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Saturday, 02.04.2012 |
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| Smart Business, Stupid Business |
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Product Details
Notes
success is determined by your mindset
there is no failure, only feedback
later on, you can shift to passive income
but in the beginning, it takes hard work
you have to invest either your time or money to get started
3 types of business income:
active - you put in time and get paid for it
leveraged - you hire others and manage them to expand your business
passive - you build automated systems that create value
here's the first tax strategy:
an internet business can be located anywhere in the world
you can move the hosting server to another state or country
and have the business make its income there
and then pay you in your home state or country
governments will still try to tax you even if you make money overseas
an economic downturn means cheaper resources and less competition
in general, do the opposite of what's expected
when you're making money, save the extra profits
when things are down, spend more and invest in the business
if you make an extra $100, you might only keep $70 after taxes
but if you find a way to save $100 on your tax bill, you keep the full $100
find the intersection of 3 things:
entrepreneurial abilities - your unique talents, what you can do well
emotional charge - your interests and passions, what excites you
economic marketplace - size of the market and type of customers
3 biggest risks to a new business:
not knowing your business well enough yet
lack of cash flow to keep it going
other people's bad intentions
if you're losing money in the beginning, you have to prove it's a real business
if you make money 3 out of 5 years, you should be fine
but even if you don't, you may still be able to pass the IRS test
as long as you show that you're running it like a real business
Amazon.com and other websites lost money for many years
have a separate business bank account and do financial statements
show that you're putting in time and effort to grow your business
if losses are typical in your industry or out of your control, it's okay
the key negative is if you lose money for years and you don't try to improve
PayPal will begin reporting people who sell over $20,000 per year in 2011
they're looking for people who have a business but don't report the income
it's better to report your business anyway to get the tax deductions
work on business projections, best case and worst case scenarios
also do an estimate of the most likely middle ground outcome
top-line is the expected gross income
bottom-line is the estimate of net take-home profits
look at seasonal trends from past data
factor in known long term income, possible new income sources
add up known ongoing expenses and possible new expenses that might arise
3 stages for a possible way to build a new business:
work in your business part-time first while you have a full-time job
transition into doing your business full-time
work on your business to build systems and remove yourself
3 ways to find money for your business:
bootstrapping
business credit
other people's money
if you're bootstrapping, stick to what you know best
you don't have time for a long learning curve
keep costs under control and don't invest for the future yet
find free or cheap ways to get noticed and market your business
don't do any loss leaders, every product must be profitable on its own
create a sales funnel and look for a recurring business model
setup different service levels, charge more for a premium service
look for complementary products or services that you can promote
build strategic relationships with other companies
bill and collect in advance, don't carry debt or extend credit to customers
give a discount to those who pay in advance, you need the cash flow
don't assess a late fee, structure it as an early payment discount instead
take credit cards if possible to make it easy for people to pay you
give a thank you discount for repeat customers
provide free information widely to promote yourself
take all the tax deductions available to business owners
move expenses "above the line" (paid with pre-tax dollars)
business credit should be completely separate from personal credit
you want to establish a credit history under the corporation itself
that prevents personal liability, and interest rates could be lower too
if you have vendors, you have tier 1, 2, 3, and 4 trade accounts
these build up a credit history for your company
tier 4 trade accounts are creditors that will give you a credit card
this is a credit card under your business name, with no personal guarantee
other people's money includes personal loans or a public offering
if you borrow from friends or family, make sure you write repayment terms
otherwise it becomes a demand note
anyone who gets equity in your company becomes a business partner
a private placement document will state risks and prevent refunds
if you borrow from unaccredited investors, those are unregistered securities
don't take any shortcuts when raising money through equity sales
an individual with over a million in net worth is an accredited investor
don't raise money just because you can, have a clear purpose for it
don't partner with someone for their abilities, hire them instead
you can give a percentage of net profit without giving actual equity
if your partner is bringing in money, try to borrow it instead
avoid partnering with anyone who has cash flow issues already
don't partner with someone who thinks like you or has the same skills
write a legally-binding Buy-Sell Agreement including an exit strategy
your partnership is also with the person's spouse and heirs
employee theft adds up to $652 billion each year
it is responsible for 47% of store theft in the retail industry
do a criminal check before hiring and run their credit report
make sure owners and managers are ethical role models
make anti-fraud policies visible and explain them
enforce mandatory vacations, that will reveal fraud
also do cross training and job rotation
you want to avoid letting one person always handle one task
if someone else takes over, they can't hide things
don't use a bonus plan that encourages people to cheat or lie
unhappy employees are more likely to steal
get an external CPA to do an internal control audit
a common excuse for ignoring accounting is being too busy
but good accounting can save you more money than you make
the IRS may send you a letter to question a deduction
good recordkeeping is important to show that your business is tight
keeping good financial statements means you can invest well too
most businesses use a third party as the resident agent
an S corporation may not be ideal once your income is above $300,000
a loss in an S corporation can offset salary income from another job
C corporation can do more benefits like medical, education, etc.
