How To Set Up A Business
The Inventive Journey Podcast for Entrepreneurs
How To Set Up A Business
The Inventive Journey
Starting and growing a business is a journey. On The Inventive Journey, your host, Devin Miller walks with startups along their different journeys startups take to success (or failure). You also get to hear from featured guests, such as venture firms and angel investors, that provide insight on the paths to a successful inventive journey.
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number one is pick up the phone and have a consultation with an attorney most attorneys including my firm and probably yours too will will have an initial consultation of a certain duration at no cost to the client to kind of walk them through and ask the right questions and see if a further consultation or services are warranted a lot of people have the i can do it myself mentality and that's good up to a point when you actually figure out you don't know what you don't know so i tell everybody you know if you're preparing your taxes that's not a time to do it yourself and tell your cpa later what you did you should be consulting with a cpa in that early decision everyone this is devin miller here with another episode of the inventive journey i'm your host devon miller the serial entrepreneur that's grown several startups into seven and eight figure businesses as well as the ceo and founder of miller ip law where we help startups and small businesses with their patents and trademarks and if you ever need help with yours just go to strategymeeting.com and we're always here to help now today we have another great guest uh expert episode we have another great guest but also for a great expert episode which is scott williams and uh scott we're going to talk a little bit about different things related to business uh generally about kind of starting a business what things you should should consider on entity formation partnership agreements employee employment issues especially in california employee versus employer contractors whether they should be employees or hourly or salary or how that would be setting up and maybe a bit also on the estate planning and succession planning so a lot of fun and uh interesting episodes or episodes interesting topics and so and i uh you're you're i'm already getting tongue-tied before we even get going but with that much as a as an introduction welcome on the podcast scott devin thanks to be here absolutely so i gave kind of a quick introduction about what we're going to be talking about but before we dive into that maybe just introduce your audi or yourself to the audience a bit take it a minute or two and let them know why you're an expert in this area sure we are the small business law firm it's the name of our firm and we focus on everything from a startup with nothing more than a concept and zero employees up to about a 25 employee company the big thing is most small businesses are looking for guidance they're looking for help someone to hold their hand they don't know where to turn they often go to a big law firm and they get one lawyer for contract somebody else for employment law and the lawyers start billing each other having these conversations and all of a sudden you know that they're in the wrong place so we try to be nimble and focused on really the entrepreneur the small business and helping them grow much like you do in the ip side no it definitely makes sense and now just is the audience how long has the firm be established how long you've been kind of practicing in this area sure we're in our 21st year in business uh growing every day uh two lawyers hiring a third and um most of our most of our clientele is in california although we do some transactional work across state lines awesome definitely definitely makes sense so now diving into a bit of the topic at hand which is kind of a lot of to do with starting a business how to format how to get it all set up and and kind of how to plan for that diving in a bit if you're to say you know had somebody walk in your office as an example and they have the world's best idea and this is you know i hear from the iep side but world's best ideas some of them are world's best idea others are just okay ideas but yeah let's say it was the world's best idea and they said okay now how do i get started you know what should i consider from forming my business from getting it set up and that type of thing and they're saying you know do i need an llc an s corp a c corp do i just do it on my own or what what or what would be kind of the general advice of somebody to walk in your door as far as how to go about starting to get a business set up or what they should consider sure the number one thing i look for in a new business setup is liability operating a business as a sole proprietorship or two or more people as a general partnership are the default entity choices and people don't often realize that when two or more people go into business together unless there is a clear written agreement to the contrary they have just formed a general partnership and a general partnership by very definition means that all general partners no matter how active they may choose to be are vicariously liable for every liability of that partnership and so i tell people do you really want to be exposing your personal assets to your partner driving down to office depot and picking up a box of pens and takes out a school bus and the other partner says well i wasn't driving the car and the law says we don't care it was in furtherance of a partnership a for-profit enterprise so there are only three real choices for most small businesses today to form a business entity for liability protection uh llcs corporations which are divided into either c corporations or s corporations and i'll address all three an llc certainly the simplest form of liability protection it can be formed with as little as one member or as many members as you want uh advantages of the llc they're fairly simplistic to operate you don't have to have separate meetings of directors or shareholders the members themselves can run it with one layer of management and