The decision to start an online business is one that opens you to an entire new and different range of opportunities and pitfalls then what is found in a regular brick and mortar business. No matter what area you decide to focus on for your online business efforts (affiliate offers, merchant retail sales, membership sites, and lead generation are just a few hot topics for many Internet Marketers today), having a solid business foundation is always critical to the long-term success of your online business. When starting off, you might be tempted to scrimp on setting up the proper foundation for a long-term business. This is a mistake, and one that far too many IMers make that ends up costing them severely in the long run. Just as you wouldn’t build your dream house on a shaky foundation, you don’t want to jeopardize the long-term success of your business with a shaky start.
Rule #1: Set up a Business Structure!
I know what you are thinking, “It is just going to be me running the show, why should I spend the time or money; I’m no big corporation.” Exactly, and that’s the problem. You are never going to grow your IM business to something big if you don’t treat it like a business. Attorney Aaron Kelly also says “You’re also going to open yourself up to legal “gotchas” that may prevent your business from ever reaching its potential. The first step in any business is having a business plan. Contrary to some people’s belief, you don’t need a 40-page document full of market analyses, competitive data research, and projected profit/loss statements for the next decade. You can do all that if you want it (and you might have to if you are seeking outside financing) but most business owners file these away and quickly forget about them once they start actually running their business, and the online business world is no different in this regard. What you do need, at a minimum, is a written statement of how your business is going to get revenue and turn a profit. Specifcally, Aaron Kelly in Arizona says Do you want to promote CPA offers to sell snow-cones to Eskimos through email opt-ins? Great, then write down a few paragraphs about who you are going to target, how you are going to get paid, what your expenses are, and what makes your angle different then all the other snow-cone sellers out there. If you can’t write out at least a few paragraphs that generally describe what your gameplan is that an outsider could read and basically understand, then maybe your business model isn’t as well thought-out as it could be. As Peter Lynch, the most successful mutual fund investor of all time once said, “I never invest in any idea I that I can’t illustrate with a crayon.” Make sure your business plan can at least pass the crayon test.
Choosing a Business Structure: From lemonade stands to multi-national conglomerates
OK, so now you’ve got a gameplan, you have an idea of how you’re going to make money online, so you’re ready for the next critical step, setting up the legal structure of your business. In the U.S. there are basically 5 different main types of businesses; Sole Proprietorships, Limited Liability Companies (L.L.C.), C-Corporations, Sub-Chapter S Corporations, and Partnerships. Each of these has their own pros and cons. The following is a brief description of each one and the relative advantages and disadvantages. By all means, consult with a professional or your own Secretary of State, before using a business entity structure that might not be ideal for your particular situation if you still aren’t sure.
Sole Proprietorships
This is what every business is if they don’t take any steps to set up any kind of business structure.. The 6-year old down the street with the lemonade stand? Yep, sole proprietorship. That kid next door mowing the lawn; sole proprietorship. A sole proprietorship is the default structure in most states if the owner does not take the proper steps to set up the single owner. Sole proprietorships lack many of the protections and the advantages of a formal business entity. Sole proprietorship doesn’t necessarily mean small, but you aren’t going to run into a lot of large successful companies that are still sole proprietorships, and for a very good reason. The most dramatic advantage all of these other business forms give you over a sole proprietorship is that the business is now its own legal entity apart from you the owner. It can borrow money, buy or sell assets, sue or be sued, go bankrupt, etc; all independently of you and your responsibility. If your sole proprietorship lemonade stand poisons all your neighbors, it is the same as if you personally had poisoned them; there is no difference between “You” -the person and “Lemonade Stand” -the business. When your sole proprietorship gets sued and goes bankrupt, so do you! Compare that with a business entity, which provides a “separation” between your personal assets (car, house, bank accounts, etc) and the business, and you will quickly see that everything you have and own personally, even if it didn’t come from your sole proprietorship business, is at risk if you don’t form a protective business entity.
If you are serious about making money and protecting what’s yours, you need a better business setup than a sole proprietorship. Don’t make the mistake of thinking you should wait till the business is making good money before setting it up. Doing things right at the beginning will save you a lot of trouble, and it is the #1 downfall of IMers that get into legal trouble from their online activities.
