Starting a business - What are the initial steps?

Starting a Business - What are the key steps?

Starting a business takes time, effort, and planning. Most people, when considering such a move, don’t necessarily know where to start. In this article, I’ll lay out the key items from a high level, generally using my home state of Michigan as the example. Note that most states are similar, with a few, but sometimes important, nuances.

Note that none of this article should be considered to be legal, tax, or financial advice.

Here we go…The steps to starting a business.

Step 1: Write a business Plan

This is a fundamental step for a variety of reasons. It forces the business founder to think strategically about the business. Is it really viable? What does the competitive landscape look like? What differentiates my business? Can it truly be profitable, and what is the path to profitability? How long will that take, with how much funding required? What does the go-to-market plan look like? Etc., etc. 

Business planning is a critical component of any successful business. Without having a game plan, you have more risk with the business, and your bank or any other lender is not likely to provide any level of financing/support.

There are many resources where you can find templates for your business plan.

Key components of a plan would be:

• Executive Summary
• Products & Services
• Target Market
• Business location(s)
• Marketing & Sales Plan
• Milestones & Metrics
• Company & Management Team
• Financial Plan

To take a look at a sample template of a business plan, go to https://startingyourbusiness.com/business-plan-template (startingyourbusiness.com is a great resource in general for new businesses)

There are many examples of business plan templates that you can find with a simple search on the web. And if you wanted to get more elaborate, liveplan is a great tool. https://www.liveplan.com/

There are numerous other business plan tools such as BizPlanBuilder, GoSmallBiz, and PlanGuru. Most of these companies have multiple additional resources for small business owners/founders.

Step 2: Select a business entity (structure) and register your business

Once the business plan is written, the next step is to determine the best business entity structure and then to register it. 

The business entity is how the business is structured for doing business. Selecting the business entity is a very important step, and if the entity needs to be changed at a later date, it can be quite expensive.

Entity choices are:

• Sole proprietorship
• Partnership
• Limited Liability Company (LLC)
• C- Corporation
• S-Corporation

A Sole Proprietorship is an individual going into business for themselves. It’s easy and inexpensive to set up. On the negative side, the owner may pay more in taxes – self-employment tax and taxes on all profits - and he/she has unlimited liability, as the owner is responsible for all actions and debts of the business. If sued, the owner’s personal assets are at risk.

Note – In Michigan there is no filing requirement (registering requirement) for setting up a sole proprietorship.

Partnerships are where two or more people own and conduct business together. Partnerships carry the same liability risks as sole proprietorships. Profits and losses are passed through to the partners on their personal tax returns, as the partnership itself does not pay tax on business income. The partners’ income from the partnership, is subject to self-employment tax.

If a partnership entity type is selected, make sure that you have a well-crafted Partnership Agreement that outlines terms if there were ever any disagreement between any of the partners and what would be done if one or multiple parties want out.

Like the sole proprietorship, in Michigan there is no filing requirement for a partnership.

Notes on filing a DBA (Doing business as) for partnerships and sole proprietorships.

In Michigan if you are doing business as a sole proprietorship or partnership and using your full first and last names (legal names) for the business there is no filing requirement. If, however, you are using another name for the business, you need to file a “Certificate of Persons Conducting Business Under Assumed Name” with your County Clerk’s office where the business is locating. (Note: it needs to be filed in every county where the business is located.)

The Limited Liability Company (LLC) is a very popular business entity choice for a variety of reasons. An LLC provides the liability protection of a corporation without the complexity as it operates similar to a partnership or sole proprietorship. LLCs aren’t required to have a board of directors and board meetings, or shareholder meetings taking formal minutes, etc. LLCs also have tremendous flexibility – better than any other entity type – with respect to the management of tax, because of how income can flow to the members (Owners of the business).

LLCs should keep documentation of formal decisions, and should have a documented “Operating Agreement”, although Operating Agreements are only formally required in 5 states (CA, DE, ME, MO, and NY). An Operating Agreement is similar in function to a Corporation’s By-Laws.  

