By G.M. Filisko • Bankrate.com
In
every economic downturn, corporations shed employees to shave costs.
And in every economic downturn, many of those let-go employees make
lemons out of lemonade by starting that small business they've always
dreamed of operating, whether it involves doing what they were doing as
an employee or trying something entirely different.
Like
all small-business owners, newbies need to start off on the right foot
by avoiding legal, tax and financial problems that too often trip up the
freshly self-employed. Here are five tips for making your launch
successful.
1. Create the right legal structure
One of
the first questions every small-busines owner must consider is whether
to operate as a sole proprietorship or as a corporate entity. "You
automatically start out as a sole proprietorship," says Certified
Financial Planner David M. Williams, founding director of
Business Enhancement Associates LLC in Cordova, Tenn.
Operating as a sole proprietor costs no money because you don't have
to pay to create corporate documents and tax returns. Whether you should
continue to operate as a sole proprietor, however, depends on your
business and personal risk tolerance.
"We always strongly urge
people to set up a corporation because it gives you some legal
protection," says Don Mazzella, chief operating officer and publisher at
Information Strategies Inc., a Ridgefield, N.J., provider of
publications for small businesses. "You'd be suprised at the liability
you can engender when you set yourself up as a business owner. People
may come at you with litigation or try to dun you for bills. If nothing
else, it protects your personal credit rating."
But Williams isn't
convinced a corporate entity is necessary for everyone. "I wouldn't say
you should run out and form a corporate entity until you know you can
be in business for yourself," he says. "It's expensive, but it's also a
waste in both time and money. Once you know you can be successful, if
you're doing consulting work and are truly the sole proprietor of your
company, staying a sole proprietorship is probably best. If there's more
than one person with capital involved -- whether that's cash or sweat
equity -- form an entity that spells out how much is owned, who is
responsible for what, and whether taxes should be paid at the corporate
or individual level."
Cost shouldn't be the driving factor in
structuring your business. "Many online sources allow you to create a
corporate entity for just a few hundred dollars," says Allen Bostrom,
CPA, president and CEO of Universal Accounting Center in Salt Lake City,
which trains accountants, tax preparers and bookkeepers. "You just put
in your information, and they'll create templates." Just a few are
Legalzoom.com, The Company Corp., SCORE and Incfile.com.
2. Pay taxes -- if you must
The
way you structure your business will provide guidance as to how soon
you need to begin paying taxes on your earnings. Though there can be
twists, the general rule is that if you operate as a sole
proprietorship, you don't need to begin immediately paying taxes. "Going
by the letter of the law, if you make more than the de minimus amount
of $400, you're supposed to file taxes quarterly," says Williams. "But
there are no penalties if during the year you shift from being an
employee to being self-employed and you don't make quarterly tax
payments."
That's not true if you've formed a
corporate entity. "Those entities must begin filing taxes on income as
they earn it," says Williams. "If you as an entity make money, you have
to report it quarterly."
3. Set aside self-employment taxes
When
you're an employee, your employer withholds roughly 15.3 percent of
your income to fund Social Security. You pay half out of your pocket,
and your employer covers the other half. When you're self-employed, you
shoulder the entire amount. You don't have to make quarterly payments to
cover the tax, but you can avoid getting stung at tax time by setting
aside funds to cover those taxes.
4. Think hard about whether insurance is necessary
Few
startups have extra capital to spend on insurance they don't really
need. Can you save a buck by going without? "In general, you don't need
insurance until you hire your first employee, and then you'll need a lot
of insurance," says Mazzella. "If you're working out of your home and
your only liability is someone tripping and falling during a visit or
losing your office equipment in a fire, you can make sure your
homeowners insurance covers that. If you're operating outside your home,
you'll want a minimim of insurance on your office and assets."What
about liability insurance? That depends on your business. If you're a
service provider who's unlikely to get sued no matter how poorly you
perform, such as a proofreader or graphic designer, you probably don't
need insurance. "We tell our bookkepers that every insurance agent will
tell them they need errors and omissions insurance," says Mazzella. "But
we've never heard of bookkeepers being sued unless they stole from the
business or committed fraud, and no insurance will cover that."
If
you sell products, you again have to evaluate your risk. "If you sell
bottle corks, your liability would probably be limited to replacing bad
bottle corks," says Williams. "If you mass-produce cherry jam, you have
the liability caused by people getting sick on your jam or breaking
their teeth on a cherry pit. You wouldn't want to self-insure that
liability. You'd want product liabliity insurance."
5. Make sure you get paid
What
good is being your own boss if you don't get paid for your work?
"Wherever possible, collect 10 (percent), 15 (percent) or 25 percent of
your fee upfront," says Bostrom. "Your clients' reaction to that request
will tell you a lot about whether they're capable of paying you."Always
use contracts, recommends Alan Siege, president and CEO of Small
Business Management Consulting in Brooklyn, N.Y. "Specify clearly what
the deliverables are and what and when people will pay you -- and make
people acknowledge it. By having a contract, you're saying that you play
for real and that you're someone whose business people need to take
seriously."
