Episode #7 - Getting Started with a Business (Part One)

Episode Transcript

Meredith Matics: Welcome to Business Reflections with your host Meredith Matics, and we are here to reflect on the business topics that are affecting you today and how you can better run your business. 
Meredith: Welcome to Business Reflections with your host, Meredith Matics, and we are here to reflect on the business topics that are affecting you today and how you can better run your business. 

Welcome to our two-part series on getting started with a business. Today, I'm joined by guest co-host, Courtney James.  

Courtney James: All right, guys. So today we wanted to talk about getting started with a business. We wanted to talk about it kind of generally speaking, but also in a bit, as it pertains to different industries, I think generally, we'd like to go to tax professionals and CPAs, and sometimes you have one when you're getting started and sometimes you don't. 

So as you're kind of asking around, I wanted to talk to Meredith a little bit more in depth about this one today. She has a lot of experience, uh, getting, getting folks started. And Meredith, maybe you can kind of just frame up some experiences that you've had. And, where do you think people fall short and where they hit some, some roadblocks as they're getting started in their new business? 

Meredith: Yeah, I think that the first thing is, is in the general way of doing business in business in America, there isn't really much, you have to do to get started in general. But when you get into certain industry specifics, there may be, you know, licensures or regulations or requirements, but what's beautiful about business is that we have set up in the way that we operate in the United States is that you can just go out and start doing a business. 

You want to just start selling cookies, you can sell cookies, but where it gets important is the fact that we do have to document things for taxes. You know, you can do a business, but if you're not documenting it for taxes, you're either A, doing it as a hobby. Or B, you're trying to pull one over on the IRS. 

So it's really important to think of your business profitability and what you want to do with it. And what classification or how do you want it to be? So in business, there's generally six types of business entities. There's the sole proprietorship, the general partnership, the limited partnership, a C Corp, a S Corp, and an LLC. General and limited partnerships are generally between multiple people. So we'll probably skip them today. Cause we're thinking of just, you know, the base entrepreneur or in my industry specifically would be brand new therapist or brand new doctor wanting to start a private practice. But this could also be a yoga instructor wanting to start their own teaching or can, do you want to make cookies and sell them professionally? 

You know, how do you set up your business for success around what is it going to matter when you collect taxes? One of the things that I get often is like, Why does it really matter which way I pick up and why do I need to set it up right from the beginning? Because when you get into the more complex entities there's  usually fees involved, but we'll start with the sole proprietor. So the sole proprietorship is probably the easiest to get started and anybody who wants to start a business essentially a sole proprietor, just to begin with you, just go out there with your social security number, yourself, and you start selling a product, making a product, selling a service, and you become a proprietor. 

What becomes critical about a sole proprietorship is realizing what that entails. And that is basically you pay taxes on the difference between what you make and what you spend in relation to that topic of what you're doing. So, we'll go into my industry like a therapist. And that would be, you know, if you make a hundred dollars an hour as a therapist, but you spend $900 a month on rent and you know, $250 a year on your license, that all comes out. And then at the end of the year, you basically just subtract what you made and what you've spent, and then you pay taxes on that. And that's what your business has made.  

Courtney: Meredith on, on that. Maybe break that down before we move to the next one here. If I'm at, if I'm a therapist and I'm brand new, um, in terms of has gone through my  , um, I've gotten my license. That's a general startup costs, right? You're saying license fees or rent. You know, I have an hourly rate. How would you break down kind of startup costs perhaps in the first year of a therapy?  

Meredith: That's a really hard one to say, because even when they, for therapists and each industry is going to be very different, very specific, but with therapists, um, they may already be used to paying for their license. 

You know, even as like an intern for testing for CEU's. So really what they state specifically or county specifically is going to vary. But I mean, I would say that if I'm like, I wake up and I want to be a sole proprietor or anything, I'm going to need to put away at least a little bit of money. We're prepared to be putting out some as I'm getting started. But as it's mentioned with a sole proprietor, you can kind of jump in without a great giant investment. And that's usually what people like as you're putting out for the things that you're going to be utilizing. Regularly your license, you know, your rent, maybe you need a computer, things like that. 

But the problem with the sole proprietor in that sense is it's under you. And so a lot of people want to just give out their social security number as their tax ID and a sole proprietorship. And don't realize it's still very important to register with the IRS and get an EIN or a tax identifying number that you use instead of your social security number, because with therapists, they get insurance contracts. You don't want that going out on every person that you see is contract. And if you're a baker or whatever, whenever you're purchasing things and you know, I need to provide a W-9 or if somebody is going to need your tax information, you don't want to be giving them your social security number. 

