This “Scaling Up” podcast features Numbers Coach Mike Iverson discussing how to prepare your business financially for the future and the economic outlook for the next few years:
The Hidden Cost of Doing Nothing to Market Your Business
by Tara Lamboley, CEO of REV Demand
Oftentimes I am asked “Who is your biggest competitor?” And I always answer: “Indecision.”
It’s quite true that the biggest hurdle we at REV (and I suspect many of you) must overcome in converting a prospect to a customer is to get that prospect to decide to do something, to make a change. It’s often not the case that the prospect decides to business with another company—it’s that they don’t decide to do anything at all.
In his article “The Cost of Doing Nothing,” Michael Lippig of IDCON, Inc. asserts that:
“The cost of maintaining the status quo for professional services business owners is enormous. The status quo affects each and every one of us every hour of every day, at work and at home. We have come to accept doing nothing as a safe and acceptable alternative. We even make it the default solution.”
So why do business owners who want to grow their businesses default to doing nothing? There are many reasons we can recite, including lack of money, lack of time, lack of desire, unsure of what to do, etc. If we do nothing, it seems like a safe choice that protects our valuable time and resources.
However, there is a hidden cost, as Lippig writes: “Doing nothing is the management equivalent of a baby’s pacifier. It makes us feel safe and comfortable. But there is a cost to doing nothing. Economists and accountants frequently refer to it as ‘opportunity cost;’ what you could do yourself with your resources if you were not doing what you are doing right now.”
By doing nothing different this quarter than last quarter with your marketing, you can be sure you will cost your business the following:
- Your e-newsletter, direct mail, social media updates, prospecting emails, etc. will not go out, and so your prospects will get colder
- Your customers—past, present, and future—will not hear from you enough to make repeat, expanded, and new business a consistent reality
- You won’t build your reputation online and offline as an expert in your field that prospects must seek for solutions
- You won’t invest in that training to make yourself that much more knowledgeable in your field of expertise
- You won’t connect with strategic partners that can expand your sales capabilities
- You won’t get off the unending roller coaster of project work and cyclical sales
Make no mistake: When you decide to do nothing about marketing your business, you are still making a decision. You are deciding to stay where you are and not grow your business. You are saying you are comfortable with your current income, profitability, and lifestyle.
Of course, sometimes doing nothing may be the best decision for you at this time. If you have other life priorities that need to take precedence right now over growing your business, it makes sense to maintain the status quo.
However, if you are ready to grow your business, then you have to start doing something to push your business forward (i.e., marketing) and/or stop doing the things that hold you back (i.e., not marketing).
Need help? REV Demand offers a free, 1-hour, no-obligation assessment of your business development capabilities (including current marketing strategy and tactics as well as sales goals and processes). We’ll help you build a plan of action to grow your business. Contact us for more information.
What are the Benefits of a Diversified Revenue Stream?
by Michael Iverson, Principal of Trillium Financial
When you think about the way America’s small businesses get started, it should come as no surprise that a relative few have revenue streams that could be considered diversified. A great many startups are the result of the entrepreneurial recognition of a market need. In many instances, the market need is that of a single, sizeable customer.
For instance, I once made the acquaintance of a woman who helped manage the investments of a state pension fund. One of the challenges of her position was keeping abreast of corporate governance matters for a universe of nearly 2,000 stocks owned by the pension fund. Her team had a fiduciary duty to vote the shares in the best interests of the pensioners. Yet, keeping tabs on executive compensation plans, auditor changes and corporate acquisition proposals for 2,000 different stocks was nearly impossible, given the small staff of the pension fund. Why wasn’t there a service that could provide advisories on the stocks owned by her fund and other pension funds?
To make a long story short, she left the pension fund to become an entrepreneur and start the business that would address the very need she had identified. She started a fiduciary advisory service to track corporate governance issues of stocks held by pension funds. Her former employer became her first customer.
Starting Out
In the early years of a startup, it’s not uncommon for a business to be strongly dependent on its first customer. For some startups, it is 100 percent of first-year revenues and more than 50 percent of second-year revenues.
