Question: What can you learn from mistakes of other start-ups? One lesson: structure your business up front in a way that will give you the flexibility you need later.
So, you’ve crystalized your money-making concept and are ready to rock and roll. What are you going to be: a Limited Liability Company? Corporation? Limited Partnership? Does this stuff make your eyes glaze over? Nutshell:
ü Picking a structure is largely about how you are going to have to pay taxes on money your business makes; how much you’ll be able to treat the owners of your business in different ways; and how much exposure you personally will have for your business’s liabilities. Each corporate structure on the menu comes with its own rules.
ü Some really popular structures may not suit you at all. For example – BOREDOM ALERT – a flow-through entity (like a partnership, S corporation, or LLC) doesn’t itself have to pay federal income tax. Its owners do. Specifically, its owners pay the tax on income that’s attributable to them. Now, attributable is a curious notion. Imagine that instead of having common sense, you had federal-tax-bureaucrat sensibilities: guess what happens when this flow-through entity you own doesn’t distribute to you any of the money it makes. CORRECT: you still can be liable for tax on that income your pockets never saw. Sweet deal for Uncle Sam, eh?
ü How would this play out? Karen Client comes to us with a problem: the S-corporation she co-owns did well last year, and she owes substantial tax. But her co-shareholder, Lucifer, controls the finances and is trying to force her out of the company. Karen and Lucifer never signed a minimum-distribution agreement, and Lucifer isn’t distributing any of the money the company earned last year. Does Karen still owe tax on attributable amounts her business hasn’t paid her yet? She does. And she’s feeling kinda stuck.
Correction tends to cost more than prevention, as it does here. We assemble a team of litigators and financial professionals and eventually negotiate a deal in which Karen becomes the company’s sole shareholder. Now she controls the company’s finances and can distribute money to pay her taxes. Happy ending. Avoidable problem.
ü Point is, to avoid locking yourself into financial conditions you’ll regret, either
- Master the pros and cons of the various corporate structures yourself. (Bright people with researching skills can do this: you learn enough about each kind of entity to choose one that fits you — and enough about its pitfalls to have the right protections in place from the beginning.) This autodidactic approach builds mind-stretching skills that serve an entrepreneur well.
- Or, hire a professional whose experience substitutes for your mastering corporate-structure issues yourself. This approach costs less time and more money. But if you pick the right professional, you quickly can get a great deal of the benefit that comes from learning from the mistakes of others.