typically they'll elect to tax the llc if it's a single member which means also a husband and wife in a community property state it'll be a disregarded entity which means you put it right in your schedule c of your tax return and no separate federal return is required uh the drawback of that is uh an llc single member following the schedule c it has the highest audit rate known to mankind so for a very small business not a big deal when you start making money you don't want to have your income on a schedule c a multi-member llc is going to be taxed as a partnership it'll file a 1065 federal partnership return and that's also fine when the business isn't making a ton of money but when it starts becoming very profitable at this point you start looking at the advantages of an s corporation and an s corporation very simply is it's still a pass-through entity meaning the s corporation itself doesn't pay federal income tax all of the income flows through to the individual shareholders on a k1 is reported on their personal tax returns but you can do a lot more with an s corporation in that you only have to take a reasonable minimum salary for your services and then everything else goes out on a k1 as a distribution on those distributions you do have to pay state and federal income taxes but you don't have to pay fica and medicare and unemployment insurance and disability insurance and all of these other junk taxes that can add up to like 13 15 percent so for a lot of small businesses the s corporation is the preferred choice of entity if they qualify to do so and in many cases the only requirements are that all of the shareholders be us citizens or u.s residents you have to have one class of stock and less than 100 shareholders all of whom have to be natural people it can't be other entities or corporations c corporations yeah they still do exist and they are formed occasionally uh although rarely does an entity want to be a c corporation nowadays just because you have to pay everything out to the shareholders as a salary uh so that the corporation makes no money and avoids double taxation no and i definitely think that makes sense now one one thing i'm going to circle back to is you talked about you know limiting your liability in the sense of hey you know if you're if you don't have anything set in place your partner goes they get in a car accident on company business so to speak and now you're on the hook that they can come after your house your life savings and everything else because you're equally limited if you didn't if all you were in is a partnership now the question would be is between you know s corp c corp llc um you know and then there's an llp and some other variations but really when you look at that from a liability perspective is there any real difference between s corp c corp llc or the from liability or about the all the same and then you're really looking more for tax or tax purposes or or how you want to set it up for investing meaning hey s corporate c corp i would do it shares and so maybe if i'm having venture capital or angel vests or angel investors or something come in i want to have them buy air get shares in the company because they're easier to do that as opposed to having to split the equity up all the time but liability wise is there any difference in liability so statutorily all three a corporation which is taxed either c or s and an llc are going to have the exact same liability protection that's assuming you run both of those entities properly llcs you can be a lot sloppier in your accounting and in your management because they don't have to have minutes of shareholders and directors and they don't have to have the same accounting paper trail because a single member llc is a disregarded entity for tax purposes with a corporation you do have to have annual minutes uh annual meetings of the shareholders annual minutes of the directors and you have to record those in minutes takes five minutes hold up a glass of wine to a mirror have a meeting with the shareholders it's not that difficult but you're supposed to document the stuff in in minutes from an accounting perspective any time you're borrowing or lending money to an entity other than your own you should be documenting that with a promissory note especially if that's going to be carrying over to the next taxable year not a big issue with a single member llc but it is with a corporation okay and that and that definitely makes it so far to maybe summarize from a legal perspective business as long as you run them properly as long as you have either the you know the board of directors take some minutes or whatnot or an llc is even they're more lacks or than that as long as you're following within what the requirements are for each entity you'd have the same from the liability perspective now on the getting into it a bit because one of the questions they have is you know let's say i'm a startup and i want to i'm going to seek angel investors or venture capital is there a preferred way another one in otherwise in other words are they looking for an llc are they looking for an s corp so they can get shares in the business are they looking for a c corp or when you're going out and saying you know there's a difference if i'm bootstrapping and i'm doing it myself and i'm just trying to reduce or keep it simple and keep the cost low maybe an llc works but if you're looking to say hey i'm going to be going raising a series a or series b or something in those rounds and i need to raise a substantial amount of cash should they be settings or doing anything to set it up initially sure so one of the challenges of an s corporation is it has to have only one class of stock which is common stock so if you want to have multiple classes of stock for what you're recruiting investors to buy one class but not all classes s corporations typically don't work that well they're generally when the ownership is established angel investors if they're coming in to acquire equity most of those investors don't want to be getting a k1 for the profits and loss of the business until they actually see some profits in in many cases they'll ask the entity