file an annual report for the corporation
keep minutes of a yearly meeting to prove you're a real business
if you have a personal claim, they might seize your corporate assets
they can force liquidation of those shares
LLC shares cannot be seized, so it's better than an S corporation
there is more flexibility in tax election for an LLC
in the early years, incorporate in your own state, not Nevada or Delaware
the bigger your business gets, the more likely you'll get sued by someone
payroll tax penalties and IRS notice of non-payment are very serious
do not ignore these, they are more important that income tax penalties
pay yourself and your spouse a reasonable salary
make sure withholding and reporting are accurate
reconcile payroll reports with your business tax return
the Amazon tax means you might have to collect sales tax in certain states
based on whether you have an affiliate in that state
this is all ongoing legislation, so keep track of the latest changes
an employee in another state means you have a nexus in that state
that may also apply to independent contractors or a virtual assistant
if you pay your children, have a written job description
keep track of their hours worked and pay a reasonable wage
it's better to get your business started and deduct current expenses
rather than needing to amortize your expenses as start-up costs
if you have a loss, you don't have to pay yourself a salary
do a regular profit and loss statement (income statement)
look at gross income, cost of goods sold, and administrative costs
also do a balance sheet
snapshot of assets and liabilities on a certain date
finally, do a statement of cash flow
this translates between the profit and loss statement and the balance sheet
adjust net income for cash received or spent in operations
depreciation is a deduction for net income but does not cost cash flow
change in inventory doesn't change net income, but it impacts cash flow
accounts receivable and accounts payable can also affect cash flow
loan financing or repayments can affect cash flow
you want to make sure your cash flow isn't just coming from loans
also watch out for cash flow from selling off investment assets
you're measuring how well you convert profits into cash
even if you have cash in the bank, it may be gone soon
so the cash flow statement shows you where the cash is flowing
and alerts you if you have to pay back a big loan or pay a vendor
that means the cash in the bank may be already spent
so your business may not be doing as well as you think
if you have no money in the bank, you may still owe taxes
because you might have spent it on something that is taxable
when you build inventory, you reduce cash and make it less liquid
if you're growing quickly, you might have to hire more staff
those are expenses you pay upfront, but your business income might lag
so you have to watch your cash flow so you don't run out in the short term
accounting is all about balance
assets = liabilities + equity
current assets are cash and anything used or converted to cash in a year
inventory and accounts receivable are current assets
if you are prepaid for your services, then the work to be done is a liability
fixed assets are long term things like equipment, vehicles, or real estate
assets are based on their historic cost
so if you bought a building cheap, the asset value is the original cost
even if it's now worth a lot more
this is because of generally accepted accounting standards
you can include a note on true, fair market value to potential investors
a current liability is something you'll repay within a year
this includes monthly expenses and taxes
long term liabilities are things like debt, mortgage, lease, or a car loan
equity is the net worth of your business
the income statement is over a period of time
if you pick a short time, you might have a big sale or big cost
that could skew the picture
so compare a longer time frame to see how your business is doing
inventory starts as an asset and becomes an expense
you can only expense inventory against gross income when it's sold
buying a lot of inventory can make your business asset rich and cash poor
if you're short on cash, you have to hope that sales continue strong
basically you spent too much too early, assuming that you needed it later
current ratio = current assets / current debt
keep the current ratio above 1:1 and close to 2:1 or higher
"current" is defined as three months in this case
debt ratio = debt / equity
higher ratio is greater risk to a creditor
shoot for a range of 1:1 to 4:1
2:1 is common for small businesses
not using debt can mean a company is not growing with leverage
gross margin or profit margin = gross profit / sales
measure of your ability to make a profit
return on sales = net profit / gross sales
shows you how much profit comes from every dollar of sales
look for trends over time and the effect of operating and overhead costs
accounts payable turnover = cost of goods sold / average accounts payable
low turnover may indicate a shortage of cash to pay your bills on time
investment turnover = gross sales / long-term assets
efficiency from year to year, you need income to build long-term assets
return on investment = net profit / equity
what you put into the business vs. what you get back out
watch the trends in your financials
what worked before that you can expand on?
