5 things startups should know before starting

There have been startups as long as there has been business. But only recently has the idea of the “startup” taken on the meaning it has in today’s tech-saturated economy.

Today, when we think of startups, we think of cash-flush twentysomethings developing the next mobile app or social media platform with millions of dollars of other people’s money. This new startup world brings with it immense opportunities, and large pitfalls, for today’s entrepreneurs. Here are five ways to make sure your startup turns into a successful company and does not fold after the last of the VC cash dries up.

Choose your team wisely. When we think of startup successes, we think of individuals — Mark Zuckerberg, Jack Dorsey and Larry Page. But startup success is truly a team effort. Choose your team wisely. Pick team members that fill the gaps in your own resume. And pull together a team that can cover all aspects of business — finance, creative, marketing. If you become known as the next Mark Zuckerberg, it will be because of your talent in team-building as much as your programming ability.

Don’t overspend. The current tech startup culture glorifies the big-spending, VC-backed tech entrepreneur. But spending heavily during a startup period where you have no revenue coming through the door is a recipe for failure. Keeping control over your expenses will make your startup capital stretch further, allowing you to focus your money on the core of your business — product development.

Don’t be a one-hit wonder. You may have a world-changing product idea that you know is going to be successful. But once you get your first product off the ground, you have to continue thinking about product development. Apple didn’t stop with the Macintosh or the iPod or the iPhone. Google didn’t stop with a search engine. Focus on your first product; but know that if you are going to be successful in the long-term, you have to build a company that embraces a culture of innovation and never stops thinking about the next product or service.

Build a business plan, but be flexible. A business plan is integral to your success. You need to know your target consumer and study your competitors. But especially in the fast-changing world of technology, you need to be flexible and aware of the changes in the marketplace. Build a business plan but continue to refine it and adapt it to changes in the marketplace. Add to it as you learn more about your industry, your consumer and your technology.

Don’t bank on an acquisition. There seem to be a large number of startups whose business plans could be stated in one sentence: “Get acquired by (insert name of large technology company here).” While acquisition is clearly one exit strategy for tech startups, putting all of your eggs in that basket limits your options. Startups should build their companies with the end goal of making it a viable company on its own. Have the discipline to build a company that can be monetized. Do that and you will be even more attractive as an acquisition, and will also have the option of standing on your own two feet as well.

Cash contributions and distributions & loans to and from entities

By Matt Lipkowitz

When asking an owner of a small business what is the difference between cash contributions and distributions and loans to and from entities the most common answer would be “Aren’t they the same thing? It just depends on how my accountant classifies the transaction.”

This common misconception with majority of individuals who own and operate their own businesses can cause quite a headache when it comes to taxes and the Internal Revenue Service.  It is smart tax planning to be informed about all possibilities and tax consequence that may occur as a result of providing capital to your small business. There are both benefits and detriments to the classification and treatment of member/shareholder loans to and from an entity and by understanding these issues it may prove to be a win/win situation for both the owner and the entity.

When creating loans between owners and their entities there are a list of items you want to be sure to include, this will limit the ability for the IRS to question the reasonableness of the loan.

  1. A loan agreement.
  2. A fixed payment date and provide adequate stated interest.
  3. The Interest rate should be at or above the applicable federal rates, which can be found on the IRS website.
  4. Rights to property as secured collateral.
  5. Terms that reflect commercial reasonableness – such as waiver of demand, presentation and notice, rights to attorney’s fees.

The items above will help support the facts of a bona fide loan between an entity and its owner. Making it much more difficult for the IRS to reclassify the loan as contributed capital, a cash distribution, or a cash dividend.

These reclassifications can greatly impact the taxable income of the owner of the entity. By reclassify a loan as a cash dividend in a C Corp or S Corp this creates additional dividend income for the shareholder, and is not a deductible expense of a the C Corp or S Corp.

If a loan is reclassified as a cash distribution, this may reduce the owners’ basis below zero, which may disallow and suspend any losses previously taken. This may greatly increase the taxable income on the return of the member creating a much larger tax burden than expected.

Loans reclassified as contributions don’t create as many problems since cash classified as a loan or contributed capital both increase the basis of owner’s interest in their entity. However, it may postpone or limit the repayment of the contributed funds due to cash flow and operating activity of the entity.

So be sure to examine the loans between you and your entities to be confident that they are reasonable and have the items list above to help support the purpose of the loan. As always consult your tax advisor if questions and concerns arise about loans between you and your entity, being overly cautious is always a good way to go.

Life insurance: an integral tool for business planning

Life insurance often is viewed as financial protection for your family in the case of untimely death. But these policies also often play a very important role in the business world.

From business partnerships and buy-sell arrangements to business succession plans, life insurance can ensure a stable revenue stream and continuity in the event of the death of a partner, owner or integral employee.