Creating an LLC Operating Agreement is how the members legally define the ownership structure and each member’s responsibilities and roles. The agreement also outlines the business' financial and functional decisions, how profits and dividends are to be distributed, how new members will be admitted, and how existing members may transfer or terminate their membership.

The Operating Agreement, once signed by the members, is the official contract binding them to its terms. If there is not an Operating Agreement, the LLC is governed by the state's default rules. Operating Agreements are sometimes used as proof that the LLC is a separate entity from that of individual owners. That is a critical item.

Operating Agreements are stored in the LLCs’ company records and are not required to be filed with the state in Michigan. 

LLC Tax notes - LLCs are not recognized by the IRS as a business entity. For federal tax purposes, they must be classified as a corporation or partnership. If filed as a corporation, LLCs are responsible for corporate income tax and are reported on from 1120. For LLCs with at least two members, they report income as a partnership, and they report on form 1065. 

A Corporation is a stand-alone legal business entity. The key advantage of a corporation is that, unlike a sole proprietorship or partnership, and like an LLC, the corporation shields the owner’s personal assets. There is no unlimited liability – short of fraud – with a corporate business entity. This protection when deciding on business entity, in most instances overshadows the fact that corporations are more complex and expensive to set up. Corporations must have a Board of Directors, shareholder meetings, issue stock, create By-Laws, etc.

Corporations also have great flexibility in how they are taxed, and they have no self-employment tax as income to the owner(s) will come from either a salary or dividends. 

To form a corporation, the Articles of Incorporation need to be filed with the Department of Licensing and Regulatory Affairs (MI), or a similar department in most states. Here is the link for Michigan. https://www.michigan.gov/documents/lara/500_08-15_527667_7.pdf

There are two types of corporations – C-Corporations and S-Corporations.

Taxes as a C-Corporation will require more paperwork than other business entities, however, if at some point the business may go public (think big), it may be best to go the C-Corporation path. Beyond cost to set up, other disadvantages are high tax rates (up to 35%), double taxation (Income paid out to shareholders salary is then taxed again at the shareholders personal income tax rate, and payments of dividends to shareholders is taxed at the current dividend rate of up to 20%)

A C-Corporation is often preferred by companies who are seeking external investment or plan to take the company 'public'. If that is the case, corporations generally are formed under Delaware law. 

(Note: If seeking external investment or going public, you may want to review my previous article, The Business Startup - One that needs funding and can scale.

 https://www.dhirubhai.net/pulse/business-startup-one-needs-funding-can-scale-jon-baron-mba/)

If the Corporation meets certain restrictions it can be elect to be treated as an S-Corporation from a tax standpoint in order to avoid double taxation.

An S-Corporation is considered to be a mix between a C-Corporation and an LLC. It’s basically a pass-through tax entity. 

So, business owners can elect to have their business treated as an S-Corporation from an IRS standpoint. This allows C-Corporations to avoid the double taxation issues.

There are specific requirements for S-Corporations. They are:

• There can be no more than 100 shareholders
• It can have only one class of stock
• It has no nonresident alien shareholders
• Its only shareholders are individuals, estates, or exempt organizations
• Each shareholder consents to the S-Corporation election
• It must be a domestic business
• It isn’t one of the “ineligible corporations”. (A bank or thrift institution that uses the reserve method of accounting for bad debts, an insurance company subject to tax under subchapter L of the Internal Revenue Code, a corporation that has elected to be treated as a possessions corporation, or a domestic international sales corporation (DISC) or former DISC. )

 To be treated as an S Corporation, the LLC or C-Corporation must be set up first and a form 2553 must be filed with the IRS.

Before the LLC was created, S-Corporations were used so that business owners would be shielded from double taxation. Currently, most people choose to operate as an LLC because of its flexibility and simplicity.

Legal requirements/documents depending on entity type selected:

There are many documents/agreements required to be filed or completed regardless of the entity selected or because of the specific entity selected. The following are just some examples.  

