When it comes to setting up your business, you may find yourself in a place where you have to make some financial and legal decisions.
You may be asking yourself:
- What's the first step in establishing my business?
- How should I split equity with other members of my team?
- Do I need a trademark?
We've provided you with a step by step guide to setting up your business.
The purpose of this guide is to act as an outline for the steps you'll need to take to get your business running (mainly U.S. advice). When making any serious legal decisions, we advise to consult with a lawyer first.
Decide Whether Your Business is an LLC, S Corp or C Corp
There are benefits associated with organizing your business with any of these corporations. Choosing one depends on what is right for you and your operation.
These three options are found to be the most common when starting a small business, and all serve to protect your personal assets and also provide you with certain tax benefits.
- LLC: All income and expenses from the business are reported on the LLC personal income tax return.
- S corp: Owners pay themselves salaries + receive dividends from profits.
- C Corp: C Corps are separately taxable entities that file a corporate tax return (Form 1120). No income tax is paid at the corporate level and any tax due is paid at the owners individual expense.
We also want to outline a few pros and cons of each to support your research:
LLC Pros and Cons
- Easy and quick set up: The application is only a few pages long and there aren't as many rules & regulations as there are in an S-corp
- Tax return benefits: Owner of LLC technically does not have to file a tax return for the LLC specifically (need to declare on personal taxes)
- Economical: Not nearly as expensive as an S Corp. Only costs a couple hundred dollars
- Risk associated with not separating business transactions with personal transactions - otherwise known as: Piercing the corporate veil
- Self Employment Tax: Members of the LLC may be responsible for paying self employment tax based on the business net earnings.
Here's some great advice from Alex Benjamin, founder of Recruiter Written on how he set up his company with under $600 including the LLC:
S Corp Pros and Cons
- Major benefits when business is profitable: Tax benefits are offered when the business has distributions, and any remaining profits from the company are distributed and taxed at a lower rate.
- Expensive set up: The cost to form the S Corp is much higher than an LLC
- Lengthy and strict application process: you can check out some of the application requirements here
- Risk associated with not following strict guidelines: Must follow stringent rules at all times.
C Corp Pros and Cons
- Unlimited number of shareholders
- Lower max tax rate
- Ownership Flexibility: Anyone can own shares, including business entities and non- U.S. citizens
- Double Taxation: Tax is paid on its earnings and shareholders pay tax on dividends - so the business earnings are actually paid twice
Colin McIntosh, Founder of Sheets & Giggles walks us through lessons learned when launching his business:
Lesson: We should have been a C-Corp from day 1 (we were an LLC at first). Corporate transitions cost attorney fees.
Habit: I always try to have an action bias, and I try to focus on getting items done that “unlock” my team members’ work. If someone needs me to write some copy that allows them to do 4 hours of work, I’ll take care of that first thing in the AM. Or, if someone needs to be trained on logistics software to do customer service, I know my life will be made easier if I train them ahead of tackling my must-do’s for the day
Don’t hire people you know are assholes just because you need someone to do the job. Suffer and do it yourself, or delay the launch, but don’t hire assholes. It’ll hurt you more in the long run.
Patent or No Patent?
Securing a patent can be a very valuable tool, but it's important that you are 100% sure this will be a smart business move for you, or if you may not be ready quite yet.
This is not to say that you shouldn't apply for a patent, in fact, this is highly suggested from most of the founders we interview, but you may want to consider the following factors:
- Make sure you have already developed your basic prototype first and foremost We provide you 7 tips here
- Understand your market - Is there interest for your product in the marketplace? Will the time you spend on getting a patent be worthwhile once you finally secure it?
- Make sure your idea has not already been patented by conducting a search on US Patent and Trademark and Google Patent Search
- Understand the time, energy and costs that are associated with securing a patent
- Check with your attorney first!
Robert Patton, founder of Sheath LLC discusses how the steps leading up to securing a patent validated his idea even further:
Before moving forward with my pouch underwear idea, I did some research to see if the product had already been invented.