No matter how solid that first customer may be, it is prudent to become less dependent on the customer by diversifying the revenue stream. Keep the original customer happy by providing outstanding service, but develop new customers as quickly as you can.
Diversification of revenues provides financial stability for your company, reduces business risk and makes your business infinitely more marketable when it comes time to sell. Diversification can be number of customers, geography of customers, and product offering. One of the metaphors that I have heard over the years is a three-legged stool offers more stability then a two-legged stool.
Shoot for 15%
As a goal, try to diversify your business to the point that no single customer is responsible for more than 15 percent of revenues. Until you achieve that goal, the possible loss of your largest customer (due to reasons as varied as a change of ownership or a sudden downturn in the customer’s industry) carries significant financial risk to your business.
I have met any number of business owners who have lost a customer responsible for 30 percent or more of their revenues. The results can be devastating. Imagine having taken on debt to expand the business, only to lose a customer of that size. Some businesses can’t survive that kind of a hit; others survive, but with great difficulty and sacrifice in the way of layoffs and contract renegotiations.
As many of my clients know, it’s not easy to achieve the 15 percent target. It’s not uncommon for talented service providers to be approached by a large customer who wants more of their time, not less. I advise clients to be disciplined and politely dismiss opportunities that would make them more reliant on a large customer.
Even though the initial financial rewards may be tempting, there is an important trade-off in terms of autonomy. A business owner who hitches his wagon to a single customer often feels more like an employee than a business owner.
Is your business in need of a more diverse base of revenues? We have ideas about acquiring new revenue streams. Give Trillium a call at (404) 353-2148 or send us an email.
Numbers Coach Crafts Financial Models for Brewing Company
COMPANY
In 1993, Red Brick Brewing (RBB) started as one of the first craft brewers in Atlanta. The Red Brick team is dedicated to providing the consumer with world class Southern beers and ales. The consumer gets a consistently great-tasting beer from unique blends of hops and other ingredients. The RBB team of dedicated people are passionate about brewing the best-tasting Southern beer. (Red Brick Brewing rebranded back to their original name of Atlanta Brewing Company in 2018.)
SITUATION
In 2012, the Red Brick team was transitioning its financial management and reporting with the goal of creating a financial model that would communicate the company’s key performance indicators (KPI) and drivers of its financial results to management and investors. However, the team quickly found that it was challenging to accomplish this goal on their own.
SOLUTION: The Numbers Coach Financial Leadership Services
The Numbers Coach (“NC”) financial leadership services were an ideal fit for developing RBB’s customized financial model and metrics. NC’s,Mike Iverson, created the model and also reviewed the company’s financial results each month to help the team identify areas of concern or improvement.
RESULTS
NC effectively pulled together the required financial and non-financial data to complete a customized financial model, providing insights for the team to do product and cash flow planning. The model was developed with “what if” scenario planning capability. This allows the team to see how changes to key metrics drive the financial results of the business. The model also has the option to provide a rolling forecast for the team to get visibility on how they might finish the year given actual results to date.
According to RBB investor (and founder of North Highland Global Consulting) Dave Peterson: “Mike at the Numbers Coach jumped in and set up a customized financial model that matched Red Brick’s business and key metrics. His solid understanding of financial reporting and analysis provided our company with the right tools for financial planning. We would highly recommend the Numbers Coach financial leadership services.”
For more information on Red Brick Brewing Company/Atlanta Brewing Company, visit https://atlantabrewing.com.
To learn more about the Numbers Coach financial leadership services, click here.
“Mike jumped in and set up a customized financial model that matched our business and key metrics. His solid understanding of financial reporting and analysis provided our company with the right tool for financial planning.”
Dave Peterson, Red Brick investor & founder of North Highland Global Consulting
Cash Flow Management: Now More Important Than Ever
From “Mom&Pop” companies to major corporations, businesses today are looking at every penny flowing in and out. No one relishes turning up the heat on clients to pay invoices faster. That’s why you should implement proactive cash flow management practices—before your bills start to pile up and your lines of credit are tapped out.
