Cost-Saving Strategies

For many small businesses and entrepreneurs, the idea of consulting a lawyer conjures up frightening visions of skyrocketing legal bills. While there’s no denying that lawyers are expensive, the good news is there are more ways than ever to keep a lid on costs.

Start by learning about the various ways lawyers bill their time:

• Hourly or per diem rate. Most attorneys bill by the hour. If travel is involved, they may bill by the day.
• Flat fee. Some attorneys suggest a flat fee for certain routine matters, such as reviewing a contract or closing a loan.
• Monthly retainer. If you anticipate a lot of routine questions, one option is a monthly fee that entitles you to all the routine legal advice you need.
• Contingent fee. For lawsuits or other complex matters, lawyers often work on a contingency basis. This means that if they succeed, they receive a percentage of the proceeds — usually between 25 percent and 40 percent. If they fail, they receive only out-of-pocket expenses.
• Value billing. Some law firms bill at a higher rate on business matters if the attorneys obtain a favorable result, such as negotiating a contract that saves the client thousands of dollars. Try to avoid lawyers who use this method, which is also sometimes called “partial contingency.”

If you think one method will work better for you than another, don’t hesitate to bring it up with the attorney; many will offer flexible arrangements to meet your needs. When you hire an attorney, draw up an agreement (called an “engagement letter”) detailing the billing method.

If more than one attorney works on your file, make sure you specify the hourly rate for each individual so you aren’t charged $200 an hour for legal work done by an associate who only charges $75.

This agreement should also specify what expenses you’re expected to reimburse. Some attorneys expect to be reimbursed for meals, secretarial overtime, postage and photocopies, which many people consider the costs of doing business. If an unexpected charge comes up, will your attorney call you for authorization?

Agree to reimburse only reasonable and necessary out-of-pocket expenses.

No matter what type of billing method your attorney uses, here are some steps you can take to control legal costs:

1. Have the attorney estimate the cost of each matter in writing, so you can decide whether it’s worth pursuing. If the bill comes in over the estimate, ask why. Some attorneys also offer “caps,” guaranteeing in writing the maximum cost of a particular service. This helps you budget and gives you more certainty than just getting an estimate.
2. Learn what increments of time the firm uses to calculate its bill. Attorneys keep track of their time in increments as short as six minutes or as long as half an hour. Will a five-minute phone call cost you $50?
3. Request monthly, itemized bills. Some lawyers wait until a bill gets large before sending an invoice. Ask for monthly invoices instead, and review them. The most obvious red flag is excessive fees; this means too many people–or the wrong people–are working on your file. It’s also possible you may be mistakenly billed for work done for another client, so review your invoices carefully.
4. See if you can negotiate prompt-payment discounts. Request that your bill be discounted if you pay within 30 days of your invoice date. A 5-percent discount on legal fees can add thousands of dollars to your yearly bottom line.
5. Be prepared. Before you meet with or call your lawyer, have the necessary documents with you and know exactly what you want to discuss. Fax needed documents ahead of time so your attorney doesn’t have to read them during the conference and can instead get right down to business. And refrain from calling your attorney 100 times a day.
6. Meet with your lawyer regularly. At first glance, this may not seem like a good way to keep costs down, but you’ll be amazed at how much it reduces the endless rounds of phone tag that plague busy entrepreneurs and attorneys. More important, a monthly five- or 10-minute meeting (even by phone) can save you substantial sums by nipping small legal problems in the bud before they have a chance to grow.

When the dreaded tax season comes around, whether you operate an online business or not, you’ll be feeling pretty much the same way every business person does. Here are some facts about your taxes that might help ease your fears and your woes.

Do you operate your business from your home? The majority of online entrepreneurs do, and that entitles you to take some significant tax deductions if you meet certain IRS conditions. For one, your home office must be used “exclusively” and “regularly” for business use. That means the primary purpose of that space is for business, such as contacting clients or managing your books.

It also means that the space is not used for family or personal activities, unless you want to start dividing up that time by saying 75 percent of the time the home office is used for business and 25 percent of the time it’s used for playing games or doing homework.

The second IRS stipulation is fairly easy for most online business owners to meet: Your home office must be your “principal place of business.” Essentially, that phrase just means that the business activities you conduct in your home office can’t be conducted anywhere else, such as in a rented office space.

If you meet both of those requirements, then you can deduct many of the costs associated with your home, including property taxes, utility bills, insurance costs, mortgage or rent payments, even the cost maintaining your property. Of course, if your mortgage payment is $800 per month, you can’t deduct that entire amount if you only use a small portion of your home for business.

You need to determine what percentage of your home is used as a home office, then you’ll use that figure to calculate the deductions you can take. For example, if your home office represents 10 percent of your home’s square footage, and your mortgage payment is $800 per month, then you could deduct $80 every month, which would be $960 for the year. The same applies to all the other expenses related to your home.

You do need to be aware of one thing when calculating these deductions: You can’t use them to demonstrate a net loss during that tax year. For example, if your online business generated $50,000 in revenue in 2004, but you could claim $60,000 worth of home business deductions that year, then you can’t claim a net loss of $10,000. Instead, you could only report zero net gain. However, you can carry that remaining $10,000 onto next year’s taxes to help you reduce your tax burden.

