LLC vs S-Corp vs C-Corp

So you are ready to incorporate your new biz? Great.

You’ve probably read a million blog posts, Googled “LLC vs S-Corp” or “S-Corp vs C-Corp” a dozen times, asked your business owner friends, and maybe even consulted a CPA.  Great.

I this post I’m going to share with you a lesson I learned regarding business entities that created an unexpected tax liability.

THE CONTENT IN THIS POST IS MY OPINION BASED ON MY EXPERIENCES AND SHOULD NOT BE TAKEN AS FINANCIAL ADVICE. CONSULT YOUR CPA OR A CERTIFIED TAX PLANNING PROFESSION AND YOUR LAWYER.

In my opinion, the number one thing you need to be planning for with your business entity is what happens if it is successful.  You might be thinking “well duh.”

Tax planning is easy when you don’t make any money.

But what happens when a company makes a lot of money?  It’s a pretty easy question to answer, there are only 3 options:

  1. The owners take money out of the company and do whatever they want with it personally, like buy Lamborghinis, bigger houses or vacations.
  2. The owners leave money in the business and use the money to grow the business.
  3. Some combination of #1 and #2.

Let’s look at a scenario #2 because that is probably the most likely scenario for a first year … I’m using Oregon tax percentages so the totals might seem high if you are in a different state that has lower income taxes.

Let’s say you start a company and have a good first year.  Your business grows, you make money.  You pay yourself a reasonable salary as an employee (something you should be doing regardless of the entity) and pay your employees and expenses. At the end of the year you have an extra $100K in the bank. Most people would consider this a good first year.

Now what are you going to do with that extra $100K?

If you are like most people you say “I’m going to keep it in the company for operation and expansion”.

Here’s the snag. If you are using a pass-through entity such as a LLC or S-Corp that money you are leaving in the company (retained earnings) is personally taxable to you in proportion to your ownership of the corporation.

Said another way, if the company has a profit of $100K and you decide to leave the money in the corporation for next year’s growth, you’re going to be personally paying taxes on your share of the $100k.

Here is why that is particularly nasty.  #1 you are paying taxes on money you didn’t actually receive. #2 you will likely underestimate the amount of taxes to withhold.

Let’s say you paid yourself a small but reasonable salary as a business owner – $40K.  Your payroll software will calculate tax withholding as if you made $40K.  But when you file your business return for your LLC or S-Corp, your share of the $100K gets passed thru to you personally as income.

Let’s say you are a 50% partner.  To the tax man you did not make $40K you made $90K.

So now here is what your tax situation looks like:

You made $40K as an employee and withheld the appropriate amount thru your payroll.

You have pass-through income on $50k, of which you have not actually received and of which you owe taxes on.

Now what would probably happen is you would take out an extra $20K from the company as a distribution (dividend and distribution is not the same, ask your tax advisor). So you won’t go bankrupt after all.  But that $100K you thought you had is now $60K (you’ll have to give the other 50% shareholder his share too).

It’s my opinion that if you plan to reinvest your earnings in growing your company, you might strongly consider C-Corp. 

If you plan to take as much money out of your company as possible, then LLC or S-Corp may suit you just fine.

3 Ways to Check Your Startup’s Viability

viability-testing
So you’ve got a great idea that’s going to make you millions! But will it?

The greatest risk in launching a new product is not developing the product… it’s selling the product. Every week I encounter a few “field of dreams” entrepreneurs. These are people who think “If I build it, customers will come.”

The reality is that selling is hard. It’s not sexy. Making mobile, photo-sharing apps in the cloud is sexy. Picking up the phone and getting rejected sucks. Driving all across town and coming home with no orders is a bummer. Spending $1000 per day on Google Adwords and getting nothing out of it is demoralizing.

When LaunchSide evaluates new opportunities we look for products that are going to be easy to sell. I don’t care if people think the idea is boring or that the market is too small. I want to know that there are people out there willing to pay for it and that I can reach those people quickly and affordably.

So how do you check your start-up’s viability before you build it?

Simple. You act as if.

Act as if the product is built and go sell it. Create your sales and marketing materials as if the product is ready to ship. Spend a week selling your product as if it exists.

Here’s the three ways that LaunchSide validates opportunites:

#1 Blind Advertising Tests
A blind test is a test where the subject does not know he is being tested. One thing we will do before we start building is run Google PPC or Facebook PPC ads to determine how many people might be interested in the product.

How it works: Create a Google of Facebook campaign targeting your market. If you are using Google you target by the keywords a potential customer would be searching to find your product. If you are using Facebook you target by your target markets demographics and interest.

For this test you don’t even need to build a website. You can make ads for a competitors site or even a coming soon page. The purpose here is just to find out if people are looking for your product and how much it costs to reach them

What to test: You want to test for three things here: Volume, Interest and Cost. Volume is simply how many people see the ad. Interest is how many people click the ad. Cost is how much you pay per click.

If it turns out that nobody is looking for your product that indicates it might be a hard sell. When people are not Googling to find a solution to a problem it generally means they are not aware of the problem or they may not be willing to pay for a solution.

If it turns out that nobody is clicking your ads your idea may need to be refined. Perhaps you are selling product features instead of benefits. Perhaps the features you are building into your product don’t matter to your customer.

The cost per click metric should be a reality check for you. If you are planning to sell your product for $10 and it costs $4 per click, you will need a 100% conversion rate to make any money (most products are lucky to get a 5% conversion rate in Google).

#2 Cold Calls / Letter of Intent
Ok, so maybe buying ads for a product that doesn’t exist or for your competition isn’t your style. The second way LaunchSide tests the viability of a product is to try to sell it via cold calling or through our network of contacts. This involves approaching customers with a brochure or sales material that explains what the product will be and asking them to pre-purchase the product.