what additional products or services can you provide?
how can you get more people to hear about your business?
how can you sell more to your existing customers?
what happens if you raise or lower your prices?
quick ratio = ready cash / liabilities due in the next 3 months
most business owners ramp up too quickly and ramp down too slowly
operating cash flow ratio = operating cash flow / current liabilities
accounts receivable days = (365 * A/R) / (annual gross income)
what are the biggest barriers to creating massive cash flow for you?
what could you do to bring in cash flow quick in your business?
what is the long term strategy to grow over time?
once you reach the highest tax bracket, a single S corporation is costly
you pay personal income tax at the highest rate
if you move some of the income to a C corporation
you could pay 15% tax for the first $50,000
that saves about $12,500 each year in taxes
this is called "upstreaming income"
you must have a legitimate reason to upstream income
do not try this without a good tax advisor
with a high income, you are in the top bracket and you lose deductions
both spouses must provide some kind of service to the business
you can separate the functions of the two spouses
one works through the S corporation, with flow through tax treatment
the other owns a C corporation and receives other income
the C corporation can have a self-directed pension plan and MERP
MERP = medical expense reimbursement plan
there has to be "economic substance" for upstreaming, not just tax savings
a multi-layered structure can work for multiple partners in a company
use an LLC that is taxed as a partnership
then each owner creates their own structure
income flows through the LLC and into the underlying structures
each owner can have their own solo 401(k) too
it also protects your liability by separating you two steps away
you can retain earnings in a C corporation to use for investments
this might apply if the company buys real estate
a doctor, lawyer, or accountant might need a professional corporation
there's also the qualified personal service corporation
which is usually also a professional corporation
but now includes stuff like performing artists and consultants
even though those aren't required to be a professional corporation
a qualified personal service corporation has a flat tax of 35%
if you expand your business, you can avoid being a personal service
show that less than 95% of your time is spent in personal service
a C corporation can have a staggered year-end for tax timing
a personal holding company is taxed on retained earnings
on top of the regular corporate income taxes
don't hold assets in a C corporation, otherwise it's a personal holding company
use an LLC or S corporation to avoid the extra tax
but an LLC is ideal for better asset protection in this case
when a C corporation goes over $250,000 in accumulated earnings
there is a "retained earnings tax"
so it encourages companies to pay out dividends to shareholders
you can go over $250,000 if you need the extra for "working capital"
or you can show the IRS that you have forecasted needs for the capital
you have to document all this in the corporate minutes
in general, you never want to have appreciating assets in a C corporation
an LLC would be taxed at the long term capital gains rate of 20%
but the top C corporation tax rate is 35%
plus you get taxed again when you pay dividends from the C corporation
the authors recommend not using an S corporation either
for real estate, stick to an LLC
the IRS knows about the possibility of several C corporations
each one could get income up to $50,000
and pay the minimum corporate tax rate
if all the corporations are owned by the same people
then you may fall into "controlled group status"
one option is to have an unrelated person own part of a corporation
they can't be related by blood or marriage
you need to have a buy-sell agreement in case something goes wrong
don't use a C corporation if you have high income
you have to get the money out in the form of salary
which will mean high payroll taxes
an S corporation can flow through some income as a distribution
corporate benefits are really good
the corporation gets to take a deduction
and the benefits are not taxable to you personally either
for an S corporation or LLC-S where you own more than 2%
you medical insurance is deducted on Schedule A - Itemized Deductions
it's only a partial deduction, and you have to be able to itemize
a C corporation can pay medical insurance at the corporate level
so it's fully deductible to the company
you must offer the same insurance to all employees
MERP = Medical Expense Reimbursement Plan
not allowed for S corporation or LLC-S, only C corporation or LLC-C
you can reimburse employees for their medical expenses