I noticed on google patent search that in 1981, a man in China invented something similar, and therefore, I didn’t think I had the option to make a full Utility patent, so I decided to create a design patent to provide some protection.
Note: Design patents are essentially useless unless you are designing a new shoe. If you are designing something with functionality, you need to attain a Utility patent.
I noticed on the United States Patent and Trademark Office search that similar inventions already existed, but nothing quite like what I had in mind. This lent credence to my design, as I now knew that others had been on the same track of thought and that there was clearly a demand to be met.
We applied for patents and did all of this out of my pocket, but you would be surprised to find that applying for a patent yourself isn’t very expensive unless you get an attorney involved. For those on the fence about it, there was a law passed a few years ago that gives preferential treatment to individual inventors and requires examiners at USPTO to walk you through the process, therefore you could file for, and get, a patent issued yourself at relatively little cost.
This would be less than $1,000 dollars and could protect your idea from infringement by others. This can all be researched and completed on USPTO.gov.
Once you have understood the different factors and requirements with acquiring a patent and want to take the next step, there are tons of different resources to walk you through this.
Here is a great resource to walk you through the entire process.
Michele Morton, founder of The Maxbit explains how she acquired her patent with under $1,000 (attorney fees included)!
Let me backtrack slightly about the patent. Once I filed the Provisional Patent Application, friends bought me a book called, “How to Patent it Yourself” and this was my summer reading as I began to write.
Another friend called his patent attorney and he agreed to ‘finish’ it for me for a small fee. It took me a summer to research and write the patent with the help of staff at our local Patent and Trademark Library. From the filing of the patent until it was issued took 18 months. In the interim we had office actions to work on and more research to establish our product was unique and we were not infringing on anyone else’s invention.
When I read what I just wrote, I think, “I made it sound easy”, but that is certainly not the case. Many people choose not to patent but to saturate the market with their product establishing brand and making money as fast as they can.
There are pros and cons to both and obstacles on both sides of those choices. I was advised to patent the powered garden tool, because that is the traditional way and secure way. Anyone who has worked with a patent attorney knows the expense and the arduous process.
After writing the bulk of my patent an attorney finished up the final draft for under $1000.
Should I trademark?
The word "trademark" is essentially just a way of saying brand or name of your business, and is a very important factor in setting up your business.
One of the reasons trademarks are so important is because it sets your business apart from others - this can be anything from your business name - to your logo - and even your phrase.
Basically, your "trademark" is the way in which your customers recognize your brand. [Apple](https://www.apple.com] or Nike are great examples of highly recognizable trademarks.
You may want to consider some of the benefits associated with registering your trademark:
- Better chance of covering yourself from "copycats" and any legal action that may arise from that
- You get to use the symbol “®” after your trademark - which adds a little clout to your brand
- You will be able to use the trademark in all countries that your products and services are sold
- Your trademark will be included in USPTO listings
Ishan Dutta, founder of Ugly Duckling provides us with some insight on the importance of registering for a trademark:
While the testing was going on, we were also working on the trademark registration, the product packaging, the website domain name, and website design. My wife came up with the name “Ugly Duckling”, and I liked it! I immediately found a trademark lawyer and registered it.
I would really recommend registering your trademark if you are an entrepreneur creating a brand, especially if you are going to be selling under this brand name on the internet. The last thing you want is someone coming in after you have done the work and taking your brand name away from you. In my case, It was really lucky I did because within two years of me starting, what exactly happened! I was able to successfully fight them because of that trademark protection. A few thousand dollars well invested!
After I registered the trademark, I also got myself a domain name on GoDaddy (the two are not exactly the same - you need to do both separately and independently) and started to work on developing an e-commerce site with a web designer. After looking around at the options, and discussing with my co-founder we decided not to go with Shopify but with Prestashop. I know that Shopify is great. But we wanted to own our code and be able to customize the website in quite specific ways. I also did not like the idea of paying monthly charges forever.
Secure The Right Permits and Licenses
Every industry is a little different when it comes to securing the proper permits and licenses, and it's usually based off of where your business is being conducted.