to reclassify themselves for tax purposes as a c-corporation one of the advantages of an llc is you have the flexibility throughout the life of the llc to file an 8832 and elect to tax it as a c-corporation you also can tax it later on as an s-corporation by filing an irs 1150 2553 so there is flexibility with an llc to make changes later for tax purposes while still maintaining the original simple structure okay and that and that definitely makes sense and so you're saying hey if we need to do distributions if we want to have different classes of stock we'll look at whether it's an s corp or a c corp and i i'd read in i didn't know necessarily here but i'd read in there an llc from a investor perspective is typically they're not looking for an llc it's more of a corporation is that a fair summary they don't want to typically get k-1s for their own personal tax returns so they'll may they may want to see a c-corp or have the llc elect to be taxed as a c-corp uh during a period of which their their writing losses a lot of angel investors simply don't qualify because they don't have any material participation to write off losses um but that's more of a tax issue every angel investor is different okay and definitely makes sense so now shifting gears just a little bit so we talked a little bit about you know getting initially figuring out s corp c corp llc those type of things i'm going to get into one that i know a lot of attorneys dislike which is you know but i get why they're why on the startup side in the small business why they do which is illegal zoom or those type of you know type of entities because you know they're saying hey it's just a really simple llc i just need some standard stuff i just want to have it in place and so that i can have you know i can get a bank account set up i can have a brand you know maybe get an amazon brand registry or have you know very simple things or open a e-commerce site i don't really need anything complicated it's me and my spouse or it's me and my friend or whatever and i said i know attorneys are saying well you know when in some self-interested they're saying hey if i do that if i always say go yes go use legalzoom then i'm going to be out of business and yet and yet there's real drawbacks as to things that oftentimes don't get considered so if you're talking to someone that is just a small business just starting out bootstrapping what are the pros and cons of legal zoom when should when maybe is it acceptable or okay and when should you say this probably isn't a good idea so i often have clients walk in my office with a binder in their hand prepared by a document preparation service and i'll leave the exact name of the company off there but there's many variations of the name you quoted sure uh by the time i sit down with the client and show them what's missing from this binder and what wasn't done properly i usually get the takeoff of the commercial oh gosh i could have had a v8 because what they didn't get was the legal advice is this the proper entity for their business a classic example is um you know professional service providers in most states can't form regular llcs they either have to form a professional llc if it's even available in that state or in safe like california they have to form a professional corporation they cannot operate their business as an llc so i get a you know a landscape architect that says form an llc legalzoom doesn't ask the right questions they just take their money and run and by the time they get to me they have to start all over again so look i don't i don't want to knock uh those businesses that are trying to save clients money but by and large the conversation you need to have with an attorney to walk you through what is the best choice of entity for you the licenses you hold the type of business you're conducting i mean it's worth its weight in gold it's just simply a matter of apples and oranges so let's say i get luck you know so now i'll ask you the the probing question i was gonna i'll change my halfway through i'll change the questions gonna ask which is let's say i don't have much money let's say you know i'm bootstrapping it this is a side hustle we're fairly limited on funds is there any time when you would say it's oh and i know it's a hard question anytime you say it's okay or it's better you know sometimes in other words i'll say well it's better than to have an illegal zoom llc if you can't afford anything right in a sense if you're if your choices are i have a hundred dollars i can either do legal zoom or i could not do anything and do it as a general partnership is that an acceptable you know is there any way that they should say i just can't afford attorney services i certainly get that attorneys are worth what they what they charge but i can't afford it should they consider doing those type of things or give a little bit of balance there so my first reaction is if you can't afford a simple fee for incorporation of a corporation or organization of an llc with a firm like ours whose fees are really not much higher than a legal zoom you really shouldn't be in business i mean if you're so strapped on cash that you just don't have the ability to write the smallest check how are you going to make expenses in your business it's just a very difficult proposition so yeah i'd rather see somebody go to an online service than try and do it themselves and mess it up but you know you have to have a certain amount of cash behind you to operate your business unless you're simply a consultant with zero expenses and all you're selling is the brain cells in your mind well okay fine but if you have anything else at risk it's dangerous but no and i'm i said i'm playing a bit of devil's advocate so i'm just pushing back there because the reason i ask is you know starting as you're doing a startup let's say you have a few you know you have five thousand dollars set aside and i'm just gonna make up the number but then you have okay we gotta come up with a prototype we need to get an e-commerce platform because that's what we're gonna sell online we're going to be able to we we need to find someone that can