Hello, I’m Mike Sullivan. Thanks for joining us again today on M.O., where we feature small business owners and entrepreneurs and then bring you hints, tips, insights, and perspectives on what it takes to be successful.
Joining us today is Deborah Sweeney, CEO of MyCorporation. MyCorporation is an advocate for the protection of personal and business assets. Deborah Sweeney has a great deal of experience in the startup and entrepreneurial industries. Now, Deborah, I know MyCorporation does a lot of incorporating in LLCs, but I know there’s a lot more to the business. Would you mind telling us a bit about it?
MyCorporation is an online legal filing service. We incorporate and form LLCs for small businesses, and our goal is to go beyond just forming the business but also to provide a package or a bundle that creates a scenario where a small business can come to us and feel like they’re getting more than just the incorporation. Where we do domain names and startup packages and relationships with QuickBooks and other business products that we have partnerships with, so we create new business bundles that enables them to choose from one of a few bundles and make kind of an easy decision about their incorporation process.
In your opinion, what’s the right point in time for an entrepreneur to create a legal business entity? Is it right when the idea comes to mind, or should it be further down the line when the idea is more solidified and ready to go to market?
Well, my perspective is that before you go into business and start selling products or services, it’s wise to incorporate or form an LLC. Really the incorporation process doesn’t have to happen when you’re coming up with your idea, because you’re not actually out there accepting money and having somebody invest in it. But that’s not necessarily the case when you’re having investors or people that are buying assets in your business or interested in investing in your business.
So with that said, when you have an investor, then you really need to incorporate and think of an LLC right from the beginning, because when you start selling ownership and trust in your business, then you need to have some sort of form or substance from what you sell, and so that’s where the incorporation or LLC has to be there from the very beginning.
But if we’re not talking about that, we’re just talking about, “I have an idea,” you would not necessarily need to incorporate until you really get yourself and your business established. You want to open a bank account and start accepting money for that business.
How does someone know if what they’re doing is just a hobby where they’re making money or if they should make it more official and form a business around it?
A lot of times when it’s just a hobby, kind of a side hobby, and then you start making money, it becomes quite obvious when you need to evolve it to a business in the sense that you start getting checks for your new product or service. When you do that, you have to take it to the bank. The bank says, “Well, is this your business?” It’s not under your specific personal name. It’s under a business name, and the bank requires that you have an account in that name. So with that, you’re going to have to incorporate because the bank requires incorporation papers in order to open an account.
So that’s sort of a practical reason. But the emotional reason is, hey, I’m giving up my other job, or I’m moving on beyond this other full-time thing and this is becoming more full-time than I had anticipated. That’s sort of the emotional position at which a lot of people identify that they’re no longer just a hobby…
Deborah, what are some of the mistakes you’ve seen business owners make when forming their corporations, and what suggestions do you have for them?
A lot of times when people form corporations they think that they need to define the type of entity from the very beginning in the sense that they need to be sure it’s an S corporation or a C corporation, or the type of entity that it is. The reality is that if you’re formed, you can make changes and adjustments along the road.
So many changes are based on your taxes and accounting, what sort of income and revenue your business is generating. So those are changes that can happen down the road. You don’t need to make all of those decisions right from the beginning. A lot of times entities form as an S corporation, and then over time they no longer qualify as an S corporation, and so they need to begin to re-distinguish themselves as a C corporation and withdraw their S corporation election.
Those are changes that can be made, but I find that people get so worried about making their tax decision or making their incorporation strategy so perfect from the beginning that they don’t incorporate at all, and that’s not the solution. Protecting your personal assets and saving on taxes are critically important from the beginning, so it’s important to incorporate, talk to your accountant for the best strategy as it stands today, and then know that you can evolve that.
You can even file a conversion from a corporation to an LLC. You can withdraw, as I mentioned, your S corporation status. There are lots of variables that you can add in or make changes to based on your tax situation or your economic situation as it changes throughout your business life cycle.
So, basically, it is don’t get too hung up in the details. Start something, and you can always change it down the line.
Right. I don’t want to sound whimsical, like, “Just incorporate!” Right? It’s important to make sure that from a legal standpoint you’re protecting your personal assets, you’re differentiating your personal from your business, and then from an investment standpoint that you have a business structure that’s in place that you can sell ownership if necessary or to investors. You want to have that in place. You want to look legitimate. Sometimes people kind of get mired in the details and they just never do it. So I think it’s important for people to…
What are the benefits of, say, an LLC versus a corporation?
Usually, people look at an LLC as being a simpler form of structure. When businesses are really new to being in business, they find that the maintenance of a corporation can often be significantly more time consuming. So you have to have your minutes and your bylaws and your operating agreement and all that stuff in place with your corporation. With an LLC, you really don’t have to have as many of those corporate formalities. You don’t have to have an annual meeting. You don’t have to give notice of your meeting.
So all of those little things that often come with the corporation, the maintenance of a corporation, you can be kind of not worried about. But with that said, both you still have to have your annual filings every year and of course taxes. But the biggest difference is that corporations are taxed at the corporate level and are taxed again at the individual shareholder level, whereas LLCs the taxes pass through as if it were a partnership, and so in that instance it’s just really a tax analysis.
