The Legal and Tax Aspects

There are many legal forms for your new business to take. You can be an unincorporated business and report your income for tax purposes.You can form your business as a Limited Liability Company, which has many of the best tax characteristics of a Corporation and a partnership. Which should you choose? In general terms, you want the income of the business to pass through to you and be taxed on your personal return. This is generally true for most small businesses. If you are unincorporated, this happens automatically, but being unincorporated is generally not the best idea from a legal standpoint.

When you’re in business, you open yourself up to claims and risks that you don’t have as an employee. Your customers or vendors might sue you. Your bank might sue you. Competitors may issue claims against you for copyright infringement or any number of other things. You want to insulate yourself against these extra risks so that third parties can come after your business but not your house or other personal assets. Being unincorporated doesn’t help you. Organizing your business as a partnership doesn’t help you because you remain personally liable. So you want to be a Limited Liability Company. Since we have established we want to pay taxes at the individual level, you can still be self-employed working for a business you actually own.

Why then, are we saying it’s better to report the income of the business on your personal return rather than on a business return? Because if the income is reported at the corporate level, you will end up being taxed twice on the profits: once at the corporate level and again as a dividend when you take your profits out of the corporation. The company does not get a deduction for dividends paid to its shareholders. To avoid the double taxation, you would have to be careful to pay yourself a salary each year equal to the full profits of the corporation. This can get tricky since you won’t always know the taxable income of the corporation before year-end.

Now that you’re legal and ready to roll, you need a plan. I don’t mean a plan you carry in your head, ideas you’ve had over the years in bits and pieces. I mean a solid, written plan that lays out all the details about your business. Describe your business, your products, your competition, your advantages, your target market, demographic information, your marketing plan, your management team, strategic alliances you have with other companies and your financial forecasts. Do not cut this process short! By doing the research necessary to complete these steps you may find out that your business cannot make it as you had originally planned. You might discover changes you have to make. You will improve your chances of success.

You might ask if you can use one of the many software packages on the market for producing your business plan. It depends on what you’re using the plan for. If your plan is only for you to use internally, they are fine. If you want to go after venture capital or bank financing, forget them! Your business plan will look just like a thousand others they’ve seen and will be lost in the clutter. To obtain financing you want to create a distinctive business and marketing plan that stands out from the rest and doesn’t look like it was created via the cookie-cutter approach. Resolve to do it yourself from scratch or hire professionals to do it for you with your input. If you hire professionals, be prepared to participate heavily in the process since it is your business and you presumably know more about the business than your consultants will. Another benefit to using consultants is that they represent a sounding board for your ideas. If you can’t afford them, do the plan yourself and use your friends and trusted business associates as your sounding board.

Your business is now organized and properly authorized to do business in your locality. You now need to consider how to monitor and account for your daily business transactions. Too many businesses make the mistake of running their enterprise by guesswork. Accounting tasks are rarely anyone’s idea of fun, nor are they considered important relative to the other daily tasks of running a business. But you need to fight this idea if that’s the way you think. Just as you wouldn’t spend thousands of pounds a year without some method of tracking the results of your efforts, you can’t run your business without some method of tracking your daily results. Your bank account will not provide you with the information you need. I won’t get into a long discourse about the differences in accrual and cash accounting, but there are a few things you need to understand.

Let’s say you make sales of £2,500 on account on the last day of your first month in business and these were your very first sales. You won’t receive the cash for several days. Did you have any sales for your first month? On the cash basis of accounting, you didn’t. On the accrual basis of accounting, you did. Which is correct?

On the other side of the coin, you purchased £2,000 of office supplies on the last day of the month but didn’t use any of them during the day. This was the only expense you had during the month. Did you have any expenses for your first month in business? On the cash basis of accounting, you did. On the accrual basis of accounting, you didn’t. Which is correct?

On the cash basis of accounting you report income when received in cash and expenses when paid in cash. There are some exceptions, however, such as inventory purchases, which must still be accounted for as inventory rather than an expense. On the accrual basis of accounting you report income when earned and expenses when incurred.

So back to our question; which is correct? If you ever need audited financial statements, your financial statements will have to be prepared on the accrual basis of accounting because it more clearly reflects income. If you need to present your financial statements to third parties, you should have them prepared on the accrual basis. If you want to manage your business using financial data that is meaningful, you need to have accrual basis financial statements.

