5 Tips for Structuring Your New Business Like a Pro
Is your new business a “lemonade stand”? That’s the term we use to describe businesses that were set up quickly with lots of passion but will fade into oblivion instantly when hit with the first sign of a legal or tax challenge. Lemonade stands are not serious businesses and are not worthy of funding. Lemonade stands are here today, gone tomorrow, and never create a legacy of wealth or success for their founders.
Don’t let your next business be a lemonade stand.
Instead, opt for the “Fortified Cash Machine” model by using these five smart tips for structuring your new business right from day one:
1. Set up an “operating entity” rather than being a sole proprietor.
With guidance from your tax attorney or CPA, select and establish an operating entity, such as a corporation or LLC, through which to conduct your business. While operating as a sole proprietor is certainly the easiest method, doing so clearly shows you’re more interested in building income for yourself rather than in building an actual business.
“It almost never makes sense to conduct business in your own personal name,” says Tim Berry, an asset protection expert in Phoenix, Ariz. “Operating in that manner exposes you to the worst of everything: The worst legal liability, the worst tax rates and the lowest chance of being able to ever sell your business in the future.”
2. Establish a “trust” to hold your operating entity.
It’s wise to have a “buffer” between you and your new business so that challenges that you or your business might face in the future will be confined and not threaten everything else that you own. Establishing a trust is a great way to create such a buffer, and it can provide a plethora of other benefits.
“A trust is essentially a way to separate yourself from some of the risks of owning things like businesses, vehicles or other assets. When a trust is well-structured, it gives you the benefit of controlling an asset -- like your new business -- while taking far less risk. It’s a very wise move” Berry says.
Trusts can be very expensive to form, but don't need to be. Expect to spend a few thousand dollars to get a solid basic trust in place for your new business.
3. Separate your intellectual property from your business.
You might think that your new business has no intellectual property, but you’d be mistaken. The two most obvious and potentially valuable pieces of intellectual property your business already owns are its telephone number and its web address.
Berry offers this ominous warning: “Imagine it’s 10 years from now and your business has been very successful, when a frivolous lawsuit is brought against your company by a competitor. Unfortunately, your company loses the lawsuit. If your company owns your telephone number or website address, your competitor could actually legally take over your phone number and website and benefit from your great reputation.
“A simple solution is to let your trust own all of your business’ intellectual property, and simply license those assets to your business. This separates those assets from your business in the event your business ever faces any problems, and also could create some tax reduction possibilities,” Berry says.
4. Establish a solo 401(k) for your business.
A solo 401(k) -- sometimes called a self-directed 401(k) -- is a special type of retirement savings account that’s available only to small businesses. It enables you to sock away as much as $50,000 or more per year and get huge tax deductions.
But tax savings aren’t the only reason to set up a solo 401(k).
“The money you place in a solo 401(k) is, from a legal perspective, extremely secure” Berry says. “If you handle the account correctly, almost nothing can touch your 401(k) savings, including bankruptcy, lawsuits and usually even the IRS.”
5. Name your business with funding in mind.
Banks and traditional lenders prefer to lend to certain types of businesses more than others, and if you need to get funding for your business, you must bear this in mind when naming your business.
“We’ve seen over and over that some businesses are just less attractive to lenders than others. For example, all else being equal, most lenders will provide financing to a marketing or management company long before they’ll fund a real estate company, because the perceived risk is so much higher in real estate” says Ari Page, CEO of Fund & Grow.
This does not mean you shouldn’t be in the real estate business. Rather, it’s a suggestion that you should not stack the deck against yourself by making the name of your business overtly real estate-related, as that stigma alone may be enough to be rejected by your lender of choice.
Creating a new business is incredibly exciting and utterly terrifying at the same time. But if you use these five strategies to form your new venture on a firm foundation, your new business can rocket past its lemonade-stand-like competitors and enjoy a strong foundation forever.