capital (“VC”) firms. VC firms are groups of investors who invest in new or unproven business ventures that carry more significant risk in exchange for equity in the business. The downside is that you are giving up a portion of the control and ownership in your business. The upside is that the investor is willing to invest in your idea as opposed to a more mature business that has been well-tested. Your business must generally be a C-corporation to seek investment in the form of VC. There are also laws that govern the sale of stock to VC firms. You may only sell shares to certain qualified investors and can only sell a certain amount of stock each year. Additionally, a company cannot generally advertise that they are selling stock. VC deals are complicated in nature and you should seek the help of an attorney if you decide to raise capital through VC funding.
Advance planning can make your life as an entrepreneur or small business owner much easier, and it will prevent legal issues and other problems from harming your business.
For more information please see:
Small Business Administration Business Planning Page:
Pennsylvania Entities Law (Title 15 Pennsylvania Statutes):
Internal Revenue Service Business Tax Section:
Ben Forbes, at the time of this post, recently graduated from Penn State’s Dickinson Law. He is from Orwigsburg, Pennsylvania and is a graduate of Kutztown University of Pennsylvania. After completion of the Bar exam, Ben will start his career as an associate at Williamson, Friedberg & Jones, LLC representing and advising small businesses.