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Uninformed Formation - Five Mistakes to Avoid in a Small Business
Here are five mistakes that anyone starting a business should avoid at all costs, drawn from real situations.

1. Not having a plan for your business - Brian*, a passionate and talented karate teacher, bought the studio from its founder a year ago. He borrowed heavily to finance the deal and the studio does not generate enough revenue for him to meet his obligations and lead even a modest existence. The studio's continued existence is now in doubt and Brian has even considered personal bankruptcy. At minimum, a realistic budget before he purchased the studio might have illuminated the problem and given Brian pause. With concrete knowledge he may have looked to delay the purchase, renegotiate the deal or look for additional investors. Many entrepreneurs love what they do but are intimidated by numbers and planning. A small investment - mostly of time - can make it possible for you to actually succeed at what you love.

You don't need a fancy printed business plan in three-ring binders- but you do need to address a few core questions. What are your cash needs? What are the cash needs of your potential partners? Can the business meet those needs? If it cannot, what will your partners do? What will you do? Are there any periods when the business may need to borrow money? Alternatively, if you anticipate profits, will you be able to pay the related taxes when they come due? Wouldn't you rather know now?

2. Not getting it in writing - A marketing firm, ML Creations, Inc. invited a senior employee to become partner. Sam was an outstanding performer and responsible for many of the firm's largest accounts; Matt and Louise thought they had him "locked in" when he accepted. A month before the kickoff to a major client project, Sam announced he was leaving the firm - in two weeks. Matt and Louise scrambled and scoured the partnership agreement Sam had signed just six months earlier. There was no notice required of an exiting partner. Had Sam been required to give, say, three months notice, at the very least the remaining partners would have had some breathing room. Or perhaps it would have given Sam pause before signing on as partner - or leaving.

A handshake is not enough. (Neither, for that matter is a kiss) Even/especially with good friends or family as partners you need sound legal agreements before you incorporate .How will the profits or losses be allocated? How are the partners to be compensated and how is that decision made? How can shareholders/partners enter/exit? This is serious business - your money, your livelihood, your relationships. In the excitement of forming a business, we don't want to think of what will happen if we cannot get along with our partners (especially if those partners include a spouse, a sibling, a best friend). But just like business planning, taking the time to sit down with your potential partners and a trusted advisor before you jump in will enhance your chances of a successful endeavor and harmonious relationships. Or you may find areas of fundamental disagreement. Wouldn't you rather know now, than later-after the business, and your relationships - have suffered?

3. Missing the tax implications - Experts in Dermatology is a successful firm of four professionals and a "C Corporation". Last year the IRS reclassified them as a "personal service" corporation, thus subjecting ED to a 35% statutory federal income tax rate. The partners, needless to say, were not pleased. Had they known the tax consequences they might have chosen a different form of organization.

Whether you are a solo shop or a shared endeavor, there are numerous and complex considerations. Partners with kids? An S Corporation selection may cost you some tax breaks for dependent care. Anticipating profits? That same S Corporation allows for distributions that save some of the burdensome payroll tax. High salaries and minimum profits? Maybe choose a C.Corp, for the benefits. Need flexibility? LLC may be the way to go. "All in the family"? Traditional partnership may be sufficient, and cheaper. It may take you a week longer to organize and cost you a little more, but obtaining proper advice will save you headaches, not to mention big bucks, in the long run.

4. Mingling your personal and business finances.

We Move It is actually one man - Jake. He incorporated two years ago for tax and liability reasons. But he still runs it out of his back pocket. Kids' school? Company account has more cash. Personal credit card? Company check. Its easier, he's busy and that's the way he did it when he was a sole proprietor, right?

It's a bit paradoxical -- your new entity is all you - your investment, your business, your decisions. Your taxes! But the legal protection you gain from incorporation is not legitimate if you do not keep it rigorously separate in financial matters. Otherwise you can run awry and a vendor or investor -or, better yet, a taxing authority -- may "pierce the corporate shield". And because personal and business activities are combined, Jake cannot properly analyze or forecast the results of his business. He may be running up a huge tax liability or slowly going out of business - but because everything is in one big pot he never knows what's in the stew.

5. Not having a reputable bookkeeper or bookkeeping system.

Hairs T-You is a successful hair salon and shop run by two young brothers. Their sales grow every year, and, maybe, their profits. You see, they are not really sure. Too busy and intimidated to pay attention to finances, they never take inventory or "reconcile" their bank accounts. Then they end up borrowing to pay taxes on profit they haven't seen...which proves to them they do not understand finances, which they then continue to ignore.

You can send hard-earned dollars down the drain by running the books out of your back pocket. There are lots of holes in that pocket, Dear Liza, Dear Liza. Not only will you not know how your business is performing and miss out on valuable tax savings, you will end up paying through the nose to have someone clean it up once a year. Bookkeeping does not have to be a huge expense and it can pay enormous dividends - and save enormous headaches.

Copyright © 2006 Richard Streitfeld
All rights reserved

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