The death of a partner or company owner is a crisis for any organization. Not only does the company lose an important member of its key leadership, but a partner’s death means the company often must pay out the amount of the ownership stake to the owner’s heirs.

For a midsized company that is not fully mature, buying out an owner while simultaneously weathering the loss of a key company leader can be a deeply challenging proposition.

A properly structured life insurance policy can ensure that the company has the money on hand to buy out an owner and continue operation of the company without having to take on more debt.

This is important since a company dealing with the death of an owner or partner is most likely already struggling to replace the revenue that the partner generated.

In buy-sell arrangements among business partners, life insurance policies ensure that even a growing company with limited liquidity can transfer ownership in an orderly manner with the insurance policy payout financing the ownership buyout.

There are many different types of life insurance, and policies can be tailored to a business’ specific needs and desired level of coverage. Businesses should evaluate their maturity, liquidity, ownership structure and business succession plans in determining what type of life insurance policy best fits them.

Finally, some companies take out life insurance policies on key staff members whose identity, vision and skill are an integral part of the company’s success.

“Key person” life insurance protects a company from the financial risk of the loss of a CEO, founder or company visionary. A life insurance policy that pays when a key person passes away can help a company weather that storm and have the needed capital on hand to restructure or reorganize.

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Living in interesting times; the Affordable Care Act for Small Businesses

By Bill Saylor

A Chinese blessing (or is it a curse?!) says, in part, “May you live in interesting times.”  Apparently, we’re all blessed these days as the Affordable Care Act continues to take effect.

If you own a small business, chances are you still have questions about the Affordable Care Act.  While it is true that most businesses with fewer than 50 employees are exempt from the penalty and tax requirements of the ‘Act, be careful if you have multiple businesses as you may have to aggregate all your employees in the related businesses to determine the total number you employ and your responsibilities under the ‘Act.

If you are a small business, you do not have to provide coverage to employees and their dependents.  However, if you do choose to offer coverage, be aware that you may be able to purchase coverage on your state exchange starting October 1, 2013. Talk to your exchange and/or your insurance broker to determine whether the exchange coverage is competitive with your existing group plan.

Also, you may be eligible for a federal tax credit of up to 35% (this increases to 50% effective January 1, 2014) of health insurance premiums you pay for employees. This credit is available if you have fewer than 25 full-time employees and if you pay average wages of less than $50,000 annually.  The more than 10 employees and/or pay average wages of more than $25,000, the amount of your credit is reduced.  Be sure to discuss with your tax advisor if you’re not already taking this credit.

Finally, although you may not have to provide coverage, you need to be aware that all your employees will have to buy coverage starting January 1, 2014 or pay a tax.  The amount of the tax varies depending on the employee’s income and subsidies may be available to individuals earning between 100% and 400% of the federal poverty level who are not covered by an employer plan.  Again, you may want to discuss possibilities with your insurance broker or attend one of the many training seminars currently being presented around country.

Good luck and blessings, my friends, it’s going to be an interesting time!

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Think globally, invest locally

Over the past several years, the state of Nevada found itself in a position no investor, public or private, wants to be in — locked in a stagnant investment fund that was losing money to inflation.

But the underperformance of the Nevada Permanent School Fund has since triggered a round of public investment innovation in the Silver State that is solving three of the state’s most vexing problems at once — increasing revenue from public investments, expanding funding for K-12 education and injecting much-needed private capital into Nevada companies.

The new investment strategy, championed by Nevada Treasurer Kate Marshall, is an example of how states across the nation are thinking outside of the box by not only increasing investment in high-return private equity funds, but also voting to keep their investment close to home, where it will finance the growth of their own state’s economy.

Nevada’s Permanent School Fund, which was invested almost primarily in government bonds, is now becoming a diversified and balanced portfolio that increases returns by adding in a mix of private equity investment and co-investment. That change was spearheaded by Marshall and her knowledgeable staff (including investment experts such as Deputy Chief Treasurer Mark Mathers) who supported state Senate Bill 75 that passed in the 2011 Legislature.

This new public investment model for Nevada seeks to create a cycle of economic growth that lifts the economy, the education system and the state’s tax base into an upward spiral of compounding investment returns.

Nevada’s modernization of its school fund investment strategy paves the way for more investment in education, the foundation of future economic growth, while also investing in the state’s current economic engines — Nevada-based companies that need capital to grow.

The investment also is attracting welcome attention to Northern Nevada’s business climate. Nevada’s partnership with world-class financial institutions such as Hamilton Lane and Providence Equity Partners is exposing Northern Nevada’s business community to world-class funding institutions.

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Employee ownership offers options to owners, workers

Many business owners reaching retirement age look long and hard for a buyer who understands their business model, is knowledgeable about their industry and will continue to operate their business successfully.

Today, more and more business owners are finding those buyers within their own companies.