That's not secure. Your business is going to require you to put that down when you, you know, apply for renting a space. If you're buying, you know, different things, you just want to have the separate entity tax wise and you don't want to be sharing your social security number with the world.  

Courtney: So let, let me, let me circle that back and make sure, cause I think this is a really important point, um, that maybe he's missed in the beginning of, of getting started in business, right is as a sole proprietor you're you're still liable for. For everything and take on the rest. It's still technically under your social security number right in you as a person. But, but we're saying here instead, while that's the case, it's still wise to get an EIN or employer identification number so that when you're applying for insurances or you're setting up bank accounts, or you're doing, you're getting all these numbers out and things set up, you're actually sending out your EIN and not your social security number, just from a security standpoint, there's a lot of value.  Am I hearing that right?  

Meredith: Yes. And even though you are personally guaranteeing something, so like, let's say you decide to go rent an office space and it's $500 a month and you sign up. For a two year lease and you bail on it after six months, you are still personally liable for that two year lease and they can come after you individually and not your business because your business is not a separate entity at this time if you're a sole proprietor, however. You don't want to be giving out your social security number to everybody on the planet. And when you get involved in business, everybody in the planet starts asking for your social or ask you for your tax ID number, because it's going to go on your business license. 

It's going to go everywhere. So you don't want everybody on the planet to be able to access your social security number, because should you terminate the business? Or should you just want to have protection, like any normal person, you need to be able to do that. So it's really critical. And it's something that I think a lot of people don't even know is out there. 

They think an EIN or Tax ID is solely corporation or a bigger company, but even Joe Schmo could go out and get one just as their sole proprietor and that's really important and it's free with the IRS. If you do it online and it's instant, so it's not like you have to wait and put in this application and be like, well, in seven years, I'm going to start this business. 

You have an idea. You want to start this business and you want to register it with the IRS and start being able to keep your finances straight and open a business bank account under that name. This is your first step. And it's, it's very easy. And all they ask for from the IRS is going to be things like what's your social security number, because now when any time, the IRS sees this EIN. They know that's Joe Schmoe, SSN, whatever, but the world will just know it as Joe's bakery.  

Courtney: Right. Right. So, so this is, it's a really important point. Um, and I, I think there's a lot of value in people not understanding the process of doing this. And it's really, if I heard you correctly, right, it's go to the IRS. Go online. You can literally type in probably E I N you get to the link, you fill out a few questions,  

Meredith: Just real fast, there is a lot of websites that try to trick you into paying them like $120 to registering EIN. It is not, they ask you for money. It's not real.  

Courtney: Just don't. Yeah, it's free. 

Meredith: It's totally free from the IRS, because the IRS does not want you to get them about your social security number to everybody.  

Courtney: Right, right. So check, check your hyperlink and url, make sure it's irs.gov, right?  

Meredith: Yeah.  

Courtney: Make sure you're there. And within a few minutes, a few moments, fill out a few questions and you're going to have your EIN. 

So it's super important, super easy as a sole proprietor. Now, now, before you move to the next entity, cause I, I like the sole proprietorship because I think this is a huge value, especially in America. Right. We can start a business legally. Almost instantly. And so it's a huge fight there.  

Meredith: Well, you know, again, depending on what industry you're in, where you are, there may be other requirements like a, you know, business license and so on and so forth. 

And that needs to be checked in specific to what your business is. But let's just say on the general aspect of how do I start a business - you come up with an idea. You come up with a product, you come with the service, you get your EIN and you start doing it. And you're a sole proprietor and you're a business owner. 

Courtney: Yeah. And so step one, get the EIN right. I think sole proprietors, now, you know, you started to elude to this late, earlier about. You know, I'm personally liable as a sole proprietor. Can you tell me, like, who would you kind of, kind of best use case who would you advise to stay a sole proprietorship rather than going to an LLC or a corporation? 

Meredith: Well, sole proprietors are great if you want to just get started and test your feet in the water of an industry. Usually sole proprietors too, are somebody who is not going to have any employees, although it's not guaranteed that you don't, you can still have employees under a sole proprietorship, but generally speaking, that would be somebody who wants to just do something on their own. 

So for instance, it could be somebody like Betty's accounting services and Betty is an accountant, and just wants to work from home and only has like two clients and isn't really concerned about those clients suing her and Betty just wants to do Betty. She could be a sole proprietor, and that would be fine, where it gets concerning is if you're going to be in an industry that has the potential for being sued or for being liable. 

So I work in the medical field, right, so medical professionals, it's not usually why is for them to be a sole proprietor without if they are, they need to make up for it and having really good insurance, but you're in an industry that people tend to sue. So if you're a personally liable for anything that happens with your business and something happens and someone sues you - you're personally liable for that. 

