The reason for hiring a business attorney may not, however, be so apparent. A good business attorney will provide vital assistance in almost every aspect of your business, from basic zoning compliance and copyright and trademark advice to formal business incorporation and lawsuits and liability. First, some general rules about dealing with lawyers:

If you are being sued, it’s too late. Most small businesses put off hiring a lawyer until the sheriff is standing at the door serving them with a summons.

The time to hook up with a good business lawyer is before you are sued. Once you have been served with a summons and complaint, it’s too late–the problem has already occurred, and it’s just a question of how much you will have to pay (in court costs, attorneys’ fees, settlements and other expenses) to get the problem resolved.

America’s judicial system is a lot like a Roach Motel — it’s easy to get into court, but very difficult to get out once you’ve been “trapped.” Most lawyers agree that while nobody likes to pay attorneys’ fees for anything (heck, let’s let our hair down–nobody likes paying or dealing with lawyers, period), but the fee a lawyer will charge to keep you out of trouble is only a small fraction of the fee a lawyer will charge to get you out of trouble once it’s happened.

Originally Posted on: Florida Small Business Consulting - SuncoastGlobal.com

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Royalty Financing is appropriate for established companies that have a product or service, or emerging companies about to launch a product with high gross and net margins. Also for companies with elastic pricing–i.e., the ability to raise prices without impacting sales. Appropriate for companies that experience a quick cause and effect between marketing activity and sales increases.

Royalty financing may appeal to investors who typically do not make investments in private companies. In addition, angel investors; venture capitalists, and even state, city or regional economic-development agencies can be talked into the concept of royalty financing.

Royalty financing is inexpensive for companies with high-margin products or services. It is relatively easy to find because the technique appeals to a wide variety of investors. In addition, because royalty financing is essentially a loan, it generally does not provoke state and federal securities laws.

Many companies still in their formative stages face a difficult dilemma when looking for equity capital. Equity investors, whether they are angels or venture capitalists, often demand a big piece of the company because of all the risk they incur. The problem is compounded by the fear that, if the organization gives up 30 percent, 40 percent or even 50 percent of its equity on the first round of outside financing, nothing but a grubstake is left by the time the company goes public.

Enter royalty financing, which eliminates the dilemmas of equity financing by removing them from the picture, explains Peter Moore, founder of Rockwater Capital Management, a consulting firm in Portland, Maine, that helps companies raise capital, and a proponent of the royalty financing technique. “Instead of selling equity,” Moore says, “a company simply pledges a piece of its future sales against an advance provided by the investors.”

Here’s how Moore structured a financing transaction to help a software company turbocharge its sales. Rather than go after angel investors, Moore approached the Greater Portland Building Fund, and Coastal Enterprises Inc., quasi-public economic-development organizations charged with developing business in the state.

But instead of a loan or equity, Moore sought for his client an “advance” of $200,000 against its future sales. If the advance were made, each investor would get 3 percent of the software company’s sales for 10 years, or until they received payments totaling $600,000. This $600,000 would represent the original $200,000 investment, plus $400,000.

At the broadest level, for the investors to earn the agreed-upon $600,000 within the maximum allowable time frame, the software company would have to generate total sales of $20 million over 10 years. Although the software company had less than $1 million in sales at the time, it had over the course of its three-year life doubled sales each year.

“This was a big selling point,” Moore says. Moreover, investors were comforted by the fact that the firm’s software program, which helps companies manage hazardous-waste streams, meant there were 300,000 potential customers.

The deal was structured so that the time frame was flexible-up to 10 years to make repayment-but the return, $600,000, was not. Because of this, the return the investors could earn was variable as well and ranged from pretty good to exceptional. Specifically, if the software company repaid the advance in 10 years, the investors would earn a compound annual return of 11.6 percent on their investment.

If, however, the company’s sales mushroomed, and $600,000 was paid to the investors in five years, their compound annual return also mushroomed to 24.5 percent-a rate that even an institutional venture capitalist would have to admire.

It took Moore and his client about four months to hammer out all the details of the deal. One of the key terms he negotiated was for a delay in the commencement of royalty payments. Specifically, royalties did not accrue until 90 days after the deal closed. In addition, the actual royalty payments did not have to be paid until 60 days after the revenues were recognized.

“All in all, it was five months from the time the company received the financing until the first payment was due,” Moore says. “This gave the owners the time they needed to put the capital to work and start producing sales.”