Conduct a Cash Flow Analysis
Cash flow controls the extent to which a business builds or consumes available cash and credit capacity. Cash flow analysis is not simply an interesting management tool. It is necessary for the good health and future of every enterprise.
“At the end of the day, well-run businesses will use cash flow analysis as a tool to manage their destiny by preparing for future needs,” says Joe Dresnok, President of Management Horizons in Roswell, GA. “For those companies that have the wisdom to keep either cash or credit resources available beyond the resources that they currently anticipate, those firms will likely have the ‘staying power’ to withstand the machinations of this turbulent economy.”
Your business software may already have built-in features that allow you to run regular cash flow analyses. These analyses give a larger and more accurate picture than net profit or bank statements.
Use Cash Flow Forecasting
Run several different cash flows forecasts for your business: a best-case scenario, a worst-case scenario, and a middle case scenario.
“When thinking about cash flow management, a thirteen week rolling forecast is a very useful tool,” says Mike Iverson, CEO of Trillium Financial. “Today is the first week of the 13-week cycle. Use this tool to think about where you will be in three months.”
While economic turbulence does make it more difficult to predict exactly what your business will look like in three months, running these forecasts tells you if you will be able to pay bills, and help you create plans to be proactive in managing your cash flow requirements.
If you feel overwhelmed by a thirteen week period, then Iverson suggests “running a shorter one, for example an eight week cash flow forecast.”
“Cash flow projections is a valuable tool,” explains Dresnok. “It can mean the difference between success and failure – even for a growing business. In short, cash flow projection can guide the business owner to controlled, profitable growth.”
Extend Credit Carefully and Invoice ASAP
“In light of the recent slow-down in the economy, many companies are experiencing declining revenues, slower collections of outstanding accounts receivable – or even write-offs– and less access to bank financing,” says Kent Bridges, CPA, Managing Partner of Bridges & Dunn-Rankin, LLP, headquarters in Atlanta, GA. “Accordingly, businesses are having to be more proactive in their billing and collection practices including doing more to determine the credit worthiness of customers before extending them credit.”
Two of the best cash flow management techniques are (1) having policies in place on extending credit to customers and (2) having good billing practices.
Iverson suggests one tool to consider as part of your credit evaluation process is the Z-Score. It is one of several tools that you can use to assist with the dilemma of who you should or should not extend credit. The Z–Score is a mathematical calculation used to rate companies’ creditworthiness. You can find additional information about this methodology at the following resources:
• The Accounts Receivable Network (www.tarn.com)
• Credit Guru.com (www.creditguru.com)
In a cash-tight economy, fast and accurate invoicing is especially important as a good billing practice. Send your invoices as soon as possible. Don’t wait to send them out at the end of the month.
Make sure all the info on the invoice is accurate so that you don’t need to reissue a bill. One of the biggest issues for small and medium sized businesses for positive cash flow management is closing on the cash conversion cycle. The conversion is the time between when a service or product is delivered until payment is received.
Cash in Hand
Other cash flow management tools include appropriate use of debt financing and maintaining sufficient cash reserves.
“While it varies according to the business, we generally recommend having cash in operating accounts equal to at least one to two months of operating expenses, having another one to two months of operating expenses covered by accounts receivable or recurring revenue, and another one to two months of operating expenses covered by available lines of credit” suggest Bridges. “This provides the company with a minimum of three to six months of cash flow cushion in the event of a slow-down in revenue or collections. “
Remember: even fast-growing companies can have cash flow issues as they add new employees and equipment, making cash flow management important for all businesses in both good and tough economic environments.
Numbers Coach Establishes Financial Infrastructure for Start-Up
SITUATION
BodyBlocks Nutrition Systems began their business launch in 2003. The Founders were excited about their plans and the products that they would offer. The Company received seed capital from friends and family to take the business from an idea on paper to a proof-of-concept. The idea passed the feasibility study, and they were ready to raise the necessary capital to launch the business.