Employee ownership, often referred to as an Employee Stock Ownership Plan, is an increasingly popular ownership model that, if structured correctly, can benefit both owners and employees.

In a properly constructed ESOP, business owners have ready and willing buyers who will be invested in the long-term growth and health of the company. Business owners also might receive significant tax benefits from converting their business to employee ownership.

Employees, in turn, receive a part ownership of the company, in most cases without having to purchase that ownership stake. Stock typically is given to employees as an incentive, bonus or benefit.

Employee ownership does not make sense in all cases. But mature and successful companies that are valued correctly and well-managed are good candidates for employee ownership.

Employee ownership can foster a superior corporate culture. Employee-owned businesses have the capacity to be more nimble and flexible, and employee-owned businesses often have longer-tenured staff and highly committed employees.

According to a recent Wall Street Journal article, “Businesses with shared ownership plans fared better during the recession than more traditionally structured firms, including fewer layoffs, higher productivity and stronger employee loyalty.”

This corporate culture can differ starkly from a company that is absorbed by a large corporate industry giant. In that buyout scenario, duplicative departments such as marketing and human resources are often consolidated or cut, and often large-scale layoffs occur.

For a business owner who wishes to retire but wants to see the company he or she founded live on as an independent organization, the employee ownership model can be a desirable solution.

Despite these upsides, employees should not take employee ownership as a substitute for diversified retirement planning. Employees should invest in diversified retirement funds separate from their employee ownership.

The baby boomer generation represents a significant segment of business owners.

The Wall Street Journal estimated that 30 percent of U.S. business owners are 55 or older. As those business owners look to retire and pass their businesses on to another owner, a significant portion of them now will be considering their employees as potential owners.

John Solari is the managing partner of J.A. Solari & Partners. He has 25 years of accounting experience and also is a member of the American Institute of Certified Public Accountants and the Nevada Society of Certified Public Accountants.

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Estimated Tax Payments

As the economy slowly gets back on its feet there are a few things to think about when you start making more money. Believe it or not making an estimated tax payment may be necessary if you want to avoid paying penalties.

Who must generally pay estimated tax?

  • If you are filing as a sole proprietor, partner, S Corp. shareholder, and/or self-employed individual if you expect to owe tax of $1,000 or more.
  • If filing as a corporation and you expect to pay tax of $500 or more when you file.

If an underpayment of estimated tax is calculated you could be subject to penalties and ultimately footing more cash when you file your taxes. Generally, most taxpayers can avoid this penalty if you owe less than $1,000 in tax after subtracting withholdings and credits, or if you pay at least 90% of the tax for the current year, or 100% of the tax shown on the return from the prior year, whichever is smaller.

If estimated taxes are paid it will also make the tax burden much easier at the time you file your taxes.  To avoid these penalties and have a more enjoyable time filing your taxes consult with a tax professional and consider making some estimated tax payments.

“Itemized deductions” … All Good Things Must Come to an End

As the old adage goes all good things must come to an end. This is hard to visualize when it comes to anything that has to do with taxes, but this happens to be the case with itemized deductions. As part of the bipartisan agreements of the 2012 American Tax Relief Act the Pease Rule has been reinstated on itemized deductions and personal exemptions for the individuals the government has labeled as “high income” tax payers.

The rule is as follows, the unprotected itemized deductions are to be reduced by the lessor of the following two amounts:

  • 3% of the amounts by which AGI exceeds the threshold amounts listed above
  • Or 80% of unprotected itemized deductions.

So what does this mean to you???

Named after the congressman who originated the rule, it has been nonexistent the last 11 years thanks to the Bush era tax cuts, but has now reared its ugly head once again. The most basic explanation of the rule is that it limits the amount of itemized deductions for high income earners resulting in roughly a 1% overall increase to your tax rate. The adjusted gross income thresholds for when the phase outs begin are as follows:

  • Married Filing Joint: $300,000
  • Head of Household: $275,000
  • Single: $250,000
  • Married Filing Separately: $150,000

These are the base income levels for the 2013 tax year, but will be adjusted for inflation going forward. An important thing to remember is that these dollar amounts are adjusted gross income (AGI) amounts not taxable income amounts.

There are some itemized deductions protected from the rule and they include: Medical Expenses, which are already subject to 10% of a taxpayer’s adjusted gross income; investment interest expense, which is limited to investment income; and casualty or theft losses, which are also subject to 10% of a taxpayer’s adjusted gross income as well.

The unprotected itemized deductions subject to the rule are the three most common deductions: home mortgage interest, state and local taxes, and charitable deductions.

An example:

You are filing married filing jointly and your AGI is $500,000. Therefore, your AGI is $200,000 above the Pease threshold amounts and your unprotected itemized deductions add up to $50,000. The unprotected itemized deductions would be reduced by the lessor of the 3% rule, $6,000($200,000 x 3%) or the 80% rule, $40,000($50,000×80%), therefore your adjusted unprotected itemized deductions would be $44,000($50,000-$6,000).