Originally Posted on: Florida Small Business Consulting - SuncoastGlobal.com

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The supply of venture capital is limited. According to recent surveys from the National Venture Capital Association, U.S. venture capital firms annually invest between $5 billion and $10 billion. Many of these investment dollars go to companies already in the institutional venture capitalist’s portfolio.

Venture Capital may be used for everything from financing product development to expansion of a proven and profitable product or service. It is also extremely expensive. Institutional venture capitalists demand significant equity in a business. The earlier the investment stage, the more equity is required to convince an institutional venture capitalist to invest.

Venture Capital is extremely difficult to acquire. Institutional venture capitalists are choosy. Compounding the degree of difficulty is the fact that institutional venture capital is an appropriate source of funding for a limited number of companies.

First Steps

Using a shotgun approach means you send your business plan or some derivative thereof to as many venture capitalists as possible and hope that the numbers alone will strike one that has been looking for a deal such as yours.

The shotgun approach has its proponents and its critics. For instance, Gordon Baty, a partner with Cambridge, Massachusetts-based venture outfit Zero Stage Capital, says, “Of every 100 plans that we get, 90 are completely irrelevant because they do not match our investment criteria regarding the industry, stage of development, geographic location, or the amount of capital we typically invest.” Of this misguided bunch, Baty says, “our receptionist can weed out their business plans.”

Fair comment. But the shotgun approach has one significant advantage over the rifle method. The latter relies on intensive research that is based on a venture fund’s past investment patterns. What your research will fail to turn up is all the available venture capital funds that have now decided to focus their energies on restaurant deals, business service companies, publishing companies or Internet-content businesses.

In many cases, your mail will be well off the mark, and your letter will be weeded out by the receptionist-or the college intern sorting the mail. For instance, some venture capital firms might specialize in wireless communications companies from the so-called first stage on, while your company, which makes disposable medical devices, is in the development stage.

A more reasonable approach might be to take at least one pass through your institutional venture capital sources and weed out the obvious misses for your particular line of business. Even a quick screen prevents many obvious misses. Of course, such an effort, while seemingly logical, undermines one of the chief benefits of the shotgun approach to begin with. That is, it lets you reach investors who may have changed their historical investment criteria and are now looking for companies like yours.

If you can mail your letter, business plan summary and business reply card for 50 cents each, it’s worth going after the 1,200 to 1,800 traditional sources of institutional venture capital.

The rifle approach, which favors limiting your search to 15 to 20 well-researched targets, is the one favored by most attorneys, accountants, consultants and other assorted experts. Venture capitalists seem to favor it because a highly targeted approach by entrepreneurs replaces an abundance of irrelevant opportunities with a manageable number of interesting ones.

The rifle approach is simple but time consuming. Basically, you search by five variables and then rank your candidates by how well they meet these criteria. The five key search variables are:

• Searching by line of business: Most venture capitalists specialize in one or more industries. It’s the focus on a particular technology, industry or business that supposedly lets them pick winners in their formative stages. This specialization is good news because it allows you to easily identify venture capitalists who should be interested and those who probably won’t be.
• Searching by geographic preference: The very hands-on approach of institutional venture capital investing makes distance a factor. That is, to be a board member, and perhaps be intimately involved in a company’s development, a venture capitalist would find it difficult to invest in companies that are 2,000 or 3,000 miles away.
• Searching by stage of development: In the same way that venture capital investors specialize in one industry or another, they also specialize in different stages of development. That is, some companies invest in early-stage companies, while others invest in more mature companies.
• Searching by leadership status: In the world of venture capital investing there are leaders and there are followers. The leaders, also known as “lead” firms, are those that have recognized expertise and who conduct extensive due diligence on their prospective portfolio companies. The followers, known as “follow-on” investors, are more passive. They simply invest alongside the lead firms.
• Searching by deal size: Institutional venture capitalists generally place upper and lower limits on the sizes of their investments. These limits are closely related to the overall size of the fund the venture capitalist is managing. VCs with $250 million to invest typically don’t want to look at your $500,000 deal. Why? Because to invest the entire fund in $500,000 increments means the firm would have to invest in 1,000 deals.

If you follow the above methodology, your list of prospective venture capitalists should be short-perhaps 15 or fewer.

Originally Posted on: Florida Small Business Consulting - SuncoastGlobal.com

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It’s best use is for commencing initial operation to the point where outside investors can see and feel the venture, as well as understand that you took some risk getting it to that point.