Body Blocks realized they needed a financial consultant who could take them from an idea to launch, and on to the next level as an emerging growth business. What did they need?
- A comprehensive financial model designed to match their business strategy
- Capital
- Basic Financial Reporting
- Administrative Infrastructure (financial, risk management, and human resource functions)
SOLUTION: Numbers Coach Financial Services
At the end of 2003, BodyBlocks hired the Numbers Coach “NC”) to help them in their financial leadership. They did not have a need for a full-time CFO, but did need the financial expertise. NC immediately designed a financial model so the company could begin the process of telling its “story” to potential investors, and raise the necessary capital to launch its products. Within a few weeks the model was complete and ready for investor meetings.
At the same time NC began establishing infrastructure for the company finance and accounting functions. A foundation was created so that costs were variable and fit the specific needs of an emerging growth company in the early stages of its evolution. NC also advised Body Blocks on how to secure the right level of business insurance to protect company assets.
NC managed and designed the human resource functions, bringing together key HR resources to develop critical documents, formal personnel files, and policies. Payroll solutions were implemented to ensure all taxes were reported in a timely manner.
Numbers Coach Advises & Establishes Financial Infrastructure for Pain Management Company Spun-Off from Parent Company
SITUATION
Pain Consultants of Atlanta, LLC (“PCA”) is one of the leading pain management medical services firms in Georgia. In 2004 a decision was made by the owners to spin off PCA from its parent company. PCA’s management team recognized the need for financial leadership during this time to help them navigate through the spin off and become a successful stand-alone company.
SOLUTION: Numbers Coach Financial Leadership Services
PCA engaged the Numbers Coach (“NC”) to provide recurring financial leadership services that would assist in the transition to an independent company. NC developed a detailed plan with specific deliverables to meet the transition deadlines.
RESULTS
PCA has successfully established several key self-sustaining business components:
- Established a billing department and acquired financing for the billing system and computer hardware necessary for successful in-house financial operations. An internal billing and collections department allows for greater control and is designed for increased reimbursements.
- Outsourced accounting functions to a bookkeeping firm, allowing the company to remain focused on their core business, instead of adding fixed operational overhead. Outsourcing also provided a scalable accounting system that PCA can use during its growth phases.
- Created and implemented a detailed transition plan to migrate PCA’s employee benefit plans from the parent company in a manner that protected the employee’s current level of benefits.
Numbers Coach Leads Online Financial Network to Merger Success
SITUATION
In 2002 Phil Binkow founded the Financial Operations Networks (“FON”). His vision has been to create the preeminent online publishing resource for back office support operations. His first product, The Accounts Payable Network, has become the “go to” online SaaS resource for financial professionals seeking information, benchmarking, best practices, tools, templates, and advice on the Accounts Payable processes.
In 2013 Binkow and his team were approached by a company that had recently purchased one of FON’s competitors and wanted to make a strategic acquisition that would make it a major player in FON’s market. A letter of intent with an offer price was provided to Binkow and his team for consideration in mid-October and after amicable negotiations FON accepted the offer.
SOLUTION: The Numbers Coach M&A Support Services
Numbers Coach (“NC”), Mike Iverson, had been providing financial leadership services to FON since its inception. For the due diligence process that FON was to embark upon, Mike served the central role in facilitating and coordinating all financial due diligence activities and processes, including the establishment of a sophisticated online data room to house the key financial and non-financial documents. The parties wanted to accelerate the due diligence process to meet an aggressive goal of closing the transaction before the end of the year which meant completing due diligence and the purchase agreement documentation in less than 60 days.
<p=>RESULTS
NC was able to efficiently and effectively pull together the required financial and non-financial information to meet the accelerated due diligence processes and deadlines. This was possible due to Mike’s comprehensive and methodical approach to measuring and reporting financial results and having well-organized structures around FON’s financial reporting systems. The highly organized financial, administrative, and human resources information were key in getting due diligence completed by early December, well in time to close before the end of the year.