Limited Liability Companies (LLCs)
LLC’s are a strong upgrade from a sole proprietorship, mainly due to the “separation” they create between the business assets and liabilities and personal assets and responsibilities described earlier. They are a state entity, which means they are subject to the rules of whichever state they are set up in, but all of them basically work the same. A New York LLC is not too different from a Texas LLC in terms of the advantages it provides, even though the setup varies a little between states. The filing fees usually aren’t more than a couple hundred dollars (varies by state) and can be set up either by yourself or by an attorney. An LLC is an upgrade for your business image too; it looks a lot more professional to vendors if you are Superstar Media LLC instead of John A. Smith. This factor alone can add value to your business, with no additional work or revenue required. Generally speaking, an LLC has a little bit more paperwork to file (it varies by state) but they are not much more complicated to do your taxes on, and the money they make is treated as income for the owner just as it would if you were still a sole proprietorship. Also an LLC may have owners that are U.S. and non-U.S. based.
Partnerships
The treatment of a partnership varies by state. Overall, a partnership is typically going to provide more protection than a sole proprietorship, but you need to check with your state’s rules to see what you have to do to make sure your partnership is a legal entity. In most states, a partnership has many of the same protections and advantages that an LLC or a corporation would have, but you can only use a partnership if you have at least 2 or more partners. Many states distinguish between limited partnerships and general partnerships, so you want to make sure you abide by your particular state’s rules. Because of these specifics, many businesses with multiple partners elect to set up their partnership as an LLC or corporation. If you are unsure how to make sure you are protecting the individual partners from liability, consult with an attorney in your state or your local Secretary of State website. Partnerships provide a very flexible way to split up the duties, profits, and risks between different partners based on their individual goals and contributions. A partnership is of no use to you if you are a single owner of a business.
Corporations: Minding your C’s and S’s
The grand-daddy of them all, the corporation; bringing to mind images of high-rise buildings and high-powered executives in expensive suits. Think of any name brand company you know doing business all over the world, guess what, it’s a corporation. You don’t have to be big to be a corporation though; small one-man shops can be a corporation just as much as Apple or Microsoft can. Corporations are usually a bit more paperwork-intensive to set up and maintain than an LLC or a Partnership, with more yearly paperwork around tax time especially. They have a perpetual duration, meaning they can continue to operate as a business long after the original owner(s) are gone. A C-Corporation is the form that most large well-known corporations elect. They can be publicly owned, operate in any state, hire employees, enter into contracts, borrow and lend money, and basically do anything an individual can and then some.
The chief drawback to a C-Corporation, at least in the U.S., is the concept of double taxation. As a business, a corporation earns profits, and pays taxes on those profits. Whatever profit is left over is distributed then to the corporation’s owners. In the case of publicly traded corporations, those “owners” are the shareholders that own the company’s stock. When these shareholder owners get paid their share of the profits, then they have to again pay taxes personally on that income (usually at a lower capital gains rate). For this double taxation reason, it is often advantageous for the small business owner to elect to be a Sub-Chapter S corporation over C corporation status whenever possible. The vast majority of internet marketing companies meet the qualifications for S-corp election.
S Corporations: The Perfect Hybrid?
So named after the section of the IRS code that gives them their special status, a Sub-chapter S Corporation (S-Corp for short) has basically all of the advantages of a C-corporation, but without the double taxation issue. The advantages of a C-corporation combined with the simpler “pass-through” personal taxation of an LLC or Partnership is an attractive model for many business owners. There are some limits on the number of partners an S-Corp can have (currently 25), whether they can have any foreign owners (typically not) and some other small items that don’t usually apply to the average small business owner.
Best of all, in addition to avoiding the double taxation issue, these hybrid corporations can actually save you tax money over a regular LLC or Partnership by legally classifying your income in two ways; a regular “salary” like other business entities (on which you pay relatively high taxes) and also as a tax-advantaged ‘distribution” of business profits similar to what stock shareholders would receive (on which you pay relatively low taxes). You can legally and legitimately avoid paying the dreaded self-employment and Medicare taxes on the bulk of your income, just by setting up your corporate entity status right from the beginning. These tax advantages can become very profitable at higher levels of income for Subchapter-S corporation owners, so consult with a tax professional to determine how best to take advantage of this status.
The bottom line when deciding whether to establish your business as a legal entity is; treat your IM like a hobby, and that’s all it will ever be. Start treating IM like the business it is; select an appropriate model and business entity accordingly and you’ll be in a better position to take your business to the next level, as well as protecting yourself when you get there. While these business entities and taxation issues discussed are specific to U.S. businesses, most developed countries have similar business structures and protections that a smart online businessperson can avail himself of and use to his profitable benefit.