Startup financing will possess two of the following three qualities: good, cheap and fast. It will never possess all three qualities. How easy it is to get depends on two things. If you have nothing, it’s difficult. If you have personal assets, the hard part is putting them at risk. But doing so is the rite of passage to both success and failure.

First Steps

If you’re starting a business, it’s your baby. This idea may leave you feeling simultaneously liberated and inspired. But it also has an edge. Specifically, if it’s your baby, it’s also your obligation to finance it beyond the “I’ve got an idea” stage.

How do you get that first dollop of funds that will either advance your idea to the point where it can attract outside capital, or perhaps jump-start you into profitable operations? Here are some options:

• Sell Assets. If you own things, you can sell them. It’s that simple. Jewelry, rugs, pool tables, boats, time-shares, second properties–the list goes on. Most people’s largest assets are their homes and cars. Homes are covered later. Here’s what you can do with automobiles.
• Borrow Against Your Home. This is the oldest trick in the book. It’s also one of the best because you can exert almost total control over the process. Here’s how it works: Say you need $50,000, your home is worth $250,000 and you owe the bank $100,000 on your mortgage. You can borrow against the equity, in this case $150,000.
• Borrow Against Insurance Policies. If you want to know where all your money goes, look at your insurance payments. Each month you probably pay for health insurance, life insurance, disability insurance, auto insurance and perhaps homeowner’s insurance. Unfortunately, you can only borrow against whole life policies, but most have some cash value after three years.
• Friends and Family. Friends and family present a formidable source of capital. Your typical friend or family investor is male, has been successful in his own business and wants to invest because he wishes someone had done it for him, according to Kirk Neiswander, senior vice president of Enterprise Development Inc., a nonprofict subsidiary of Case Western Reserve University’s Weatherhead School of Management in Cleveland. But, take the following steps to protect everyone from each other:
  • Get an agreement in writing. This will eliminate all conversations that start with, “You never said that.”
  • Emphasize debt (loans) rather than equity (ownership). You don’t want friends and family in your company forever. Before you know it, they start telling you how to run the place, and long-buried emotions emerge. Make it a loan, and pay it back as fast as you can.
  • Put some cash flow on their investment. If Dad says, “Here’s $50,000–try not to lose it, and pay it back as soon as you can,” that’s great. But consider paying some nominal interest at regular intervals so that you and he have a reality check. And it’s better to pay this quarterly rather than monthly. This way, when things are teetering, your lender won’t immediately know it.
• Borrow Against Your Investments. If you’re starting your business part time while keeping your full-time job, a potentially stable investment is borrowing against your employer’s 401(k) retirement plan. It’s common for such plans to let you borrow a percentage of your money that doesn’t exceed $50,000.
• Credit Cards. They’re not terribly creative. But credit cards are quick and easy. In a perverse way, they are also cheap. That is, a minimum payment of $50 per month can hold down a whole lot of debt. Of course, if you only make the minimum payment, your balance continues to grow, and if the business fails, you have to pay the piper. But if things go well and the business pays off the balances without missing a beat, then you look back at your early credit card financing with a nostalgic fondness, and perhaps a twinge of longing for simpler days.

Originally Posted on: Florida Small Business Consulting - SuncoastGlobal.com

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Eventually, you’ll find you just can’t continue to oversee operations and sales and accounting and fulfillment and marketing–and hope to continue to grow your business.

When you reach this point, it’s time to think about bringing other high-level managers on board to help you out. You need to build a senior team that’s able to manage all the critical areas of your business to take it to the next level.

Building your team demands matching jobs to people’s strengths. That means giving people responsibilities according to skill level, not based on how close a friend they are, or how closely related they are to you, or whether you just like their sunny personality.

That includes you as well–don’t give yourself an impressive title and job unless you’re right for the job. The fact is, many smart entrepreneurs hire their own boss when they realize their skills lie elsewhere in the company.

When it comes time to hire an executive team, you’ll need to find people to fill the following roles:

• Chief Executive Officer (CEO). The fact of the matter is, the CEO is the boss of everyone and is responsible for everything. They determine the company’s strategy. They hire and build the senior team. They make the final call on how resources (read: money) get divvied up, and they’re the one whose face appears on the cover of BusinessWeek.

  The CEO’s skills must include strategic thinking, the ability to rise above the daily details and decide where the industry and business are headed. They must then be able to decide the company’s best route for navigating the future market conditions. They have to be able to make good bets.

  The CEO’s key skill, however, is in hiring and firing. The right management team can cover a CEO’s shortcomings. A CEO may be able to set strategy, predict the future and control the budget, but if they don’t hire the right team, they have to master it all themselves. So they need to be able to identify and hire the best, fire the ones who don’t work out, and run the show in between.