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“Mike has been an integral part of our team since we founded FON. “His solid understanding of our business and its needs for financial reporting, combined with his highly ordered and disciplined approach to financial reporting and accounting structure were instrumental in our growth and the positioning of FON for a successful exit. He is such a pleasure to work with, and remains a key player on our team as we move forward.”
Philip Binkow, Co-Founder / CEO
Could Cash Flow Be the Problem?
by Collette Parker
Did you know that almost half of businesses have their best-ever year right before they file for bankruptcy? They grow right out of business, and usually it’s not because of lack of sales – it’s poor management of cash.
“They may have had their best year on paper, but when you look at cash flow and working capital’ it’s going south real fast,” says Mike Iverson, CPA, and CEO of Trillium Financial.
The old adage is true: you can’t manage what you don’t measure. And even if sales are good, if you have vendors and employees asking for money, and customers who don’t have to pay for another 45 days – it’s a perfect storm for a cash crisis.
“Take the time to do a financial business plan every year,” Iverson says. Not 30 pages, but a simple two-pager with a financial forecast and a budget for 12 months. “That will give small businesses a leg up from those businesses who don’t write this out.”
Visuals help. It’s not enough to just go through a plan in your head. The process of examining your business closely enough to work out a model and a 12 month plan helps you to understand the flow of your business, including issues of seasonality. If you plan cash flow properly you can figure out how much money you can have in hand when you go into manufacturing season, and how much you’ll make in the selling season. “You can’t just set a $12 million goal, and divide the revenue figures by 12 for the year,” says Iverson.
One financial management tool that is useful in managing cash is a 12-month trailing budget. Once January closes, look at the last 12 months (including January) and chart the revenue. Then look at December and the 12 months prior. Are the numbers higher or lower? Look at the graph. Is it flattening out? Going down? “Graphing a trailing 12 month budget is a simple visual tool,” says Iverson, “and can be used for both sales and expenses.”
“If your management team sees a graph instead of a bunch of numbers, they can understand the concept. Hopefully you’re spotting a positive trend. Either way, you can understand what your cash trends are, and then have a budget that is detailed enough to effectively plan for the year.”
When planning the budget for healthy cash flow, be mindful of how much is invested in your working capital, and keep track of three key areas:
1. Accounts Receivables – Unless you are a cash business, chances are you extend credit to your customers. If your terms are 30 days, your customers should pay you within 30 days, not longer. If you begin to see a trend where customers are waiting 45–60 days to pay, you will probably begin to see cash flow problems. Don’t be a free bank for your customers.
Look at ways to reduce the time it takes customers to pay you: ask for advances from customers, or a down payment, installment, or some level of prepaid portion of the sale. If you’re in the situation where you really need the cash now, you can work with a factoring firm for receivables, or the bank for a loan.
2. Accounts Payable – Have favorable credit terms and solid partnerships with your vendors. In this area, you want to hold on to your money as long as you can. But, if vendors offer early payment discounts and you can afford to take it, go ahead. Sometimes, even if you have to borrow the money to pay early, it might make sense to do so. If you can borrow money at eight percent and take a two percent discount for 10 days early (2% 10 net 30) you are effectively earning 36 percent over a year. (If you do that, make sure the borrowing doesn’t put you at risk for running out of cash and not being able to pay your other bills.)
3. Inventory – Manage your inventory so that it doesn’t sit in a warehouse for too long. Once you’ve paid for the inventory, it should be sold and generate profit for you. Adjust your inventory for the seasonality of your industry so you’re never caught with too much.
An example of good management of these three factors would be to extend 30 day terms to customers, purchase inventory and turn it around in 15 days; and pay vendors in 30 days.
Financial planning doesn’t have to be complicated to be effective. Measuring the past 12 months of working capital performance, income statement performance, sales growth and profit, will give you a really good picture of your business and let you prepare for future sustainable growth.