actually build a website we need to hire it you know at least a part-time employee that can help out you know they've got all these things competing in their interests and so you know and and i would say and i'm absolutely the same way and i always look at everything well you need to have intellectual property because you'll kick yourself down the road if you don't have a patent and somebody rips it off or a trademark and they're always you know there's always more things to spend money on than money to spend as a startup and so how do they balance you know the kind of the follow-up questions what he said is you know if i'm just getting started i only have a few thousand dollars that i've saved up for over a period of time and that's all i have and i know basically once i spent through that if i don't start making income then the business goes out when should they start or when is the drop dead and i know it's hard it's a it's a depends question but when is when should they say by this time i should do it should they start out as a partnership doing it for a few months seeing if it's worthwhile to invest or get you know spend other money there should they should it be the very first thing before they ever get going to do an llc or you know a business corporation or kind of how do you balance that so so the number one concern i have is you mentioned the word website merely having a website that turns out is not ada compatible could expose you to tens of thousands of dollars in litigation fees just by having a website there are plaintiffs lawyers out there professional plaintiffs that go on websites check them out to see if they're compatible for the visually impaired and they just start filing lawsuits and the first reaction the the business owner has is what did i do wrong well you know you didn't do anything intentionally wrong but if you have a website and it's not ada compatible you can be sued for it i'd much rather have that website in an llc or a corporation where it has no assets where the worst case scenario is i start over again with a new llc than to give a plaintiff's lawyer ammunition to work with when they go to sue no and that definitely makes sense and i said i i would i always counsel now now that i'm not playing devil's advocate on the flip side is that you know it's always easier to your point llc's you can get fairly inexpensive it provides a high much higher level of protection it's always worthwhile so i like to push and play devil's advocate just to tell people understand why that is that you know you should be considering things earlier on now shifting gears just a bit one of the other questions is people start getting into a business formation is you know should i hire people as independent contractors as employees should it be hourly should it be salaried should it be you know um you know a bonus structure you know or something of that nature or so how do you start to figure that out for your business with your as you form your business how you should be setting up with employees or contractors or you know commission base or bonus structure or salary or whatnot any considerations on any of those sure so there are federal laws governing whether a person should be classified as an employee or a contractor and then there are state-specific laws the more restrictive of the two the one that pushes you into employment is the one that applies the federal standard is not a cakewalk but it's not very difficult to me basically if you don't exercise independent control over how the work is done if you simply pay people to accomplish a project and you don't micromanage their time schedule you can pretty much make people a contractor under most federal irs guidelines the problem is more and more states today are looking at the federal guidelines as being way too weak and they're all passing their own laws that tighten up the requirements to be a contractor so by default if you can't meet the test of a contractor that worker needs to be an employee and i can think of no other state that has a pendulum that swung to the far direction than california in california last year we passed ab5 and ab5 basically says you now need to meet a very stringent abc test in order to be a contractor you have to be free of degree of control that's easy it's the old test the new one the b prong is you have to provide services that are different than the employer provides and then c you have to be in an area that's customarily staffed by contractors so for example if you are a small business and you're in the uh you're selling dresses in a dress shop any sales person on the floor has to be an employee they can't be a contractor outside sales people have to be contractors i have to be employees if you if you hired a web designer to build a website for a couple of days and then they went away you could argue hey i'm not in the web design business therefore that person can still be a contractor you probably get away with that but more and more states today are passing laws like that and it's becoming more difficult to hire somebody and properly maintain them as a contractor the problem you have is at some point that relationship sours and the employee marches off to the unemployment department and says i'm filing an unemployment insurance claim the first thing unemployment insurance says is i'm sorry we don't have any reportable wages for you therefore you don't qualify for unemployment insurance and that's when the worker says oh i was misclassified as a contractor and the edd or the state agency that manages unemployment insurance then says oh we've got a special window for you step over here we'll get you taken care of out of our slush fund and by the way we'll start an investigation against the business that audit is very expensive it can result in you paying up to three years of back taxes in many cases workers compensation insurance for the people that weren't properly covered so it's it's always a challenge making people a contractor it's very state specific before you classify anybody as a contractor that isn't already an established business corporation or llc check with local employment council