  You know you need a professional CEO when you’re mired in the details for way too long and can’t pull yourself out. CEOs think about where the organization is going, the people and processes needed to get there, and how they’ll work in the current market. If you like details rather than strategy, either shift your thinking or hire a CEO to do the job for you.

• Chief Operating Officer (COO). A COO handles a company’s complex operational details. Think about UPS moving three billion packages in the two weeks before Christmas: The company’s COO insures the business can deliver day after day.

  He figures out just what needs to be measured so he can tell if things are going well. Then his team creates the systems to track the measurements and takes action when the company isn’t delivering.

  In a one-location retail business, the store manager is effectively the COO. When you expand to multiple locations or when ensuring smooth operations becomes a big part of your business, it’s time to hire someone who revels in measurements, operations and details.

• President. No one knows just what a president does. I’ve asked dozens of executives, and everyone’s answer is different. Some say a president oversees staff functions–human resources, finance and strategy–while the COO oversees daily operations. Others proclaim that the president is a synonym for COO, especially in smaller companies.
• Chief Financial Officer (CFO). Plain and simple, your CFO handles the money. They create budgets and financing strategies. They figure out if it’s better for your business to lease or buy. Then they build the control systems that monitor your company’s financial health. The CFO is the “bad guy” who won’t let you buy that really cool videoconferencing equipment and makes you pay down a commercial loan instead.
• Chief Marketing Officer (CMO). Recently, companies have been bringing in a marketing expert at the C-level rather than as just a vice president. The reason is simple: Many current business battles are battles of marketing, so corporate strategy often hinges on marketing strategy. The CMO owns the marketing strategy–and that often includes the sales strategy–and oversees its implementation.
• Chief Technology Officer (CTO). I’m a techie from way back, so I’m pretty opinionated about CTOs: Many of them just don’t belong in the C-suite. A CTO should keep up with technology trends, integrate those trends into the company’s strategy, and make sure the company keeps current when it’s necessary. They should not be buying new toys and leading-edge technology just because it’s the latest, greatest thing out there.

Finding Your Team Members

Unfortunately, good executives don’t grow on trees (and you wouldn’t want to hire the ones that do). Since their decisions can make or break your business, you want the best. Newspapers, classified ads and internet bulletin boards are not the way to go.

Mass-market ads will attract exactly that–the mass market, people who have no other job prospects. (A skillful, former executive rarely lists themselves in the same newspaper section as used backyard grills and heavy farm machinery.)

If you have the funds available, executive search firms are a good way to go. Although they charge through the nose to find candidates, they do due diligence and present you with pre-screened candidates, so when you’re running around handling the emergency of the day, they can be a huge time-saver.

They also monitor the pool of executive talent and can likely reach candidates you couldn’t approach on your own. Search firms may specialize by industry, function, geography and level of job, so if you decide to hire one, make sure you know what you’re getting.

Networking is a time-honored way to find new hires. Let your professional and personal networks know what kind of person you’re looking for. Then get one-on-one introductions, and take the candidate to lunch to test the chemistry.

When networking, avoid specific “networking forums.” Go straight for what you want. If you want a law firm CMO, spend a weekend at the Legal Sales and Service Organization’s Raindance conference, which attracts senior marketing folk from law firms. Network, network, network–but make sure it’s targeted.

Once you’ve got a potential candidate, how will you know for sure they can do the job? Executives have great impact–on employees, on systems, on profits–so it’s worth your time to check them out thoroughly. Call each of their references, and listen between the lines (with lawsuits today, recommendations always glow).

A CFO may have embezzled from his last company, but the employer still says “They did a good job” (I swear–this is a true story). This grade inflation means you need to listen for less-than-glowing opinions. “Fred showed up and sat at his desk like a real trooper” is a sure sign that Fred enjoys taking every Wednesday off to go golfing with the boys.