The Sale of the Small Business
by Glenn Lyon, MacGregor Lyon, LLC
Thousands of small businesses change hands every year, but often not enough money is left in the hands of the seller. As such, MacGregor Lyon would like to share some advice about preparing your business for sale.
- Have an exit plan. Most entrepreneurs have start-up plans and growth plans, but too many fail to prepare for the time when they want to sell the business or reduce their day-to-day involvement.
- Know the market value of your business. Know the value in the world marketplace. Simple formulas are often misleading and inaccurate measures of the value of a private business.
- Explore ways to increase value. A business could be made more attractive to prospective buyers if changes are made in the organization, key personnel, or marketing strategies.
- Understand when the market is ready. Be ready when buyers are active, money is plentiful, and interest rates are low.
- Don’t assume the best buyer is local.
- Document the growth potential of your business.
- Consider which perks you’ll miss after selling your business. Usually the transaction can be structured to retain those executive perks which you enjoy while meeting the buyer’s needs.
In addition to implementing these tips, be sure to work with a competent business attorney and tax professional. This is not a time to skimp on professional help.
Phased Approach Makes Marketing Planning Easy AND Effective
by Bernadette Peters, Natural Marketing Services, LLC
It’s the new year again. We’ve all been working on budgets, evaluating our financial strength and setting goals for the new year. One of the biggest challenges for any business owner or manager is creating a marketing plan. There’s a misnomer out there that the plan requires several months of work and the final result is a large tabbed notebook of strategies and initiatives. But that’s not necessary to create a plan that you can implement in 2010.
As a marketing services provider and consulting firm, we have worked with a lot of small businesses. They all need a marketing plan, but didn’t necessarily have the budget or time to go through the full marketing planning process. So we developed a phased approach that any business can use to produce positive results in the short-term and over the long term.
It looks like this:
- Evaluation/Discovery
- Strategy Document
- Implementation Plan
Evaluation/Discovery: When a business is small, the owner or manager has a pretty good sense of where his or her customers are coming from, which marketing strategies are working or not working and the general areas that the business needs to focus on to grow. But as a business expands, owners and managers “wear fewer hats” and are more disconnected from the reality of their marketing effectiveness. The evaluation and discovery process provides real data to get the owner or manager back in the driver’s seat. Actionable data is the result of this process. During our client marketing strategy session, we go through a discovery process which looks like this . . .
- Financial – this discussion centers around revenues, profit margins (per product/service or customer group), average number of transactions, average transaction amount, growth goals for the following year.
- Target Market – we look at existing customer demographics, psychographics, buying behaviors, then combin the financial data with this information to determine adjustments to the desired target market, and products/services that go with that market.
- Database – since data is everything, we look at the types of data that the business maintains on their current customers, inactives, prospects and strategic/referral partners. We evaluate trends through reporting that will help shape our strategy phase of the plan. We also look at the marketing tracking – activites that lead to new sales, retention, or cross-sales to existing customers.
- Marketing activities and infrastructure – this is probably the most time-consuming part. We look at all marketing, communication and sales initiatives for the year, evaluate their effectiveness and prepare for the decisions we will make in the strategy phase of our plan.
And guess what? If you never get past the first phase, you’ll still have created something valuable to make a difference in your marketing. But if you want to go from “good” to “better,” move to the Strategy phase.
Strategy: This is where we take all the data from Discover/Evaluation and create ideas to improve on what’s working, make decisions to remove what is not working, and then reallocate funds or effort toward new marketing initiatives that we will test and track in the coming year. The result of this process can be a one-page marketing plan listing specific goals and high-level initiatives or a multi-page document with enough detail to get the process started.
At this point if you don’t have the time or resources to move into the implementation phase, you can use this document to move forward. We suggest going back through it to rank the initiatives in order of potential effectiveness (A, B, C), then list target dates for each initiative.
Implementation Plan: If you have a team to help you implement the marketing strategies, we highly suggest moving to this phase which will take your plan from “better” to “best.” This is where you put specific information to your plan. Each initiative will have associated tasks, resources needed to implement them, and time required for each step.