You’re probably protesting that you’d need to be an accountant to do this! Well, you should have an accountant for a variety of reasons, but you don’t have to have one to keep your books on the accrual basis. It’s simple. Get a software package to do the work for you. An accounting software package does not simply give you an input screen into which to put accounting transactions. It will give you software that will allow you to input your business transactions and will automatically create your books and records for you. For example, you use a sales order entry screen to enter your sales information; the accounting system will make the proper entries for you. By entering the sales order information, you’re also getting the ability to print professional looking sales orders, track sales orders, convert the sales orders into invoices, record the invoices as receivables, and apply cash receipts to those receivables. These are all tools you need anyway to manage your business properly. The accounting for the transactions happens behind the scenes automatically. The same thing happens with your payables, your payroll, your job costing, or whatever other functions you require. Granted, you may need some help in setting up your system to make all this occur seamlessly, but once that’s done, you won’t have to worry about it anymore. Anytime a third party needs your financial statements, you simply print them out. You’ll have tools to help you know where you stand financially, what your receivables are, what your payables are, what the status of your orders are, what you have in inventory and so forth.

You might be a great potential entrepreneur but you still need to spell out exactly what it is you plan to do, who needs it, and how it will make money. A good starting point is to look around and see if anyone is dissatisfied with their present suppliers. Unhappy customers are fertile ground for new businesses to work in.

One dissatisfied customer is not enough to start a business for. Check out and make sure that unhappiness is reasonably widespread, as that will give you a feel for how many customers might be prepared to defect. Once you have an idea of the size of the potential market you can quickly see if your business idea is a money making proposition.

The easiest way to fill an endurable need is to tap into one or more of these triggers:

• Cost reduction and economy. Anything that saves customers money is always an attractive proposition. Lastminute.com’s appeal is that it acts as a ‘warehouse’ for unsold hotel rooms and airline tickets that you can have at a heavy discount.


• Anything that offers the prospect of making exceptional returns is always a winner. Competitors’ Companion, a magazine aimed at helping anyone become a regular competition winner, was an immediate success. The proposition was simple. Subscribe and you get your money back if you don’t win a competition prize worth at least your subscription. The magazine provided details of every competition being run that week, details of how to enter, the factual answers to all the questions and pointers on how to answer any tiebreakers. They also provided the inspiration to ensure success with this sentence: You have to enter competitions in order to have a chance of winning them.


• Niche markets. Big markets are usually the habitat of big business – encroach on their territory at your peril. New businesses thrive in markets that are too small to even be an appetite wetter to established firms. These market niches are often easy prey to new entrants as they have usually been neglected, ignored or ill-served in the past.


• Differentiation. Consumers can be a pretty fickle bunch. Just dangle something, faster, brighter or just plain newer and you can usually grab
  their attention. Your difference doesn’t have to be profound or even high-tech to capture a slice of the market. Book buyers rushed in droves
  to Waterstones’ for no more profound a reason than that their doors remained open in the evenings and on Sundays, when most other established bookshops were firmly closed.

Now you have the day to day details of running your business so how do you keep going?

There are several things to look at here:

• What are you good at and what do you enjoy doing? Make two lists - one of the jobs you like and one of the jobs you don't do very well. Take the second list and have a look at what you might outsource or automate. Do you love doing those accounts or would your time be better spent in forward planning while your accountant does the sums? Must you personally reply to every enquiry or could you create a FAQ which you can post on your website and refer people to by autoresponder? In the early stages of your business you might find you don't have the money to pay someone to do the jobs you hate. Could you swap skills to get the help you need?


• Why are you doing this? You need to be motivated to start a business and keep it going. The best way to do this is to know what the effort is for. What really moves you to get up in the morning and do what you need to do even when you don't really feel like it? Write your reasons down. Find pictures of that house, or that holiday and put them where you can see them.


• How do you deal with those bumps in the road? Not everything you do will be perfect - sometimes things you've tried will be a disaster - it's the way you react to problems that matters. If you curl up in a ball and give up at the first sign of failure you'd better not be in business. It's all about attitude.


• Have a plan and stick to it as far as possible but be prepared to be flexible and open minded. Sometimes the most unexpected opportunities come and you need to be ready to seize them. - as Joe Vitale says 'Money likes speed'.


• Get a mentor - learn from someone who has done it. Someone to bounce ideas off and who can encourage you when things get tough is invaluable.

And most importantly, never let anyone put you down and never be afraid of failure:

"It is not the critic who counts, not the man who points out how the strong man stumbled, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena; whose face is marred by dust and sweat and blood; who strives valiantly; who errs and comes short again and again; who knows the great enthusiasms, the great devotions, and spends himself in a worthy cause; who at the best, knows in the end the triumph of high achievement; and who, at worst, if he fails at least fails while daring greatly, so that his place shall never be with those cold and timid souls who know neither victory nor defeat" - Theodore Roosevelt.

A Great British Business did not just happen - It was planned that way.