or business council in your state now let me ask because you hit on that at the very end so would it be worthwhile if i were to looking to hire an independent contractor whether it's one individual or multiple ones that i should simply require them to be you know in an ideal world require them to be our independent contractor for us they have to first form their own llc and then i engage with that llc as a vendor and independent contractor in that type of arrangement does that aid in it or is that there it doesn't really help much so that does help if you're paying a corporation or llc meaning you're paying a legal entity those entities cannot go on payroll because only individuals can be on payroll but that only works if they have yet to provide services for your business if they're already employees on payroll and you tell all your workers i can't afford these workers comp insurance premiums everybody has to go get your own llc the labor commission and your local state will see that as a subterfuge and they'll say sorry these people are still employees so in other words if you're gonna now here's the question and i i know it's always hard because especially when it's situation specific but let's say you know so one thing it sounds like if you're going to do that you would have to do it before you engage your services saying hey before i engage your services i only engage with or llcs or other independent or independent vendors that are have a business formation if you'd like to do it we'd love to hire you but go for your llc it's not very expensive go do a type of a thing now if you're in that process situation already meaning you didn't know that you already have an independent contract agreement that's with an individual not an llc and you know you're saying okay gosh it'd be a lot easier to go back and try and retroactively do that theoretically and i know it's harder in theory could you fire them or let them go not do work for with them for a period of time and then re-engage the llc if they formed one or is that going to not obviate any of the issues i don't see any benefit there the real test is is the is the individual incorporating their business or forming an llc for their business because they want to or because they're being told they have to that's the test that a labor commissioner is going to use how long ago they quit or whether there was a gap in work that's not the big issue uh you know if i'm forming an llc because i'm a consultant and i'm doing it because i'm marketing myself as a consultant to multiple businesses that's generally good enough for most labor commissioners but if the business is telling their their their workers go out and get an llc otherwise i can't hire you or i can't keep you it's never a good thing okay no definitely makes sense so well now shifting gears a bit and we i kind of brought it up but touching on it is there any considerations when you're doing hour hourly versus salaried as far as you know how you should pay people you know what considerations you might think of you know everything from hey i'll just pay them you know no matter if they work x amount of hours i'll pay the max amount of dollars versus i should put them on a salary thoughts on that issue sure so employment law is highly state specific you have federal law that has some pretty basic guidelines issued by the department of labor and there is a federal minimum salary that an exempt worker has to have to be qualified as exempt if they don't make at least that much money they have to be an hourly employee which means they're subject to at least the federal overtime guidelines of 40 hours a week many states have minimum salaries that are significantly higher than the federal government california even for a small business today the minimum salary is 54 000 a year and every time the minimum wage goes up that minimum salary goes up with it so in addition to meeting the minimum salary they typically have to meet a test that allows them to be an exempt worker as opposed to a non-exempt worker uh there's three basic categories to uh subs to summarize and simplify it they have to either be managerial which means that they're spending at least half their time supervising two or more employees somebody who has a title of office manager but also answers phones and files papers isn't going to qualify second is a professional exemption you know doctors but not nurses lawyers but not paralegals dentists but not hygienists architects but not drafts person they can qualify and the third category is one that's a bit more esoteric it's called the administrative exemption this is a worker who exercises a high degree of administrative independent decision making not somebody who performs routine tasks for example an executive secretary to a ceo of a big company could probably qualify for the administrative exemption whereas a receptionist answering phones could not hmm no it definitely makes sense so so now we do that so let's say hypothetically i i get my business formed and i said okay it's gonna be an llc and s corp c corp whatever and then i say okay independent contractors are too tricky and especially in my state i'll just go in employees and i'm going to just go salary because then i don't have to worry about minimum wage or all those other things and i get all that set up and then i say okay all good to go finally got everything set up and then i say okay now i'm now i'm gonna and i don't know that it's ever completely finished and you should probably be checking things in as the business grows and pivots and adjusts but get all that set up and now i'm looking to say okay now i should probably think about and probably should have thought about earlier estate planning and succession planning or anything of that nature how should you start tackling that from the especially as a business owner you know co-owner founder you know owner in the business how should you start to grapple with that or set that up sure so the number one thing that most business partners fail to do is establish a written partnership agreement at the beginning of the relationship i say the word business partner if you're