you can setup a two-tiered retirement plan
401(k) for all employees
then a second plan for executives allowing higher contributions
by stacking plans, you could get $150,000 in retirement deductions
your pension plan can buy a house for someone else
it can't be yourself, your parents or your children
but it could be a sibling or other relative
one Keogh plan type is the money-purchase plan
this is good for high income earners
a key point is that your retirement plan can invest in mutual funds
but it can also invest in other things like real estate
you can invest in real estate with leverage through a Solo Roth 401(k)
education to help your business is a tax deduction
this includes books, courses, and advisors to your business
calculate your personal ROI
take your biggest check and figure out the number of hours
use that as a baseline for your hourly rate
then brainstorm ways to make more per hour of work
go from being self-employed to growing your business
stop working in your business and start working on it
plan for the future, hire and lead a team, build systems
focus your vision, create joint ventures, monitor stats
identify and expand niches, create sustainability, build a legacy
use your personal ROI to identify tasks that are below it
look for repeated things that you hate to do or aren't good at
document exactly how you do the task
break down the process into small pieces
figure out who else could do each step or how you could automate it
you need an "audit defense strategy"
given your tax strategy, you need the return to be prepared well
and you need clear, honest, full disclosure on your tax positions
once you really understand the details of each task
you might get ideas on how to expand your business
or launch new directions based on your systems
in the beginning, test outsourcing one small detail at a time
see how it works and measure the success before moving on
eventually, you want to automate or outsource as much as you can
later on, your employees or partners might know more than you
especially about certain parts of the system that they focus on
you can now build a bigger system together
use a group forum to document tasks and let people comment
when someone has a question, they post it to the internal forum
others suggest ways to change or improve the system
once the discussion is complete, write up the final notes in your manual
ordinary income is subject to payroll tax and self-employment tax
investment expense can only be used to offset investment income
capital losses should also offset capital gains, with minor exceptions
passive income is defined by the IRS based on "material participation"
- if you worked more than 500 hours in the tax year
- you did more work than anyone else in the company, even employees
- you did 100 hours of work, and someone else did less than that
- the activity is a "significant participation activity"
- you materially participated for 5 of the 10 preceding tax years
- you did a personal service activity for any 3 preceding years
- you participated on a regular, continuous, and substantial basis
if you're an investor, you can monitor finances but you can't be a manager
your spouse is included in any of your participation
one option is to get a CEO, CFO, and employees to do the work
you are the owner but you're really just an investor
another option is to invest your business profits into real estate
you can take the money out of the business as a loan to an LLC
then have the LLC buy the building
and your business then pays rent to the LLC
the LLC can depreciate the real estate and get a big deduction
you want the rent as high as possible, but it has to be fair market value
a third way is to look at the assets of your business
this is especially useful for real estate
if you own a building but don't use all the space
you can rent out the extra space and make some additional income
soft assets can include things like software, patents, or a mailing list
brainstorm ways to make more money from these too
if you're already helping people as a service, can you build a product?
can you take your knowledge and package it to serve more people?
even if you don't help them to the same detail, you're adding value
a lot of real estate looked good during the boom
you can fix, flip, and make money from appreciation
but most deals weren't setup for long term cash flow
besides real estate, you can try affiliate marketing or network marketing
cash flow may be more important than real estate appreciation
you can also build content once and resell it in many forms
what problem does your business help to solve?
which products or services are doing the best?
what do your customers or clients want that you don't have yet?
where could you expand? what could you stop doing or making?
how can you provide more value in a scalable way?