Interviewing Tips

When it comes time to sit down with your potential C-suite candidate, there are a few things to know that will make your job a little easier:

• Make sure your candidate really knows the job. If your CMO-to-be doesn’t know the difference between marketing and sales or your CFO can’t tell you the difference between LIFO and FIFO, pass ‘em by.
• Interview for chemistry. Do you trust this candidate? Do you want to spend time with them? Believe me when I say, you don’t want an abrasive team member, no matter how talented they may be. One COO I know, scared to make the hard decision, reorganized his entire company around a highly talented, incredibly obnoxious executive that everyone despised. The exec’s talent got to shine–but everyone within 100 yards quietly subdued theirs.
• Talk to people from your candidate’s former company. Are the candidate’s claims of divine brilliance reflected in what their former peers and subordinates have to say about them? Find out if they got the work done and also how they contributed to the company’s culture. In a small business, cultural issues can be every bit as important as getting things done.
• Always hire really smart people. Here’s a good guideline to follow: Every new hire should increase your company’s average IQ. That means they should all be smarter than you. Get used to it.
• Look for evidence of learning ability. Will your candidate repeat mistakes they’ve made in the past? Or will they learn from those errors and adapt that knowledge to your company?
• Use “behavior description interviewing” techniques. Don’t ask about principles, knowledge or “what if” stories. Instead, ask your potential executive team member to share specific past events. Their stories will reveal their values, skills and abilities. For example, you might ask a CFO to describe a budget they set up and how they handled it when a manager exceeded their budget and asked for more.

One word of caution: Be wary of hiring friends or family members. They’ll expect you to trust them and just assume they have a high skill level. What’s worse, you may trust them and assume they have a high skill level without any evidence to the contrary until after you’ve hired them. And unless you take care to be very clear about the boundaries between friendship and work, you may find your friendship in ruins over workplace disagreements.

Making The Deal

Once you’ve found the executive you’d like to hire, you have to entice them to join your team. There are no standard rules for the best deal to offer them. Hourly workers may be thrilled to get cash, but executives aren’t so easily satisfied. They often want stock options, exorbitant pay and an annual–or even quarterly–bonus.

Since their job is to make the entire company succeed, use stock options and a bonus plan to link their income to the company’s overall performance. Stock options should be aligned with long-term performance, while bonuses and profit sharing should be based on the past year’s results.

Of course, not all executives crave stock. Ideally, you’d love someone capable who’s happy with a challenging job and modest salary. And they’re out there! Some well-qualified people care much more about family time, a fun culture, a challenging job, or being part of a world-changing effort.

The more you understand each person’s drivers, the more you can craft deals that satisfy them in ways that transcend mere dollars.

But no matter what you decide to offer, keep it simple. If your bonus formula requires a PhD in higher math to understand, it won’t motivate anyone.

Delegating to Your New Executives

Once the new members of your team are on board, it’s time for the truly hard part: trusting them. Your gut will fight you every step of the way. You’ll assume your instructions are clear and misunderstandings are their fault.

You’ll assume when you disagree that you’re right and they’re wrong. But you’ll sometimes be wrong. The key to successful executive relationships is changing what your gut tells you.

Remember how you interviewed for trust? That’s important because once you hire an executive team, you must let them take their responsibilities and run with them. That means agreeing with them about what their roles are, what deliverables they’re responsible for and on what time frame.

It’s also worth deciding in advance how you’ll handle disagreements. You hired this person assuming their judgment was better than yours. So when you disagree, if you did your job right, chances are that they’re right and you’re wrong. Discuss early on about how you’ll make the call, so you get the most benefit from constructive conflict.

Just remember: If you agree on everything, one of you is redundant.

Entrepreneurship is about going for the things that are much bigger than what you could do alone. Your job isn’t to reach the goal; it’s to build a team that will reach the goal. If you really want to reach your goals, you’ll need to bring on others to help.

Creating a good executive team means knowing what you need them to do, finding good candidates, and giving them what they need to do their jobs. If you choose well, they’ll be successful and make you successful as well.

Originally Posted on: Florida Small Business Consulting - SuncoastGlobal.com

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The plan should cover one year. For small companies, this is often the best way to think about marketing. Things change, people leave, markets evolve, customers come and go. Later on we suggest creating a section of your plan that addresses the medium-term future–two to four years down the road. But the bulk of your plan should focus on the coming year.

You should allow yourself a couple of months to write the plan, even if it’s only a few pages long. Developing the plan is the “heavy lifting” of marketing. While executing the plan has its challenges, deciding what to do and how to do it is marketing’s greatest challenge. Most marketing plans kick off with the first of the year or with the opening of your fiscal year if it’s different.

Who should see your plan? All the players in the company. Firms typically keep their marketing plans very, very private for one of two very different reasons: Either they’re too skimpy and management would be embarrassed to have them see the light of day, or they’re solid and packed with information . . . which would make them extremely valuable to the competition.