Most people talk to their CPAs when they’re in business for themselves, and they figure out kind of what’s the best structure for their business. Should they be taking it to the corporate level and then leaving the rest of the profits in the business? Or do they want the income and the revenue of the business to pass straight through onto their personal tax return?
One thing that’s interesting, it used to be very clear that the corporate tax rate was higher than the individual tax rate. That’s no longer the case in many instances. So now it’s not so crystal clear that someone doesn’t want to be taxed as a corporation, because sometimes the corporate rate is actually more beneficial than being taxed at your individual rate.
And you’re quite an entrepreneur yourself, going from general manager of MyCorporation to buying it from Intuit. Would you mind telling that story?
Sure; I was General Counsel for MyCorporation when we were acquired by Intuit back in 2005. I ran the business division under Intuit for five years, and working in a small environment under a huge corporate umbrella was just a really big challenge. To me, I would say it was the best thing and the worst thing. It was the biggest learning experience I could ever have as an entrepreneur, because it’s sort of where you ultimately end up if you’re an entrepreneur in some ways.
But then realizing it was the most difficult way to run a business. Our cost overhead and structure were really not commensurate with what our business revenue was. We were making just under $10 million and Intuit was making almost $4 billion. So we were such a small piece in that pie, so we got very little attention and making changes was very difficult. They recognized it and I recognized it sort of at the same time. We came together, and we were discussing what next with the company, where would this go. I kind of thought this was a great opportunity for me to present an offer to purchase the business from Intuit.
They are wonderful in the sense that they wanted the softest landing for the employees and the shareholders and of course our customers. This was sort of a nice transition. Rather than … businesses come out that wasn’t familiar or closing it or doing something that might not have been beneficial to anyone, they realized that this was probably a good solution.
So I took all of the team, and we are still in a phenomenal partnership with Intuit, and we right-sided, I guess I like to call it, our infrastructure where our costs are not more than our revenue which is awesome.
We’ve talked a bit about LLCs and corporations. What are some of the tax advantages that go along with those?
A lot of tax advantages that a corporation or LLC have are self-employment taxes. So with a corporation, you actually pay only self-employment taxes on… you are paying yourself as an employee of the business. You pay yourself as an employee the kind of reasonable salary that would be paid.
For example, in my role as General Manager, I was paid $50,000 a year. Now as owner of the company, I could be paid $50,000 a year. I don’t have to be paid more because my profits are more. So I can take that salary and only pay employment taxes on that deferment. That’s actually a large percentage, around 13% of employment taxes. So it’s a huge savings opportunity for entities that have a corporation.
There are also of course all the business write-offs that you would have: your car, your business expenses for travel, for phones, for eating, entertainment, all those things are obvious things that people also can write off. But one of the other things that people don’t think about, which is actually an opposite part of taxes, is the audit component. Your risk of being audited is .03% when you’re a corporation or LLC, and it’s almost 2.7% when you’re a sole proprietor making that type of income. That’s a huge difference.
So because you’re sort of a small fish in a big sea when you’re a corporation, you’re making $10 million in revenue, they’re not looking at you paying attention to those details. But when you’re a sole proprietorship and making that kind of money, it is a significant red flag for the IRS. Avoiding the red flag is a good thing for many, many small businesses in…
Any final thoughts for us on incorporating or other aspects of business?
I think that forming a business, a lot of times people think about the incorporation or LLC component, but I think there are other pieces that you want to make sure that you’re attentive to besides that. I mentioned early on talking about the bundle of products that we have, that you can get your domain name and your website and all of those things. All of those things are kind of built around developing a brand for your business.
Often, if you think that your business is a bit novel in some ways, but sometimes it’s a commodity, and it’s because of your brand that you’re making it unique. So there are different benefits to setting your business apart and developing a brand or business, and I’m always really cautious to tell people that it’s important to protect their trademarks, to make sure that your trademark, that your business name, your logo or slogan are protected in their…
It seems to me that when people are incorporated they think that that is one and the same as a trademark, and it’s not. It’s kind of a bummer when one day, you’re spending a whole lot of money marketing your business, building a brand for yourself, and getting your name out there and pitching your product or service, and then all of a sudden, a) you’re going to find out someone else has that name the same as you, or b) someone comes in the market and enters with a name that’s really very similar.
Unless you protected your trademark and made sure that that mark is yours on a nationwide level, and as we all know, the world is getting smaller and smaller. With the Internet, you could search, and if there’s one company out there and then Company B pops up and it’s a very similar name, which really stinks for that Company A that started out and spent a lot of money packaging and building the brand and that kind of thing, Company B can come along and… site with a similar name and similar products can really infringe on it. It’s a real risk for businesses. So I always advise that, separate and apart from looking at the corporation or LLC which is critically important, and especially when it comes to trademarks and logo, you want to make sure that if you infringe or someone else infringes, that you have that corporate veil protecting you from all of your personal stuff, either way. But besides that making sure that your logos and trademarks are protected actually.