• Business formation documents (Certificate of Incorporation/Articles of Incorporation)
• Partnership Agreement
• Stock ownership documentation, with vesting rights, etc. This should include Stock purchase agreement for each of the founders.
• Action of incorporator (The adoption of by-laws and appointment of the initial board of directors)
• Non-disclosure agreements (NDA)
• Confidentiality agreements
• Non-compete agreements
• Privacy policy and cookie policy (web site and other)

Resources available for business entity setup

To set up your business entity you can use myriad on-line tools such as Legalzoom www.legalzoom.com/, betterlegal www.betterlegal.com/ ,Rocketlawyer www.rocketlawyer.com/, IncFile www.incfile.com/, ZenBusiness www.zenbusiness.com/, etc. or you can have a local attorney do it for you.  

Note: Before you make a choice on one of these resources, you may want to explore some of the companies listed in the section on business licenses. These have substantial capabilities to assist in business set-up and beyond as well.

Currently, the LLC is quickly becoming the most popular entity type for new business formations.

Registered Agents

In most states, a registered agent must be named in the document forming a corporation or LLC or other entity. A registered agent (aka resident agent or statutory agent), is a business or individual designated to receive service of process when a business is a party in a legal action. The registered agent's address is also often used as the address where states send a variety of paperwork. A registered agent can be an individual officer of the company, or a third party such as the business’ attorney, or one of the on-line companies listed above.

All of the companies listed above can handle registered agent services, as can Northwest Registered agent www.northwestregisteredagent.com/, Harbor Compliance www.harborcompliance.com/, and several others.

Step 3: Registering a business name (should actually be completed as part of step 2) and consideration to legally protecting your name.

After deciding on a business entity, the next step in starting a business is to register a business name. 

Again, we’ll use Michigan as the example.

Corporations and LLCs must pick a name at the time of filing for the entity and each corporation/LLC must be uniquely named. 

To do a search to see if a business name is available, go to the Michigan Department of Licensing and Regulatory affairs and do a search. The site looks like this and is straight-forward to use:

https://cofs.lara.state.mi.us/SearchApi/Search/Search

Legally Protect Your Business Name

Registering your trade name protects you from someone using the same name in your state but does nothing for other states. Because of this, you may consider protecting it through a trademark. A trademark can legally stop others from using names, slogans, or logos that are associated with your name. The management of and registration of trademarks is handled by the U.S. Patent & Trademark Office (USPTO).

Below is the site for a trademark search which has instructions on how to do the search.

And this is the link.

https://www.uspto.gov/trademarks-application-process/search-trademark-database

Step 4: Obtain necessary business licenses and permits

Based on the type of business you are entering; you may not need a license or permit. It depends on location and history. 

The types of licensing are things like business licenses and professional licenses. In Michigan services such as bakeries, photographers, dog groomers, etc., are required to be licensed to operate the business. 

And in many instances sales tax licenses are also required.  (Note: you can access information about taxes in Michigan here: https://www.michigan.gov/documents/taxes/518_10-17_605471_7.pdf

But don’t be intimidated by this very detailed document! Look to the resources in this article to help.)

If your business is straightforward, you may be able to simply do a search in your state for licensing requirements. However, licensing and regulatory requirements may be quite complex, and you may have a higher-level need. The good news is that there are business license companies that can handle that process for you. They can do all the research and filing and will ensure that they understand your specific needs.

 Some good business license companies are:

• Incorp www.incorp.com/
• BizFilings (A Wolters Kluwer company that can handle extensive business start-up capabilities similar to LegalZoom, Rocket Lawyer, etc.) www.bizfilings.com/toolkit/tools/business-license-wizard This link is specific to the business license wizard.
• Corpnet www.corpnet.com/
• Mycorporation www.mycorporation.com/

 Most of these have other services for businesses that you might consider as well. 