You can’t do a marketing plan without getting many people involved. No matter what your size, get feedback from all parts of your company: finance, manufacturing, personnel, supply and so on–in addition to marketing itself. This is especially important because it will take all aspects of your company to make your marketing plan work.

Your key people can provide realistic input on what’s achievable and how your goals can be reached, and they can share any insights they have on any potential, as-yet-unrealized marketing opportunities, adding another dimension to your plan. If you’re essentially a one-person management operation, you’ll have to wear all your hats at one time–but at least the meetings will be short!

What’s the relationship between your marketing plan and your business plan or vision statement? Your business plan spells out what your business is about–what you do and don’t do, and what your ultimate goals are. It encompasses more than marketing; it can include discussions of locations, staffing, financing, strategic alliances and so on. It includes “the vision thing,” the resounding words that spell out the glorious purpose of your company in stirring language.

Your business plan is the U.S. Constitution of your business: If you want to do something that’s outside the business plan, you need to either change your mind or change the plan. Your company’s business plan provides the environment in which your marketing plan must flourish. The two documents must be consistent.

A marketing plan, on the other hand, is plump with meaning. It provides you with several major benefits. Let’s review them.

• Rallying point: Your marketing plan gives your troops something to rally behind. You want them to feel confident that the captain of the vessel has the charts in order, knows how to run the ship, and has a port of destination in mind. Companies often undervalue the impact of a “marketing plan” on their own people, who want to feel part of a team engaged in an exciting and complicated joint endeavor. If you want your employees to feel committed to your company, it’s important to share with them your vision of where the company is headed in the years to come.
• Chart to success: We all know that plans are imperfect things. How can you possibly know what’s going to happen 12 months or five years from now? Isn’t putting together a marketing plan an exercise in futility . . . a waste of time better spent meeting with customers or fine-tuning production? Yes, possibly but only in the narrowest sense. If you don’t plan, you’re doomed, and an inaccurate plan is far better than no plan at all.
• Company operational instructions: Your child’s first bike and your new VCR came with a set of instructions, and your company is far more complicated to put together and run than either of them. Your marketing plan is a step-by-step guide for your company’s success. It’s more important than a vision statement.
• Captured thinking: You don’t allow your financial people to keep their numbers in their heads. Financial reports are the lifeblood of the numbers side of any business, no matter what size. It should be no different with marketing. Your written document lays out your game plan.
• Top-level reflection: In the daily hurly-burly of competitive business, it’s hard to turn your attention to the big picture, especially those parts that aren’t directly related to the daily operations. You need to take time periodically to really think about your business–whether it’s providing you and your employees with what you want, whether there aren’t some innovative wrinkles you can add, whether you’re getting all you can out of your products, your sales staff and your markets.

Ideally, after writing marketing plans for a few years, you can sit back and review a series of them, year after year, and check the progress of your company.

Of course, sometimes this is hard to make time for (there is that annoying real world to deal with), but it can provide an unparalleled objective view of what you’ve been doing with your business life over a number of years.

Originally Posted on: Florida Small Business Consulting - SuncoastGlobal.com

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1. Pay yourself enough to get by. At least during startup until you are operating in the black. The argument here is to minimize your overhead in order to decrease the amount of capital required to make your business a success. Also, by reducing your overhead, your net loss will decrease or your net profit will increase, providing the business with lean operating requirements until it is well established.
2. Pay yourself what you are worth. Build that into your business plan so you have an accurate portrayal of how much capital you will need in order to finance your business. By paying yourself what you are worth, you aren’t painting an artificial portrait of the business that will change once you reach the black–operating costs will remain the same.

So how do you know what is enough to get by and what you are worth? You have to do some planning and simple mathematics, and then budget that amount into your income and cash-flow projections so that you know how much operating capital you will require during the formative stages of your company’s development.

What happens when you reach break-even and grow beyond that point? There are many factors that go into the equation, such as legal form of operation and tax requirements. You need to balance your needs against what you feel you are worth, what you need to get by, what the business will be able to sustain, and how your income as well as the business will be taxed.

Projecting Your Salary

As we mentioned, there are two methods you can use to determine your pay during startup. The first is paying yourself enough to meet basic living requirements. Depending on your situation, that means enough income to cover your bills, food and other miscellaneous living expenses. Strike all other discretionary items from your life for a while and get used to just the bare necessities. If you are used to dining at fine restaurants seven days a week, get used to going down to the local McDonald’s maybe once or twice a week.