It's important to do your research and understand what your business requires. One of the best ways to do this is to just ask other entrepreneurs.
Here's a great list of permits and licenses you may need in order for your business to be compliant.
Cesar Quintero, founder of Fit2Go, discusses how securing the right permits for his food business saved him financially:
Financially, starting the business cost about twice as much as I expected. I had $150,000 on hand, which I thought would be enough to get things off the ground. For example, my initial 6-month estimate of building out our kitchen turned into a year-and-a-half project—and that was all while paying rent and struggling to get the right permits. Eventually, my family and friends helped me fund it all.
I learned a lot of lessons starting Fit2Go. Here’s one key piece of advice to other entrepreneurs who are thinking of starting a food business: always find a kitchen that’s already built and with all the permits in place! It will save you a lot of time and money. Trust me on this.
Consider Obtaining Liability Insurance
Liability insurance may or may not apply to your industry, but for most businesses that manufacture or sell products, it's certainly something you may want to consider.
Why Does your Business Need Liability Insurance?
It's quite simple - so that you are protected against claims made by others (ie. personal injury as a result of your product) and you are properly protected against any risks or accidents that may happen.
The cost varies depending on the size of your business, the industry that you're in & the location of your business.
As an example, Mel Young, founder of Flowerdale Valley explains how insurance specifically applies to the skincare industry
The skincare industry is unregulated to a certain degree. Because I am a soap maker, I have had to register with Nicnas and of course, to make and sell any products, it's a must to have public liability and product liability insurance.
My business has now expanded to include moisturizers, serum, cleanser, deodorant, face oil, face wash bars, shampoo and conditioner bars, and aromatherapy diffuser blends. Everything is made right here on the farm, by me.
Apply For An EIN (Employer Identification Number) in the U.S.
Depending on your business, you may need to apply for an EIN for tax and reporting purposes. To determine if you need an EIN, you can check out this questionnaire.
There are certain cases (ie. sole proprietors with zero employees) that may not require you to have one, and instead use other forms of identification.
Whether you are required to have this nine-digit number or not, there are several benefits associated with acquiring one, such as:
- Typically speeds up the process when applying for business loans
- Allows you to open up a business bank account
- You can easily hire employees (even if it's down the road)
To apply for an EIN, click here.
Abigal Butler, founder of Chirps & Cricket Design provides us with the checklist of items she implemented (including her EIN):
When launching this creative endeavor there ended up being so many decisions to make and processes to walk through. Here’s a short list of items I not only had to educate myself on but had to implement:
- Applying for an EIN / tax I.D.
- Setting up my LLC (understanding why I wanted an LLC vs. a Sole Proprietorship)
- Because my office/studio is at my home, how did I want to direct other businesses and/or clients to send me my mail? Did I want to give out my home address? I ended up setting up and using a P.O. Box at a nearby Post Office.
- Setting up business bank accounts
- Applying for a small line of credit
- Paying taxes, both quarterly and annually
- Obtaining a sales tax license
- Learning about things like operating expenses, gross margins, cost of goods sold, ROI, sales tax, how to price my product, margins, markups, etc.
- Using an accountant vs. handling my financials and doing my taxes on my own
Determine Which Business Bank Account You Need
There are hundreds of banks out there, and it can be overwhelming to find one that's right for your business.
Here are some items you may want to consider:
- Location - Is your bank close enough that you can easily make deposits or get cash?
- Low Fees - Make sure to understand any and all fees associated with setting up and maintaing your bank account. Ask for a list - banks usually try to keep this hidden and in fine print.
- Online Banking Services - Make sure you can easily navigate through your online portal and you have easy access into everything you need.
- Line of Credit - What do your options look like (even if you don't need this now, you may need this down the road).
Every bank has something that differentiates them from the rest, so make sure whatever that is applies to your needs and values.
Check out this list of the 13 Best Banks for Small Business in 2020 and what makes them so unique.