Business licensing services save substantial work. Using them minimizes mistakes, lowering your business risks. They will file required forms timely, and to the correct entities. And they also are far less costly than using other resources like a law firm or accounting firm, and they offer continuous support. They have expertise in requirements at the federal, state, county, municipal level. Using one can save potential major, time-consuming issues.

If you choose to check licensing requirements on your own, that is possible. Again, using Michigan as the example, you can do a Michigan state license search at www.michigan.gov/statelicensesearch

Once there, you can search for terms, or use an alphabetic search. Beyond the state requirements, there can be city requirements as well. This is why business license services are such a great resource. 

Step 5: Apply for an EIN

An Employer Identification Number (EIN) Is a tax identification number provided by the IRS, containing nine-digits. It’s used for tracking businesses in the US, to file and track tax returns, and open bank accounts. Like a social security number is used for individuals, the EIN is used for businesses and trusts.

Most businesses will need to get an EIN, but some do not. Partnerships, corporations and many LLCs or sole proprietorships with employees, and trusts, must file for an EIN. (Note: In most instances, an EIN is also required when applying for business licenses or permits.)

Sole proprietorships or a single-member LLCs are not required to obtain an EIN and their personal social security numbers are used instead. The exception to this, is if they have employees. Every employer must have an EIN.

An EIN can be obtained immediately when requested online which can be done at www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online

What you’ll need to apply for the EIN:

Applying for an EIN is straightforward, but you will need certain information available before you go online. That is:

• Type of business and primary activity
• Business address
• Name of the principal officer, manager or owner
• If an LLC, the number of members 
• Date the business was started or acquired
• Closing month of the entity’s accounting year
• Number of employees expected to be hired
• Contact information

 Step 6: Separate Your personal and business assets

When operating a business, it’s critical to separate your personal assets from your business. Always keep in mind that your business is a separate entity from you.  

Key items to do in respect to this are:

• Open a business bank account
• License software to account for your business and be sure to keep the software up to date. (Note – also synch your software to your bank account. It will save considerable time.) Products such as Intuit’s QuickBooks Online and Xero are certainly viable for your accounting. And there are many other products that also are viable.
• Acquire a business charge card, or multiple cards as needed

Step 7: Financing your business

If you have a polished business plan in place, and your personal financials and financial history are in good shape, you will have several options for financing your business. Among those are angel investment funds, state and federal level programs, bank loans, peer-to-peer lending, etc.

Obtaining financing for a small business is a time-consuming, stressful process. In most instances a great deal of detail is going to be required. 

A starting point is to put together a personal financial statement. Not only is this required for conventional financing, but a specific version of it is required when applying for support through the US Small Business Administration (SBA). (That’s done on a form 413.)

A good resource for a personal financial statement is the template from LawDepot. www.lawdepot.com/contracts/financial-statement/?loc=US

Your credit score also is important for financing. You should check this before you move forward with steps to start your business. If your credit score is below 650, financing through conventional methods may not be viable. Note that it’s critical to correct any errors in your report before you start looking for financing, you should review your credit record. (Note: You can request a credit report once a year for free from www.AnnualCreditReport.com .)

Financing options

There are several options to finance a business. A few of the more popular ones include:

Conventional Bank Loans – These are available at financial institutions like banks and credit unions. With this type of loan, substantial weight is on the owner’s collateral and personal credit, as well as the business plan and type of business.

If this path is pursued, multiple banks should be considered to ensure the business has the most attractive deal.

These loans can take considerable time for approval and be aware that banks and credit unions expect the owner to invest to 15%-25% of their own equity into the business.

If the loan appears to be riskier than the bank is willing to take on, it may be advisable to pursue a loan guarantee from the Small Business Administration (SBA). If approved, the SBA will guarantee to the bank that it will pay a percentage of the loan back to the bank if the loan can’t be paid by the business owner. (Note that SBA guaranteed loans are more costly in closing costs, fees and interest.)

Grants – Most grants are for established businesses doing research and but occasionally there are grants available for business startups. Federal grant information is available at https://grants.gov. There is no need to pay a third party to determine if the grant path is viable.