Although Microsoft Project may be more software than you need for this process, you may want to consider using it or something similar. One of the key features we use is the “predecessor” fields so if one step gets delayed or an initiative re-prioritized, you can easily change the target dates of all associated tasks for that particular project. You may want to use something as simple as an excel spreadsheet. Remember, for each marketing initiative, you will want to test and track its effectiveness, and possibly adjust the marketing channel or message in order to find the most effective approach.
Here are some metrics we recommend tracking. This works for direct response initiatives (promotional programs, events, mailing, advertising), but is not as effective for branding strategies.
Response rate – you will need to define what a response is for you. It could be a sale, an inquiry, the prospect giving you an email address, etc. Response Rate = # of responses/number of impressions (mailings sent out, number of ad copies, etc.). The goal is to increase responses.
Cost per Acquisition – what it costs the business to acquire a new customer. This can be tracked on a business level, customer group level or even a campaign level. The goal is to reduce it over time. On a business level, you can divide what you spent on marketing or sales and marketing by the number of new customers acquired for that year. That will be your baseline. We’ve had clients track it on their business customers separate from their consumer customers, or even by affinity group. On the campaign level, you can track what you spend on the campaign and divide by the number of new customers you acquire directly from that campaign.
Just remember that in everything, even marketing, there’s a good, better and best approach. Going through the evaluation and discovery process will provide you with a good sense of what needs to be done in the new year. The strategy phase will provide a better approach with identified initiatives, and the implementation phase offers the best approach toward achieving your growth goals in the new year.
Which Business Structure is Right for you?
by Glenn Lyon, MacGregor Lyon, LLC
General Partnership
One of the simplest and most common ways for small businesses to bring in additional capital or someone with sought-after complementary skills is in the form of general partnerships. In these types of partnerships, stakes are evenly divided among each partner unless otherwise specified in a partnership agreement. All gains and losses general partnership are routed directly through to the individual partners’ personal tax returns and the business is typically not taxed as a separate entity, although it must still file a return detailing the revenues and expense of its partners (Form 1065). And because payroll isn’t required for general partners, if a company consists entirely of partners and has no employees, the paperwork requirements can be much simpler than that of a corporation.
However, general partnerships have some distinct disadvantages. The most important of these involves the risk exposure to the partners, who are jointly and severally (individually) liable for any debts or judgments against the company, which means the partners’ personal assets (home, car, investments, etc.) could be vulnerable to creditors. Also, many state laws mandate that if any one of the partners leaves or dies, the partnership is immediately dissolved, which can make succession planning more and legally tenuous.
Limited Liability Company (LLC)
Started nearly 30 years ago as a hybrid between corporations and traditional partnerships, LLC’s have proven to be an increasingly popular strategy for small business owners. LLC’s allow multiple owners of a company to directly share in profits as they would in a sole proprietorship or general partnership while shielding their various personal assets from liabilities or debts incurred by the business, protections normally found only in fully incorporated companies. A simple Operating Agreement establishes the LLC and sets up the rules for governing the company as well as the rights and responsibilities of each partner, or member.” As part of an LLC, members have the flexibility to chose whether to pass-through company profits to their personal tax returns or to have the business taxed as a separate entity.
Subchapter S Corporation (S-Corp)
Similar to traditional C-Corporations in every way except for a different tax structure, S- Corps have become quite popular among many small business owners. This is because S-Corporations offer the same tax advantages of sole proprietorships or partnerships—where all income is passed through to the shareholders’ individual tax returns—as well as offering the liability protections inherent to a corporation. The downside of S-Corporations includes increased administrative costs, a much more extensive set of rules and by-laws to follow regarding corporate governance, and closer scrutiny by the IRS. Also, federal regulations require that all S-Corporation shareholder- employees are paid prevailing wages (subject to Medicare, FICA, and any applicable state income taxes), before any profit distributions can be made.