To begin planning your pay, you need to put together your own personal financial statement that lists all your living expenses and any credit cards with outstanding balances as well as short-term and long-term loans. This may be one of the most difficult things you’ve ever had to do because you don’t want to leave anything out. You want to make sure that your income from the business will be enough to cover your expenses.

The personal balance sheet should include a list of common items you’ll need to consider when determining your monthly living expenses. Generally, if you can pay-down any debts before going into business, you’ll not only decrease the amount of income you’ll require each month, but also improve your personal net worth, which is important when it comes to borrowing capital to fund your business.

Once you’ve listed amounts for each of the items on your monthly budget, add them all together. This is the amount you will need to pay yourself in order to meet your basic requirements. Remember when putting together your list to include all your expenses. That doesn’t mean just monthly, but quarterly, semiannual and annual expenses. You must provide yourself with complete information. After all, you will be living on this income for at least six months to a year.

The other system from which you can project your salary is basic worth. How much do you feel you are worth? That’s a very subjective question. After all, what you feel you are worth may not be what your value is on the market. Of course, many people go into business for themselves because they want to achieve a degree of financial security for themselves and their families. Naturally, you’re going to assume that you will pay yourself a basic minimum of what your current market value is plus a little more. And that is exactly how you will set up the equation to determine what your monthly draw will be from the business.

To determine your basic worth, start by writing down your current salary or hourly wage. That is what your market worth is at this point in time. This is what you want to make at a minimum going into the business. But market worth isn’t basic worth. There is a difference. Basic worth is your market worth plus a percentage increase based on three to four times the rate of inflation.

Why is there a percentage increase from market worth? As we mentioned, market worth is a minimum, a starting point. It doesn’t take into consideration the increased responsibilities of running a business and your value to the business as its owner. With these factors taken into consideration, your basic worth is determined using the following equation:

MW/12 x (I x 4) = BW

In this equation, market worth (MW) is your total annual pay minus any bonuses or overtime. Divide the annual market worth by 12 to get a monthly amount. Then multiply this by the inflation percentage (I) multiplied by 4.

For instance, suppose you are making $15 per hour at your current job. At $15 per hour, your annual pay would be $31,200. Your annual pay of $31,200 would then be divided by 12, resulting in a monthly income of $2,600. At the time you are determining your basic worth, the rate of inflation is four percent. Multiply four by four, and the percentage which you will add to your current monthly income is 16 percent. Your basic worth would be $36,192 annually.

Of course, these are just recommended models to use when determining what you will pay yourself during the period of startup to break even. You can use any type of system you wish. The idea is to provide you with a realistic figure that’s fair and equitable.

Break-Even and Beyond

Determining your salary during the planning stages of startup is important because you need to include your income in the financial statements you will produce in order to obtain financing for your business. Even if you are financing the venture yourself, you need to have this information in front of you; otherwise, your overhead won’t be practical and any income, break-even and cash-flow projections you will perform will be inaccurate.

Any bank or investor looking through your plan will check your financials very carefully. They’re going to look at these projections to make sure you can repay the loan from the profits of the business. If they hold equity in the business, they need to determine how great a return they can expect from their investment. They’re going to check the cash-flow projection to make sure you have enough to cover your own draw and living expenses until the company is profitable, unless, of course, you have a separate income.

Keep in mind that during the first year of business, it typically takes three to six months to break even. Once you reach break-even, though, do you change your salary? If you think you can, then you will make one of the most common mistakes an entrepreneur can make.

Just because you’ve reached break-even, that doesn’t mean your company is profitable, or is even stable. If you’re paying yourself just enough to get by, raising your salary is going to increase your overhead, which will require a greater amount of revenue from the business in order for expenses and income to match. In other words, you’ve just thrown your business into the red again. If you’re paying yourself your basic worth, then you shouldn’t need to raise your salary, at least for a while.

After you’ve reached break-even, the best method to increase your pay is to tie any income above your fixed salary to the growth of the business. Therefore, if the company grows 10 percent during the first quarter after break-even, take your base salary and add a 10 percent bonus to it.

Continuing with this example, if your base salary is $3,016 per month as determined in our example of basic worth, you would multiply that number by three (the number of months in a quarter) and add 10 percent. Therefore, you have:

3,016 x 3 + 10% = $905

You would give yourself a bonus of $905.

After your first full year in business, once you’ve passed break-even, reevaluate your business to determine its annual growth and increase your salary accordingly. As an example, suppose company sales have grown 50 percent during the first year after break-even. Your current salary level is $36,192, based on the basic worth example. Multiply that salary by 150 percent and you will come up with your new annual pay, $54,288. You can retain the bonus income after the first year of break-even if you like. After all, why not compensate yourself for the increased performance of your company?