bringing on a business partner partner being a generic word could also apply to a shareholder of a corporation or a member of an llc and that person isn't already your spouse you need to have a marriage agreement and a divorce agreement all rolled into one because what happens if there is a falling out and you two can't get along what happens if one of you passes away do you want your partner's heirs to become your new business partner and these are questions that have to get asked that no document preparation company could ever draft because this requires extensive questions and answers with between the attorney and the client to find out what type of relationship and what type of provisions should be in that agreement are you are you getting life insurance for uh to buy out your partner's interest or is the value of the business starting out so small it's not important there's lots of questions that need to be asked such as how much money is each partner going to take out of the business and it doesn't matter that your living expenses are high the general rule is that partners are going to have equal compensation and equal percentage of the profits unless they agree otherwise the last thing you want to do is start taking more money out than you should in creating a bad partnership no definitely makes sense and i think that to give that some consideration and i would say you know considering that earlier on when you're setting up the partnership agreement as an example are you you know if you die does your spouse can be able to take over and half years or you know that may be a good thing or bad thing maybe you want this spouse and you know but on the other hand if your partner dies and your spouse takes over or they don't have you know or the partner and the spouse die and now it's their kids or their other family members how does that work do you have the ability to buy out their shares or did you just get a new partner that you have no idea who they are or what they can contribute and oftentimes if you don't think about that even in the partnership agreement and then even more so now when you pass on can you actually give it to your family can you sell it off can you do other things and if you don't start to plan those in earlier on in conception you'll get me or months or years or put in a whole lot of time and effort and then find yourself boxed in as to what you're able to do well right i mean you never know what you're going to get for your next partner unless you're very careful about how you phrase it yeah exactly so so as you know always more things that we could touch on never enough time but as we start to wrap things up i always have one question at the end of each expert episode which is we talked about a lot of different things and probably people are feeling overwhelmed they're saying oh my gosh that's a lot to do to figure out to do a business or anything of that nature and they're saying okay well i'm gonna start today and just do just do one thing if i if i have to get started and i will only do one thing today what would be the one thing to that they should start to to work on or tackle to get get started down this road number one is pick up the phone and have a consultation with an attorney most attorneys including my firm and probably yours too will will have an initial consultation of a certain duration at no cost to the client to kind of walk them through and ask the right questions and see if a further consultation or services are warranted a lot of people have the i can do it myself mentality and that's good up to a point when you actually figure out you don't know what you don't know so i tell everybody you know if you're preparing your taxes that's not a time to do it yourself and tell your cpa later what you did you should be consulting with a cpa in that early decision what's the best form of business entity for me the same way you consult a lawyer um we're all saving for our retirement you know are you going to pick your own stocks are you that smart maybe you are but you may have hit pick bitcoin at the right time or the wrong time and who knows no and i i i think that that's a good point in the sense of you know picking up the phone getting that strategy at least knowing hey if i get started here's the things i should consider here's when i should consider them here's the cost i'm going to be looking at and so you can part start to build that into a strategy and even i tell a lot of our clients hey it may not be that you're getting going today but it's better to at least talk to an attorney understand what your options are what you should be doing such that that's part of your strategy so when you do get to that point you already know that that's going to be something you need to get taken care of well as we wrap up if people want to reach out to they want to be a client they want to be a customer they want to be an employee they want to be you know your next best friend any or all of the above what's the best way to reach out to your find out more so go to our website www.smallbusinesslaw all one word dot org org learn more about our firm again we're primarily a california firm for small businesses but we also do llc incorporation formations in all 50 states awesome well that definitely sounds like a great way to check you out find out more from information get things figured out and go from there well thank you again for coming on to the podcast it's been a fun it's been a pleasure now for all of you that are listeners if you have your own journey to tell or your own expertise to share we'd love to have you on just go to inventiveguest.com and apply to be on the podcast two more things as a listener one make sure to click subscribe and your podcast players so you know when all of our awesome episodes come out and two leave us a review so new people can find out about us as well last but not least if you ever need help with your patents or trademarks or anything else just go to strategymeeting.com and sign up some or would sign up for some time to chat with us thank you again scott and wish the next leg of your journey even better than the last thanks you