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"The business of America is business," it seems more true today than ever before. Every year more new businesses are started than the previous year, and every year more businesses fail. With all the government documentation required, the needed understanding of all the taxes, the government regulation on commerce, banking, and industry, it is no wonder that successful businesses rely on professional consultants and financial advisors to succeed. One of the most often asked questions is, "What do I do to start up a business?" Here are a few steps to take, and things to consider, before opening a business.

The First Phase: Making a Personal Commitment.

Everyone has at one time or another had a very good idea for a business venture. The difference between some good ideas making it in business, and some never even being tried, are the people who have the idea. Those who act on them may see great personal satisfaction and financial reward for bringing their ideas into reality. Many successful business people have applied the old adage, "If at first you don't succeed, try, try, try again." Trying, however is not always enough.

Most new businesses fail within two years. There are many reasons for this, but one fact is known about successful businesses. In order for a business to succeed it must be properly planned from the beginning. Many decisions need to be made before the announcement "Open for Business" is broadcast. It will pay more in the long run to spend time on proper planning.

Successful businesses almost always start with a comprehensive business plan with special attention to accounting and finance. To be successful, entrepreneurs usually need the help of professionals to complete the large amount of paperwork and planning involved. If the venture is going to need outside capital, either as a startup or later for expansion, good financial statements and projections are essential. An investment brochure, professionally made and distributed, is often the only difference between a well-funded project and one that fails, simply because sufficient operating capital was not available. The days of going into your local community bank and getting a loan from them based on "a good idea" are long gone. If an entrepreneur needs to go somewhere other than a bank, good paperwork becomes even more important! Venture capital is money that is risked. Those who risk money to entrepreneurs want to know that every important consideration of a business has been made and documented properly.

Entrepreneurs must plan to have an adequate amount of money to fund their business. Startups usually require more cash than anticipated by even the most conservative expectations. It is well-established fact that most businesses start off under funded. A new business requires sufficient capital to endure unexpected hardships. Without sufficient funding to get the business off the ground, to persevere through business slumps, to carry receivables, and meet inventory and staffing needs, a business most certainly will fail.

So why do people go into a new business with such a high rate of failure? It is because the business owner, unlike an employee, stands the chance of higher returns for her risk. She also enjoys the personal freedom and responsibility of being her own boss. Because of these high risks, and the often high personal sacrifice that entrepreneurs must usually make, individuals pondering the jump into business should deeply consider the following questions:

1) Will my family support me when the going gets tough? Can they be emotionally supportive as well as helpful over the long haul? Will "pinching pennies" are a hardship on them?

2) Am I willing to risk all of my savings and the possibility of accumulating huge debts for the possible returns? What will I do if I must start over with much fewer resources available?

3) Do I accept the fact that a self-employed entrepreneur works longer hours than anyone else in his company, and that it is usual for business owners to work 12-14 hours per day, every day?

4) Am I skilled enough in the activities of the endeavor to succeed? Do I have sufficient training and knowledge to administer a business? Have I studied the market I plan to operate in, and do I understand how it operates?

5) Will it be necessary for me to work an outside job to make ends meet, or will I be able to put all my efforts into growing the business? Is there enough profit available to support myself better than as an employee?

6) Will it be possible to support the family on my spouse's income and personal savings until the business becomes sufficiently profitable to draw a salary?

7) Do I have enough capital, or resources for getting loans, to go as long as two years or more without a net income?

If one has pondered these questions and discussed them with their family and decided that they do wish to go into business for themselves than the first step has been completed.

Phase Two: Deciding the Form of the Business Entity.

Once one has an unshakable decision to start a business, the next step is to decide what type of business the entrepreneur should form. When setting up a business several choices are available. Many things should be considered when making the choices. Some of the most important considerations are the tax codes and laws governing the degree of personal liability an owner must assume for his business. For example a business can be set up as an unincorporated partnership, a proprietorship, or limited liability company ( LLC.) In all of these companies the tax responsibilities of the company pass through to the owner. A business can also be set up as a corporation, which has its own tax consequences, but limits personal liability of the owner. Additionally an "S" corporation may be set up which passes the tax liability through to the owners, but protects them from personal liabilities in other areas.

Many small business owners choose the corporate form of operation because of the protection it affords an owner's personal assets. LLCs also provide this protection.

In most cases a small business owner is better off to provide himself the liability protection of an "S"corporation or LLC, but allow the tax consequences to be passed through to the entrepreneur. This is because even very successful business will most likely operate at-a-loss for the first few years, and the benefits of that loss can be utilized by the business person. A business can always be changed to a taxable entity later, when profits are up and the benefits of the tax system can be better realized as a full corporation.