what's your exit strategy long term?
one option is to "keep it small and keep it all"
don't hire executives to grow your business into a giant corporation
work very few hours and make a lot of personal income
you need to keep a lot of liquid cash in case things change
avoid investors or private lenders since they'll want their cut
don't have any minority shareholders, otherwise they could sue you
you want to be able to take money out of the business for yourself
without having to support partners and other investors
use a flow-through entity that lets you take money out as distributions
this will minimize the payroll and self-employment taxes
don't use upstreaming in this case, since you're pulling out all the money
you only want to upstream to a C corporation if you're leaving money in
invest your money in something that will provide steady cash flow for later
you can shut down and sell your hard assets
but you built this business, so you may value the soft assets
like the systems you built and the client portfolio
the third option is to sell to a friendly buyer
it could be your best customer or vendor or business associate
or it might also be employees, your children, or family members
be careful about giving a business to your children
they may see the cash flow but not understand the real business
the average inheritance is gone 18 months after it's received
option four is to sell to an arms-length buyer
you negotiate the best price rather than giving a deal to a friend
you don't have to worry as much about the future success of the business
ideally, you want a buyer who can expand your business
they'll pay a higher multiple that's not just based on income
because they can ideally leverage your business into theirs
be careful about mergers, the management style has to be a good fit
make your business attractive to buyers, but don't cut off other options
you may have to sign a non-compete agreement
the last option is the IPO
you can have an angel investor or venture capital firm buy you out
you would still need to do the securities registration
or get an existing public company to acquire your business
this process takes a lot of time and money
you have to keep the business going while paying for registration
then you need to find brokers who can push your stock
think about these issues also:
death - what happens to your business if you die?
disability - can you keep your business running without you?
divorce - what's the value of the company?
departure of a partner - use the Buy-Sell Agreement
your corporation needs to file a liquidation plan and Form 966
you need to dissolve the company by filing with the secretary of state
you may receive a liquidating dividend
you can let the buyer become and employee
then a portion of their pay goes toward buying the company
there are lots of tax consequences so talk to a tax advisor
if you sell the assets of the company, you need to value them
and possibly add back any depreciation
if you have a C corporation, you can simply sell the stock
you need to know your basis in the stock
in general, think about your exit strategy
if you are planning to eventually sell, figure it out ahead of time
pick one method to do a valuation of your business
book value: based on your books, equity = assets - liabilities
this doesn't allow for appreciation and goodwill, or intangible assets
adjusted book value: tangible book value + economic book value
tangible book value = hard assets + intangible assets like patents
economic book value = book value at current market rates
discounted earnings: based on present value of projected future earnings
discounted by the required rate of return (capitalization rate)
discounted cash flow valuation: subtract present value of liabilities
from the present value of cash flow and tangible assets
price earnings multiple: price of stock divided by earnings per share
multiplied by net income, good for publicly traded company
sales multiple: sales multiple and profit multiple are the most common
annual sales times industry multiplier (usually 0.25 to 1 or higher)
profit multiple: pre-tax profit times market multiplier (usually 1, 2, 3, 4, or 5)
liquidation value: similar to adjusted book value
value of your assets at liquidation, often less than market
this gives you a bare bottom benchmark
write down your business valuation formula for your corporation
otherwise the court or IRS will choose one that's less favorable
the business valuation formula may not equal market value
fair market value is really determined by the buyer
who would buy your company and why?
how many potential buyers would there be?
buyers look for:
- a clear vision for the company that you can communicate
- up-to-date business plan, budgeting, stats, and financial statements
- a growing business at or above the average rate
- operating at or above the gross margin, good profit margin
- written strategies for maximizing cash flow
- diverse customer base, not dependent on one big customer
update your procedures manuals, the buyer wants your system
automate things so the buyer can let the business run itself
have clear job descriptions if the owner needs to do any hiring
increase marketing to build momentum for the buyer
remove yourself from the business steps until it doesn't need you anymore
setup your business to help people, both customers and employees
the more people you serve, the richer you'll become
rally your team around a cause you believe in
focus on what you are grateful for when times are tough |
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