So what does that mean? Okay. If you have a house and you have a car and you have other assets, stocks, whatever, and you get sued for $2 million and your insurance only covers 1 million. Where does that other million come from? Well, it comes from you so you're going to have to personally sell off your assets. 

So that means you'd have to sell your house, sell your car, sell your stocks to pay the difference in what you were sued for. So if you're in an industry like somebody's knitting industry. Chances are, they're not going to get sued because somebody knitting killed them or something but when you're in the medical field, there's a high likelihood you're going to get sued. 

So it's really important when deciding if you're going to be a pro sole proprietor to decide, am I doing something that has high liability. Am I doing something that other people may feel that they want to come after me legally? It also is are you doing something that you have to personally back large amounts of money for? So sole proprietor, you could work from home, you might have a small office, but you're probably not going to rent out a giant building for $10,000 a month, or you're not going to rent up a factory like Cola. So in that case, you're not backing personally, a very large investment you're backing like we said, for, we'll say $500 a month for rent. So you have to kind of weigh, if it went somewhere power and someone sued me, or I had to pay out all these debts, do I want to personally be liable for that or do I want my business to be liable for that? And we'll get into how that separates it and we get to the other entities, but as a sole proprietor, it's all meshed.  

Courtney: Yeah. That makes a lot of sense. And I think, you know, the, the scariest part for, for a lot of people getting started, started in businesses, the liability piece, right. Especially if you've never done it. And it's a new business, there's a ton of risk and liability. And I think generally, you know, the sole proprietorship entity is really a specific, right. It's, it's more or less a simple business structure, right, where there's not a lot of liabilities you're alluding to. And it's one where you don't plan to scale into an IPO or plan to have multiple locations, or you can have employees, but you're not going to have very many, right. So if you're just, like you said early, I just, I'm going to test the waters in an industry or I want to work for myself, I want to do me, Betty's going to do Betty. 

I'm a consultant, right? That's a sole proprietor and life is good and you can do as you wish. But, I think the next, and I'll let you kind of take the reigns on which business entity you want to talk about next. But I think there's, as it goes,  

Meredith: If we're starting at the easiest business entity and moving up and we're ignoring partnerships because that's a whole different beast, we're assuming that this is an entrepreneur wanting to start something on their own. 

We're going to go with that, you know, at least that parameters for this discussion, the next level up would be, um, a single member LLC. So that's what we think of as a limited liability corporation. So it sounds really fancy, but really it's just like a fancy sole-proprietor you get an EIN, like we talked about and you get a business name. 

So if I'm Betty's Accounting,  and I upgrade to an LLC, I'm Betty's Accounting LLC. And what that does is it does create a small separation between the business liability and the person who owns it. So in this case, if I'm taking out rent, I'm going to put it as you know, under the LLC, the LLC will have no, no um, credit history, if it's brand new so I will secondary backup as it, my individual self, but at least if something went wrong, the LCC could dissolve. It is a little bit complicated because when you get into doing your taxes, you do your taxes very similar to if you were a sole proprietor in the sense that it's solely, you're being taxed on the difference between what you made and what you spent and that's it. 

And so when I say that and people tend to go wasn't everything on the difference between what you made and what you spent. As an LLC or a sole proprietor what I spent would be not money I paid myself, but money I paid employees, money I paid for rent, anything like that. We'll talk about it the next level up, what that changes, but an LLC is the quickest way to protect yourself without jumping all the way into corporations, because when we get into corporations, it changes significantly. Yeah. So this is like the best step for, okay, I've maybe tested the waters and maybe I had a sole proprietorship or maybe I'm, I'm getting started, but I know I'm in an industry that's sue happy. I'm going to go with an LLC because I want that protection, but I'm going to keep track of things. 

It's going to be very simple and very similar to a sole proprietorship. It's really the best of both worlds. And it's really ideal, but it's very state specific. So each state will have different filing requirements. Each state will change what is needed about an LLC. The regulations are not federal. 

So that's kind of the only difference the price of it's going to change based on where you are. So for instance, we're in California. Currently it's $800 a year to have an LLC and you pay that up front when you register your LLC. So basically you pay your first year front, and then after that you pay it usually at the beginning of your fiscal year, which for most people is January 1st. 

So they're waving that starting in 2021. Good news for those of you that want to jump up to an LLC next year, but other States might be like $50 a year or $25 every other year. So it really depends where you are, but it has to do with how are you separating that liability from yourself, but you're running it very much like a sole proprietor. 