Other tax considerations also apply to the initial business. Some of the following nuances illustrate the complexity of the decision process:

The tax rates are different for different entities. Also the responsibilities of who pays taxes are different. A "double tax" exists on full corporations owned by entrepreneurs, first the taxes paid by the company, and then the taxes paid on money earned by the owner are taxed as income. Corporations pay at a 15% rate on the first $50K, 25% on the next $25K, and 34% on everything more than $75K! While these corporate rates are lower than most personal income tax, the money may be taxed a second time when it is removed from the company and paid to the owners.

If operating losses are a certainty during the first few years, it is advisable to establish an "S" corporation or an unincorporated form of business so that the benefits of the loss can be enjoyed against the entrepreneurs personal tax responsibility.

If the business is going to need to accumulate earnings and build working capital, or if it will be using capital to retire debt, a corporation model may be best. These earnings would likely as not be taxed at a rate of 15%, whereas if the earnings are accumulated in an LLC, "S," or a proprietorship, they may be taxed as high as the 39% personal tax rates!

Benefits like medical coverage are another consideration. These benefits are generally not deductible in a proprietorship, LLC or "S" corporation, unless the owner owns less the 2% of the business. A full corporation however can deduct medical expenses from its taxes as long as the benefits are paid to employees in a "nondiscriminatory" way. In other words the owners cannot be the only ones to receive the medical benefits.

If part of the entrepreneur's plan is to sell the business in the future for a profit, tax considerations may again play a roll in deciding the type of business operation elected. Assets sold by a taxable corporation are "double taxed." The first tax, on gains from the sale of corporate assets are taxed at the corporate rate. The money is taxed again when it is distributed to the owners. Proprietorships, "S" and LLCs would only pay a single personal tax on the gains form the sale. A corporation must be converted to one of these entities at least ten years to enjoy those benefits, or have started out as one. This prevents conversion just prior to a sale of the business solely to avoid the double tax.

The new business owner must decide whether to classify his contributions to the business as debt or equity. Money invested in a business by an entrepreneur is usually better classified as debt payable to the owner, rather than as stock purchase or ownership equity. This is because when money is later paid back to the owner it is a non-taxable loan payment, only the interest paid would be subject to personal tax scrutiny. On the other hand, removing equity from a company has tax implications for the recipient. These amounts are taxable income! With this in mind it is hard to see why all entrepreneurs do not classify investments as loans. The IRS is aware of this too, and applies various tests to verify that when money is withdrawn from a company, that it is truly a loan repayment, and not taxable income.

Transferring personal property to a business can have tax consequences for the business too. If certain criteria are met however, there need not be a tax liability incurred. These criteria include the following:

1) The asset transferred must be property. Services and labor do not count. It is also inadvisable to include owner labor as equity when seeking financing.

2) The owner must only receive stock for the transfer, not money or other of the various form of loans, bonds, or valuable considerations.

3) The owner must hold at least 80% of the company's stock after the transfer of the property.

Of course proper disclosure statements and IRS forms must be filed to avoid tax consequences in property transfers. The advice of a good tax accountant and lawyer is advised if an entrepreneur wishes to benefit properly from funding his own startup.

While nobody going into business thinks they will fail, it is a good idea to consider the implications when deciding what form the business should take. There are both tax and personal liability considerations. While liability protections are important, most small business owners will be required to personally guarantee loans to his company, negating protections of the corporation

As a general rule if a corporation's stock becomes worthless, the loss is a capital loss. Capital losses can only be written off against capital gains, unless they are greater than the total capital gains, which limits the loss to $3K of personal income. Since it is unlikely that a small business person would have more capital gains than losses, one would expect a corporate business failure to be only written of to the amount of the $3K personal income limit per year.

Small business people who have corporations which fail can however, take advantage of an IRS provision which allows the taxpayer to administer the loss as an ordinary loss, not a capital loss, for amounts up to $100K. Provisions for the write-off are straightforward. The stock had to be purchased or bartered with property, not services or labor. Only the original owner of the corporation can enjoy these benefits. The business must have been valued at less than one million dollars ( a small business) at the time it was formed. It is advisable to establish a business with these provisions in mind, with proper documentation and corporate minutes stating that the stock ownership is in compliance and intentions of the IRS provisions. This could mean significant difference after a business failure to an entrepreneur. A professional business consultant with tax and accounting expertise should be utilized to ensure compliance with these codes.