There are, of course, other factors you need to consider when determining pay. For instance, what happens when the rest of overhead, excluding owner compensation, grows faster than the rate of sales on a percentage basis? Most of these expenses are required in order to operate your business. Sure, you may be able to trim a little fat from the budget by removing any discretionary purchases, but the fact remains that if overhead grows at 12 percent, and sale grow 10 percent, it is only a matter of time before you find yourself in trouble. By increasing your base salary by 10 percent, the rate of sales growth, you are only hastening this crisis.

In order to keep your total overhead, including owner compensation, at a comfortable level in relation to income, you will have to take that rise in overhead into consideration when you determine your salary level. To do this you need to determine how much your overhead is, excluding your salary. For instance, suppose your annual overhead minus owner salary is $180,960, your salary is $36,192, and sales are $312,000. If you add during the first year after break-even, the company’s sales grow by 10 percent of sales. Now, but overhead minus owner salary grows by 12 percent to $202,675, or about 60 percent of total sales. Your raise in pay cannot exceed 70 percent, so you will be unable to give yourself a 10-percent raise unless you want to cut into your profit. Instead, you would give yourself a four-percent raise for a total of $37,600 annually.

Keeping your costs under control means checking rapid growth of your overhead costs. But no matter what you do, overhead will rise on annual basis due to inflation alone. Your objective is to try and keep it in line with the growth of sales.

A lot of people fail to realize that when you’re self-employed, the legal form under which you operate your business directly affects the way the IRS views your tax status and, therefore, will have some bearing on how you pay yourself.

The easiest way to get into business is as a sole proprietor. A sole proprietor doesn’t have any partners to worry about, nor a corporate identity to hide behind. As a sole proprietor, the buck stops at your desk and nobody else’s. If you get tagged with a lawsuit, you face the liability. It’s as simple as that.

On the other side of the coin, if your company does well, you reap the profits. Under a sole proprietorship, profits from the business and your personal income are treated the same by the IRS. There is no distinction.

After deducting all your overhead expenses on Schedule C of Form 1040, the resulting profit is your income and you are taxed on that portion, including a tax for social security under the Federal Insurance Contributions Act.

A partnership is a totally different vehicle from the sole proprietorship in terms of operations, but from the point of view of the IRS they are practically the same. Any profit generated through a partnership is treated as personal income. Instead of completing Schedule C of Form 1040, however, partnerships must file Form 1065, U.S. Partnership Return of Income.

If your business is organized as a corporation, you will get paid a salary like other employees. Any profit the business makes will accrue to the corporation, not to you personally. At the end of the year, you must file a corporate income tax return.

Corporate tax return may be prepared on a calendar- or fiscal- year basis. If the tax liability of the business is calculated on a calendar year, the tax return must be filed with the IRS no later than March 15 each year.

Reporting income on a fiscal-year cycle is more convenient for most businesses because they can end their tax year in any month they choose. Pursuant to the 1986 Tax Reform Act, a corporation whose income is primarily derived from the personal services of its shareholders must be a calendar year end for tax purposes. In addition, most Sub-chapter S corporations are required to use calendar year ends.

The salary you receive from the corporation is, of course, reported as your own personal income on Form 1040. As the CEO of a corporation, you’ll be able to plan your salary with an eye toward tax rates. You may be able to set up a staggered fiscal year, differing from the calendar year by which individuals are typically taxed.

How can you achieve this? Pay salaries that will absorb whatever profits there are in the company. There is a limit to how much of this you can do, and in most states you have to document the process with appropriate resolutions and directors’ meetings. But for most small companies not making a tremendous amount of money, it makes sense to pay income out of the corporation in the form of salary.

There is a danger to this strategy, especially when it comes to awarding big bonuses to yourself. If you’re the owner of a small, privately owned C-corporation, the IRS will look closely at returns to determine if there is “excessive compensation” to lower the tax liability of the company. If the IRS determined the bonus, in addition to your regular salary, is too large, they’ll disallow the deduction of the bonus as an expense to the corporation. In addition to the loss of the deduction, increasing the amount of tax to be paid, the IRS will also charge you interest and, more than likely, penalty fees.

No matter which legal form you choose, it’s vital that you discuss this decision with your tax accountant or attorney to make sure you’re operating legally and getting the best deal on your taxes.

Originally Posted on: Florida Small Business Consulting - SuncoastGlobal.com

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