Courtney: Yeah, that makes sense. So, and I think one other thing, and it did touch on this an LLC can be more than one person, right?  

Meredith: Yes. A LLC can be made up of multiple people. Um, what we were talking about as a sole member LLC, but there are like LLC partnerships or multi members, and that would be fairly that time  now get involved with some kind of. Legal entity to help you form it. So you, if you have a lawyer or a business lawyer, or if you're really into like legal zoom or whatever, there's a million places online that will help you set it up. 

Um, and you do your, and you can do it yourself too. There's there's ways to just file it yourself, but you're going to have to, you make some decisions about who owns it. Is it a hundred percent ownership, one person, is it 50/50, things like that, and those will be determined when you set up your LLC. But again, it's going to vary by state as to what exactly are going to be the requirements. 

Courtney: Yeah, a quick question just to tie the type, uh, the knot here and circle back on the sole proprietorship. Is it different state by state? As well or?  

Meredith:  No.  

Courtney: So, okay. So we're talking about sole proprietor, so sole proprietor beefed up one extra layer of complexity, but also opens up a lot of protection, right? A little more complex than getting set up, right?  

Meredith: Yes. And, there's some thing to, to realize with, um, a sole proprietor, you know, you just decided to stop doing business. Like you just wake up one day and you don't want to do Betty's Bookkeeping anymore or whatever. Right. You just stop and you're done. You don't have to do anything, even if you're not using your EIN and you're just kind of like done and there IRS will send you a letter and be like, we haven't seen anything or do you want to get this open? And you're like, man, when you get into an LLC, now you have to legally. Turn it off basically, or dissolve the LLC, should you want to cease doing business? So yeah, it takes a little bit more setup and it takes a little bit more tear down. 

So if you're just like, Oh, I'm going to make things on Etsy. Great, do it as a sole proprietor. But if you want to make things on Etsy and you want to take it to the next level, LLC, because, but remember once you set it up, should you no longer want to use it, you need to dissolve it. Or should you die, the business just dies. 

Courtney: What is that process to go from a sole proprietor to an LLC. Is it a heavy lift. What does that look like?  

Meredith: Well, it's depending on what industry you're in, it's generally not a big jump. As far as formation goes. As I mentioned for an LLC, you do have to fill out some paperwork and do form a legal entity, you know, in your state. 

But I would say, you know, if you go to like, one of the websites that are like the legal processing things that'll do it for you for like a hundred bucks "for a LLC." Really, it's not a big jump. Where it could be concerning is if you are in an industry that links heavily to that EIN. So for instance, in medical billing, you base your contracts on your EIN and changing that when you go from a sole proprietor, to an LLC you'll get a new EIN. 

And so each time you do this, if you have things that are in place that rely on that, those could be jeopardized. So if I'm Betty, the bookkeeper and my EIN is not linked to anything. And I just kind of do my own thing and then one day want to have an LLC. Probably really not a large jump, but if you're in the medical field and you need to now renegotiate and redo all your contracts, that's probably going to be a giant jump. 

So it really is industry specific whether you should just take that jump from the beginning or whether it's good to get your feet wet, be a sole proprietor and upgrade up. The other issue is, is if you change entity types halfway through the year, your CPA or tax person is going to be a little angry at you. 

Courtney: That's something we should all be concerned about. We don't need any, any tax folks getting angry and they're probably pretty Type A or fine if I'm not mistaken. 

Meredith: And if you do your own taxes. You're going to be angry at you because you're going to have to do them differently depending on when. The LLC formed because a sole proprietor can just get started at any given time. 

And LLC has an official form date. This is the data went into business. This is the date we started taking care of it like this. And so they're going to want records very clean. So I usually recommend if you're going to jump from a sole proprietor to an LLC, you may want to consider doing it at the end of the year. 

So like at the end of 2020 jumping into the beginning of 2021, brand new. Now I'm an LLC. My taxes for this year will be pretty clean, but if you're like, I'm going to do it in February. Well, now you're changing for one month and it's going to be kind of a pain because when you get to it at the end of the year and you file your taxes, you're going to be like, well, what date did this start? And what was this, this entity? Or was it this one? You know?  

Courtney: Yeah. It makes for keeping a little bit, uh, little more detailed than ideal. So, so let's, let's try to change at the end of the year, right, and starting on the calendar year, I think is the recommended treatment.  

Meredith: So it doesn't mean like if you get into it and you're like, shoot, I really need an LLC because I am really liable for this. I'm going to form one. Oh no, it's not the end of the year. I mean, there's pluses and minuses to everything, but if you have your choice of when to do it, the end of the year is a beautiful time to do it.  

Join us next week for part two on getting started with the business.  

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