Establishing the form of the business is often the first area in which an entrepreneur must seek outside consultation. A person going into business for the first time should consult a qualified business professional and then employ an attorney to finalize the decision and perform the required paperwork and filings.

Phase Three: Deciding on an Accounting Procedural Policy.

After the new entrepreneur decides what form of a business entity to establish, he must decide on accounting methods and financial recording methods the company will utilize. This can mean the differences between having a profit and paying it in taxes. It is not how much that a business makes, but how much it keeps that determines the profitability. This decision should not be taken lightly. The long term implications of any choice are that often the IRS will not allow a change, or may only allow for a gradual phasing-in of a change. This is particularly true when tax advantages are made available to the business person as a result of the change.

One of the first factors to be decided on is the method or "basis" of accounting. The cash-basis accounting method is available to businesses where inventory does not amount to a substantial value of the company's assets. Cash-basis allows the owner of the business to treat accounts receivable as assets after they are collected, likewise debts are not counted until they are paid. A cash-basis accounting system is good for businesses who recognize that cash flow is more important than showing accrued earnings.

Accrual-based accounting methods must be used if assets are kept in the form of inventory. In an accrual-based accounting system taxes must be paid on assets "sitting on the shelf." Likewise accounts receivable and payable are incorporated into figuring income taxes for the company.

Choosing the fiscal year is another important decision the owner of a small business must make. As a general rule however, only corporations have flexibility in deciding the fiscal year. Proprietorships, LLCs and most Sub "S" corporations are restricted to calendar year endings. Corporations may use information like seasonal trends, and utility to the owner are considerations.

Sub "S" corporations and service ( PC) corporations may have a fiscal as opposed to calender year ends. However, cautions must be made to not make calculations of income on one fiscal year for the company and defer them to the next year in personal taxes.

Inventory accounting methods can take the form of "FI-FO" first in-first out, or "LI-FO" last in- first out. FI-FO accounting allocates older inventory costs to the cost of goods sold and more recent costs to inventory holdings. If the business is operating in an environment of rising inventory costs, it may be advisable to apply more recent higher cost of inventory goods to cost of sales and retain the older, lower costs as inventory. This is known as "LI-FO." This in effect reduces gross profit, and allows for the building of assets in the lower priced inventory holdings. If those inventories are reduced, however the advantages are lost. Building equity in holdings such as antiques or collectables, in which the enterprise will gradually increase its numbers, is usually best utilizing "LI-FO."

Phase Four Begin the Formulations of the Business.

Prepare a written business plan. With all the above decisions made, a business plan spelling them out, with financial projections, initial investments, operational cash flow, identified suppliers, customers or market niche, competition analysis, physical plant needs, operational needs expenses, anticipated income, and anticipated problems that may arise with associated solutions, and any other pertinent information should be prepared. Also included in a business plan should be any already identified investment capital sources and avenues, along with budgets. The business person who thinks he has these things "in his head" and not on paper, often does not have as much of it as he believes. The actual written document must be prepared. Money spent with a professional business planner is the best money a new business person can spend.

Secure the needed capital. Bank loans, investors, lines of credit, and government programs may be used singularly or in combination to fund a business. If sufficient funds cannot be identified as such, then revisions to the business plan, or abandoning the venture is in order. A professional loan broker, who has been provided the pertinent business plans and documents, is a very wise choice. The time spent going "door to door" to find your needed capital can be better spent establishing the commerce of the enterprise. A good broker can develop a plan in which venture capital proceeds will be used to pay him for his efforts, and include that information in the offering brochure. Standard scales for these services can run as high as 5% of the capital raised, with lower percentages on larger funding amounts.

Once the entrepreneur has accomplished these steps, she is ready to begin the activities of her commerce!

Conclusion:

After an entrepreneur has decided to make the commitment to a business venture, he must consider many things. New business startups must make certain very important decisions before any actual commerce is undertaken. The possibility of failure must be considered when establishing a new business and steps taken to minimize the effects of a failure on the new entrepreneur. Tax and personal financial liabilities are two of the most important factors in deciding the form of business entity. Other considerations for the business are accounting methods and anticipated growth and ownership changes. Professional consultants are usually of vital importance in making these decisions.

About The Author
Wayne R. Parker is a business and marketing consultant. He holds a BS in clinical psychology and a MA in counseling. He has participated as team facilitator on many research and development projects. He is a business consultant and marketing advisor.

He is a principle partner in Action-Links, Internet and Marketing Firm.