The realistic effect of this limitation is that it will increase the rate of tax you pay on income above the thresholds previously state by roughly 1%. A simple way to estimate this additional tax would be that for every $100 dollars above your threshold for your filing situation you are being taxed on $103.

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Use care in classifying contractors vs. employees

*originally posted to RGJ.com

The growth of independent contractors in the workforce has prompted some to call the new, post-recessionary U.S. work world the “1099 Economy,” referring to the name of the tax form filed by independent contractors.

An estimated 10.3 million U.S. workers are independent contractors, according to 2010 U.S. Census Bureau data, and all indications are that number is rapidly growing.

But, the growth of independent contractors has led to growing scrutiny by the Internal Revenue Service, which is seeking out companies that are misclassifying employees as independent contractors to avoid paying taxes and employee benefits.

Here are two steps a company should take to avoid the penalties, back taxes and interest that can come from misclassifying a worker as an independent contractor.

Be careful to make the correct classification

Get the classification of workers right the first time and continually monitor independent contractors so you are aware if a contractor’s relationship with your company changes and necessitates a re-classification as an employee.

The Internal Revenue Service uses a 20-part “right-to-control” test to determine whether a worker is an independent contractor or an employee. The more control a company has over when, where and how work is performed, the more likely the worker is an employee and not an independent contractor. Refer to the IRS website to review a list of all 20 elements that the IRS uses to determine whether a worker is an independent contractor vs. an employee.

Don’t be afraid of reclassifying your workers

While the IRS is turning up the level of scrutiny on companies that misclassify their workers as independent contractors, they also are offering leniency for those that address the problem. The Voluntary Worker Classification Settlement Program recently was expanded by the IRS and offers companies a way to avoid stiff penalties.

“Employers accepted into the program will generally pay an amount effectively equaling just over 1 percent of the wages paid to the reclassified workers for the past year,” according to the IRS. The program eliminates interest and penalties, and assures that employers will not be audited on payroll taxes related to the reclassified workers’ prior work.

When executed correctly, the independent contractor relationship can have benefits for both workers and companies.

Independent contractors have greater flexibility in work schedule and location and are able to pursue multiple entrepreneurial opportunities. Companies gain an on-demand workforce that can scale with the ebb and flow of business without the long-term costs and commitments of hiring full-time employees.

John Solari is the managing partner of J.A. Solari & Partners. He has 25 years of accounting experience and also is a member of the American Institute of Certified Public Accountants and the Nevada Society of Certified Public Accountants.

3 considerations in determining how to raise capital

Companies poised for growth first face important decisions about financing. Growing a business comes at a price, and that price can be paid many ways — loans, stock offerings, equity arrangements, bond offerings and crowdfunding. Here are three things businesses should consider when evaluating how to raise capital:

Cost of financing
One of the fundamental financing questions a business must grapple with is: How much am I willing to give up?

Many people think of the cost of financing as a simple interest rate, but a variety of funding options are available to companies, depending on their size and funding needs. Early stage companies with few assets and minimal revenue often find that venture capital is their primary option. Venture capitalists will require an equity stake in exchange for financing, and it is important for early stage companies to evaluate the level of control and future profits they will give up in that exchange.

Other funding options for early stage companies include crowdfunding, a new model that harnesses online networks to aggregate funding from a large base of small investors.

Crowdfunding engages consumers and raises brand awareness, but achieving large investment sums is difficult, and the process can be labor intensive.

Established companies have a much larger range of funding options, and stock, bond, equity stakes and loans should be explored with an eye for the most affordable overall financing option that raises the desired amount of capital.

Investment return
The price that a company will pay for investment capital should be directly tied to the opportunities for growth in the marketplace. Buying an undervalued competitor at an affordable price or increasing market share are opportunities that must be balanced with the price of capital. Calculating this equation correctly is key to building a strong and profitable business. Focus on investments that have a long-term payoff — technology and equipment that translate into continued efficiencies, or research and development that keeps new products in the pipeline.

Analyzing risk
A rational and balanced attitude toward risk is fundamental to good investment decisions. A business that is too risk averse might miss prime opportunities to grow, while a cavalier attitude toward risk can be devastating.

A clear-eyed, objective analysis of risk should guide every investment strategy. Stick with the fundamentals of good decision-making when assessing risk — the cost of debt, the value of the investment and the profit potential. A financed investment in your company always holds some risk, but minimizing risk is key to successful investing.

John Solari is the managing partner of J.A. Solari & Partners. He has 25 years of accounting experience and also is a member of the American Institute of Certified Public Accountants and the Nevada Society of Certified Public Accountants.