This tactic is particularly useful for enterprise sales products. Are you developing a product for law firms? Great, go talk to people running law firms and find out if they agree that your product is a good idea. When they do, ask them to provide a letter of intent to purchase.

A LOI doesn’t have to be fancy or formal. It’s simply a letter printed on your customers letterhead saying that if you develop the product, they might be interested in purchasing it. It’s not binding or contractual.

Now, as you go through this process, if you find a customer that is ecstatic about your product and wants to buy it immediately you might consider getting a purchase order. A purchase order is a commitment to buy your product. Purchase orders are the most solid type of validation you can have. If you get enough purchase orders you will have no problem raising money to build your product.

#3 Direct Mail
A tech company using direct mail to advertise? Am I crazy?

We do a lot of online advertising and I can tell you from experience that online ads are no longer a top secret growth weapon. I have clients paying as high as $6 per click. Compare that to the cost of postage. Direct mail is not dead. I have customers spending $50K per month on direct mail and getting customers by the hundreds.

Direct mail is particularly useful for innovative products. Innovative products can be difficult to advertise because people do not know to look for them. However if your product serves a particular industry, its quite easy to get a mailing list of people or companies in that industry.

So for direct mail I will typically go buy a list of 1,000 names and then send out postcards or sales letters that direct users to a test website to learn more. You want to use a brand-new domain name that isn’t being used elsewhere. Then you simply track how many people come from the mail piece to your website. If you send 1,000 mail pieces and get 100 people to visit your website, that’s validates that your product and also provides you with a possible way to get customers (by simply mailing more people).

Want Professional Help?

At LaunchSide we created a service called ViabilityCheck to help entrepreneurs determine the viability of their product idea.
Check it out at http://www.viabilitycheck.com/

Tech Trends I’ve Noticed As A 16 Year Old

Being in high school, I always find it really interesting to find the latest social networks and apps that my peers are using. With the introduction of peer pressure, the presence of the network effect among teenagers seems to be noticeably exaggerated. It is easy to spot trends in how students use popular social networks and games. Some trends last longer than others, and some have a greater impact than others.

I’ve found this all to be quite interesting, and thought you might as well. I am currently a sophomore in high school (10th grade) and the furthest back I can remember these trends being present is 5th grade, in 2007/08.

5th Grade – 07/08
There were very few trends that I remember during this year. One major one, however, is YouTube. Everyone in my class had a YouTube account. Most people didn’t regularly upload videos, but people would subscribe to and comment on the videos of others.

One cool tidbit that I remember: There was exactly one kid at my school who had an iPhone. Everyone thought it was pretty cool, but hardly anyone had cell phones. I was carrying around my Palm Z22 like a total nerd.

6th Grade – 08/09
This was an interesting year. Cell phones were just becoming commonplace among students at my school, and I was one of about three kids in the school with an iPhone. (3G) Towards the end of the year, the iPod Touch became a fairly popular device, but nothing like it is today.

Google Talk became very popular during this time. It was definitely the most popular website, but the fact that the school set everyone up with Gmail accounts probably helped.

Email and chain mail was also somewhat popular. I remember having conversations with other students over email, but having my inbox littered with chain mail every day.

7th Grade – 09/10
Facebook finally became very popular during this time. Almost everyone had a Facebook account, and it had completely replaced Google Chat.

At the same time, the iPhone was becoming quite popular as well.

8th Grade – 10/11
Everybody has an iPhone. Seriously. For the most part, if you don’t have an iPhone you have an iPod Touch.

Also, if you were to ask me to find someone who doesn’t have a Facebook profile, I would have an extremely hard time. Everyone’s on Facebook, and everyone has an iOS Device.

9th Grade – 11/12
I remember many trends from this year. First, iOS is still insanely popular. iPod Touches seem to be less popular compared to the iPhone, and compared to their popularity in previous years. Everybody has a Facebook account, and very few people have a Twitter account.

During the winter of 2010 the iOS game Temple Run became extremely popular. It became popular extremely fast, which I think is rather interesting because it has very little social aspect compared to a game such as FarmVille. It’s popularity was rather short lived, for some reason.

10th Grade – 12/13
There have been quite a few interesting trends this year:

First, people seem to be moving away from Facebook and to Twitter and Instagram. I haven’t noticed large amounts of people deleting their Facebook profiles, but I have noticed many using Facebook less and less.

As for Instagram, it’s rare that a day will go buy when I don’t get a notification that one of my Facebook friends has joined Instagram.

Conclusion These trends have always interested me as they affect how I use technology to communicate with my friends and other students at my school. I doubt these trends will slow down anytime soon. It will be interesting to see what the future holds.

Huge Thanks to PDX Seed Fund

Today it was officially announced that LaunchSide is one of eight companies selected to be in the first class of the Portland Seed Fund.

We are very grateful to be part of the fund and we are looking forward to the mentoring and business development process. We’ve already learned much and are excited to learn more.

Portland Seed FundThe Portland Seed Fund exists to stimulate exceptional entrepreneurial growth in the Portland metro area and throughout Oregon. This unique business incubator is a partnership between private venture capital investors, the cities of Portland and Hillsboro and other key community supporters including White & Lee LLP, Perkins & Co. and the Oregon Entrepreneurs Network.

portland seed fund

Left to Right: Nathan Taggart, Chris Chong, Jason Collingwood - Co-founders of LaunchSide

portland seed fund

The 8 companies selected for the Portland Seed Fund w/ Managers Jim Huston & Angela Jackson