Peer-to-Peer Lending – With the difficulty of getting a startup loan from a bank, in recent years borrowers looking for loans with competitive interest rates have turned to peer-to-peer lending, which cuts banks out of the front-end process. 

These lending platforms operate by collecting a loan servicing fee to investors and by applying fees on funded loans from borrowers. After the loan is funded, the money is released to the borrower through a partner bank. The loan company issues a note to the investor that acts as security.

With the streamlined process in peer-to-peer loans, there is a fast turnaround for funding if approved, as opposed to conventional bank loans, and fees tend to be lower.  

Note that peer-to-peer loans are personal loans and rates vary based on the startup owner’s financial history. Loans will typically peak in the $35,000 – $40,000 range, although lately they have been getting larger.

As personal loans, peer-to-peer loans are not the best option for most people. They should be approached with caution. 

There are many peer-to-peer options available such as Sofi, LendingTree, Prosper, and Lending Club.

Step 7: Hire employees

If hiring employees, there are multiple agencies to register with and labor laws to understand. In Michigan with employees, a business will register with the IRS, Department of Treasury, Michigan Unemployment Insurance Agency and U.S. Immigration and Customs Enforcement. 

Businesses are also responsible for reporting new hires, verifying employees are eligible to work in the U.S., and withholding state and federal taxes.

Employers will also pay federal and state unemployment taxes, Social Security and Medicare in addition to staying on top of state and federal labor laws. 

As in the other areas, there are many resources available to take the payroll burden off the business owner(s). For example, Gusto, ADP, PayChex, Intuit, myPay Solutions, and Zenefits.  

Summary

Starting a business entails considerable planning and detailed execution. This article is a starting point and from a high-level. There are obviously other matters to deal with, differentiated by type of business. But there are resources that can help. Many are mentioned in this article. I suggest that what a good starting point would be to research some sources I’ve listed in the article to determine what, if any of the resources should be used, and for what services. Companies mentioned were:

• Betterlegal www.betterlegal.com/
• BizFilings www.bizfilings.com
• BizPlanBuilder www.businesspowertools.com/
• Corpnet www.corpnet.com/
• GoSmallBiz www.gosmallbiz.com/
• Incorp www.incorp.com/
• IncFile www.incfile.com/
• Legalzoom www.legalzoom.com/
• Mycorporation www.mycorporation.com/
• Northwest Registered agent www.northwestregisteredagent.com/
• PlanGuru www.planguru.com/
• Rocketlawyer www.rocketlawyer.com/
• ZenBusiness www.zenbusiness.com/

These companies can really help the startup process once a decision on entity type is made, which most often today for new businesses is the Limited Liability Company (LLC), and in most instances can provide on-going assistance. Take a look and compare what they offer versus your needs. Your other alternatives are an attorney and/or an accountant.

 You also have extensive resources available to help at the state and local level.

As an example, here in Michigan, free services such as SPARK in Ann Arbor https://annarborusa.org/ are available to assist any business. State assistance such as https://sbdcmichigan.org/ is also available.

 There are also resources such as Oakland County's very impressive "One Stop Shop" https://www.oakgov.com/advantageoakland/business/OneStopShop/Pages/default.aspx across the country.

And then there are organizations such as the New Enterprise Forum https://newenterpriseforum.org/ in Ann Arbor. And regular innovation and startup events are held in larger cities across the country.

In addition, there are many associations with resources to assist small and medium-sized businesses in particular, such as the National Federation of Independent Business. https://nfib.com/

Over and above the items in this article, new businesses also must invest in their “technology Stack” beyond their accounting systems and payroll systems. Technology stack items would be things like a web site, marketing tools, a CRM, Sales support tools, Cash flow tools, analytical tools, etc. The technology stack will be the subject of a follow-up article soon to come.

 If you are a new entrepreneur, good luck! 

 Comments are welcome and encouraged.

 Jon

Note that none of this article should be considered to be legal, tax, or financial advice.