Brian Wysong launched Tumbleweed TexStyles and needed a business bank account to connect to his Etsy orders. Check out his story below:
We launched our business by utilizing social media and word of mouth. We created a Facebook group to promote our newly created brand. We then gathered every email address we had from our friends and family to put into one email list. We then created an ETSY page to be able to sell our products.
During the process of setting up our ETSY website, we realized we needed to set up a bank account so the money from those orders would be hitting a neutral account and not just our own personal bank. As we went through the process of setting up a business bank account through our local credit union, we learned that we had to make our business an official business with the stated for tax and legal purposes. We decided to create a general partnership to launch our brand as an official business in the state of Texas. Jeb and I threw in our initial investment of $350 each to be able to purchase our first run of $700 value of t-shirts. We did not use a credit card nor any type of loan. We literally took out our own personal cash to start the business.
For accounting purposes, we utilize Quickbooks since it can be synced with our bank and website. Quickbooks helps our accountant keep things clean and organized so we can see a real time snapshot of how our financials look.
Allocating Founder Equity
With all the other decisions you are making in order to set up your business, founder equity is high up on the priority list.
In the beginning stages of your company, you'll be faced with this question: How do we split the equity amongst our team?
Tension and pressure might be high, and you just want to shake hands and get through this stage quickly.
Rather than agreeing and accepting the terms right away to avoid conflict, you may want to consider a thoughtful vetting and negotiation process to ensure that you're covered in the long run, in case there are unfortunate circumstances that arise with your partners.
There are hundreds of templates online, here are some free ones to get you started.
This article walks you through the do's and don'ts when building the structure of your founders agreement.
For example, Nelli Jeloudar launched Bundleboon and tells us about their third founder leaving them and how the founder's agreement they drafted up saved her.
For us, our mentors and shareholders have been the biggest help. Being a first-time founder, you make A LOT of mistakes, but having a great team of serial entrepreneurs as a support system can save you a lot of heart and headache.
The accelerator, we were part of truly helped and taught me some valuable lessons. Remember I told you that I used to have two co-founders? Well during the last month of our time at Startupbootcamp (the accelerator), one of my co-founders decided to leave us. When he came onboard, we obviously had to draft a founders agreement between the three of us.
This particular cofounder tried to convince Monique (my cofounder) and I that the vesting clause should kick in within 12 months. Meaning that if one of us decides to leave before the end of the year (in this case Dec 31st, 2018), we will be able to take 10% shares with us out. Lucky for Monique and I, we got some guidance from the accelerator and advised us to extend the vesting agreement to 3 years.
If all co-founders are 100% committed to Bundleboon, the 3 year vesting agreement shouldn’t matter. Thanks to the clause in the founders agreement, our third cofounder ended up leaving with nothing.
Get Your Accounting Process In Place
Accounting and reporting are key pieces to measure your business financial status and future roadmap.
It's important to get your accounting process right the first time, or else you may find yourself spending an overwhelming amount of time trying to put the pieces back together.
Imagine years down the road, your business is doing great and you find yourself in a serious conversation with a potential buyer or investor
One of the very first thing that buyer or investor is going to ask for is your year over year books and a financial forecast of your business. With the proper processes and systems in place, you'll be ahead of the curve.
There are tons of different ways you can find an accountant to set you up for success, for now and for the long run. Here's a step by step guide on how to find a good accountant for your small business.
Prepare for Taxes
It's important to work throughout the year with your accountant or CPA, rather than waiting until the last minute to prepare your taxes.
Here are a few tips to avoid headaches and unnecessary time spent on taxes:
- Key: keep track of your records throughout the year. Make sure they are accurate and accessible.
- Separate business from personal expenses: Avoid getting audited and create two separate bank accounts.
- If you have employees, get a payroll system so that you can easily manage payroll taxes
- Get advice from your accountant early on - they may have financial advice that can save you when taxes roll around.
Let's face it - legal stuff and finances may not be the most exciting part of launching a business, but it's a critical piece in ensuring that your business is set up for long term success.
We hope this was a helpful read. Check out our community to learn more!