To calculate your home office deductions, you’ll need to complete Form 8829 and report that total amount on Schedule C. All of these forms are available online at the IRS’s website. Remember that you can also deduct other business expenses, such as the cost of owning your domain name, paying your web-hosting company, designing your website and accessing the internet. (These fees will have to be pro-rated, however, if your family or you use the internet for non-business-related activities.)

Another tax-related issue that might be bothering you is what to do with any and all of the people who did work for your online business, such as the web-design company that helped you establish a presence on the internet, the copywriters who created press releases and marketing letters to help you gain new business and publicity, and the person who answers your customer calls or responds to customer e-mails.

By law, you have to report how much you paid these individuals during the tax year, but you also have to know how to report that information and which forms to send to those individuals.

You have two choices: They could be independent contractors or employees. There is a big difference between them. With independent contractors, you aren’t responsible for paying Social Security, Medicare or unemployment taxes, while with an employee you have to cover all those expenses. For that reason, most online business owners choose to work with independent contractors.

While the IRS has established a set of 20 questions that can help you determine whether an individual doing work for you is an employee or an independent contractor, one of the easiest ways to make that determination is to ask yourself one question: Do I control “what will be done and how it will be done”? If you answered yes, then the individual is an employee, and you will need to send him a W-2 regardless of how long he worked for you and how much money he earned.

If you answered no, then the individual is classified as an independent contractor by the IRS. With an independent contractor, you still can control “what will be done,” but you can’t control “how it will be done.” You would send them a Form-1099 if they did more than $600 worth of work for you during the year.

Because classifying the individuals who do work for your online business is important (the IRS could force you to pay the back taxes and even a penalty if you don’t classify an employee correctly), you should always have them sign a contract stating that they are doing work for you as an independent contractor. That way, both parties know what their specific relationship is going to be from the beginning, and you don’t have to sort everything out during tax time.

It’s commonly said that business valuation is more art than science. If this is true, then the practice of valuing a start-up business is squarely in the domain of the artist.

Nevertheless, entrepreneurs need to put a value on their start-ups in order to raise money, and investors need to put a value on their investments to generate liquidity. Since neither entrepreneurs nor investors are known for right-brain artistic thinking, this article aims to provide some tips for left-brain thinkers to make sense of start-up valuation.

1. You are what the market says you are. If investors are telling you that your start-up is worth $1 million, then that’s what it’s worth. You might think it’s worth more. You might even know it’s worth more because your company may have more than $1 million is liquid assets, or more than $1 million in receivables, or more than $1 million in sweat equity. But if you’re unable to raise money for your start-up with a valuation above $1 million, then you’ll have to accept the market valuation.
2. But you can also tell the market what you’re worth. Although this might seem to contradict the point made above, it’s possible to tell the market how to value your company. After all, if investors think your start-up is worth $1 million, it’s usually because of something you’ve told them. By definition, start-ups don’t have a history of financial performance on which to base a valuation. Therefore, it’s up to the entrepreneur to develop a process for valuing the company based on comparables and financial projections.
   • Comparables: Find out how much similar companies in your industry and geography are worth. You can use sites such as BizBuySell and BizQuestto determine how much businesses are selling for in your industry. If you have a high-tech or high-growth start-up, accountants and lawyers are among the best advisors to help you determine the market rate for comparable companies at your stage. In my experience, attorneys tend to overvalue star-tups, and accountants tend to undervalue start-ups, so you may want to talk to both before making a decision.
   • Financial forecasts: Although it’s notoriously difficult to forecast revenue at a start-up, you’ll need to do this to determine value-and eventually to defend your valuation. For example, if you’re starting a pet food store, your valuation and financial projections will likely be lower than if you’re starting a speculative biotechnology firm.
3. You’re not really worth anything until you’re profitable. If you’re not profitable, your business probably isn’t worth very much. That is, it doesn’t have as much liquidity as it would have if it were profitable. Many businesses cannot be sold, since there aren’t enough business buyers for every seller. Almost all unprofitable businesses cannot be sold for the same reason.

This makes valuation particularly challenging for a start-up. Since young businesses take time to become profitable, the trick of valuing start-ups is to focus on the future. First, determine how many years it will take to be profitable. A business with a long road to profitability will usually be worth less than one with a quick path to profitability. Next, determine how much comparable companies have been valued at when they reached profitability.

A company that could be worth $5 million at profitability will be worth some fraction of that number at the start-up stage, based on factors such as the likelihood of success, the time frame to exit and the quality of the management team.

It’s easy to get caught up in the excitement of valuing your company at the highest amount possible and forget that you’ll one day have to deliver on the expectations of investors. It’s also tempting to adapt your business model to maximize start-up valuation.

Be careful about overvaluing your start-up with faulty assumptions; it will only make your life more difficult-particularly if your investors have governance rights, such as positions on the company’s board.

Much like artists, entrepreneurs need to use creativity in valuing their start-up businesses. Traditional approaches to valuation based on book values and P/E ratios are akin to painting by numbers. If you want your start-up to be a masterpiece, you’ll need to use the right side of your brain as much as your left to determine value.