Congratulations! Now you can order fancy business cards from vistaprint.com and call yourself President. The bad news, Mr. President, is that this will hardly impress anybody and will not advance your search for your First Lady or Gentleman. Nowadays, everybody is a president of something and carries glossy business cards that say so. In fact, my experience shows that the more impressive the business card, the less impressive the business behind it.
Truth is, doing business and “having” business are two completely different things. Doing business means that you are, well, doing something. Things like marketing, buying, selling, building, fixing, whatever it is you do. Hopefully, you make money while doing so, but legally you are still running a business even if it loses money. The key is: you do NOT need to form an official company to be in business – neither for legal purposes, nor for tax purposes.
Likewise, merely forming a company changes nothing. You will not become rich overnight, you will not obtain tax benefits, and you will not even lose weight. Company or not – you need to do real work, not just paperwork.
This next analogy might help. No offense to anybody’s beliefs, but nowadays two people often live together, share everything from values to towels, and even raise children – all while not being officially married. At the same time, we all know legally married couples that hardly share anything except the mailing address.
With business, similarly to marriage, putting a formal structure in place brings both benefits and headaches. And most people do not realize it until they’re already “in.” (Yes, I am married.) This article is an attempt to outline these benefits and headaches, with the purpose of minimizing the latter.
1. Why create a company?
Besides the already mentioned “businessman status” (which is a really lousy goal), forming a business entity can help in four areas:
- Marketing
- Legal protection
- Tax benefits
- Management
By marketing, I mean rights to advertise under a business name. Some investors believe that, image-wise, “Realty Sharks of Houston” has more marketing punch than simply “Mr. Bob Slick.” If business name is all you’re after, then you probably do not need to form a company. Just go to your county clerk office and pay $15 for an assumed name, better known as DBA – “doing business as.” No need for an LLC or a corporation – you can use this DBA name in Greensheet and paint it on your truck.
Legal protection is something you should discuss with your attorney, and tax benefits – with your accountant. I know that Google search is faster and cheaper, but it’s only cheaper in the short time. You get what you pay for.
At the end of the day, it all comes down to management. Without proper management procedures, you’re likely to lose both legal protection and tax benefits. Basically, you will destroy your company. Yet, management means extra work and extra hassle, and who needs that?
Translation: unless you’re ready to spend extra time and effort to run your company properly (or hire somebody to do it for you) – do not bother to create one. You will create a mess, not a business.
2. What is proper management?
Proper management starts with separation between you and your company. It’s really no different from working for somebody else’s company – as in “job.” Suppose you work for Exxon (one of the few remaining operational public companies, as of this writing). You would not say that “you” and “company” is the same, right?
You don’t have free access to the company money, do you? I don’t think you can simply move some Exxon money to your personal account, unless maybe you’re a top executive. If it ever happens, then you most likely obtained an official (and documented!) company loan that you must pay back, with interest.
Next, try to get Exxon to pay your mortgage or your medical bills for you. Let me know how it goes. Maybe, they have a job opening for me.
How about this trick: you go to an Exxon gas station and ask that they pay for their gas supply directly to you. After all, you do work for Exxon, why would they mind?
By the same token, Exxon cannot direct you to pay any of the company expenses, like buy a printer cartridge for your office, out of your pocket. What if you do put some job-related expenses on your personal MasterCard, like travel for instance? Fine, but what happens shortly after you paid for it? You submit a reimbursement request, and you get paid back by the company.
So, let’s review how it works between you and Exxon:
A. Your money and Company’s money are strictly separate: separate bank accounts, separate credit cards, separate loans.
B. The only money you can get out of the Company is your paycheck, a loan, or an occasional reimbursement for business expenses.
C. Company collects all business income and pays all business expenses; you’re not part of it.
D. You’re paying all your personal bills out of your paycheck, AFTER it has been paid to you; the Company pays nothing for you.
Simple, isn’t it?
Somehow, this simplicity is forgotten once you form your own company. It should be just as it is between you and Exxon, except for the paycheck part that we’ll discuss in a minute.
I suggest that you clip the above four bullets out of this article and carry them in your wallet. If following these four principles sounds like too much work – then there is no point to form the company. Stick with a DBA.
3. How do I start with this management thing?
Probably by reviewing the A-B-C-D above. We need a simple but workable system. Below are some suggestions that have worked for many business owners before you. Please feel free to implement your own variety.
- Open a business checking account. They are free at many commercial banks. Make sure that the bank will accept checks written either to you personally or to the company name, as you will probably receive both kinds. If such business account is a problem, then at least open a new personal account just for business and treat it as if it was a business account.
- Make sure to pay everything business-related from that account, starting from day one. I understand that the business may not have its own income yet. The way you handle it is bytransferring money from your personal account into business account, as needed. Do not pay business expenses from personal account or personal credit card. Instead, transfer money into business account and pay everything from there. Did I say – everything?
- Make sure to pay everything personal outside of your business account. Will Exxon ever pay your home insurance bill or your gym membership? Neither should your own company. Yes, I have read that those fat cat corporate executives get their companies to pay for everything. Well, this may explain why they end up on the front pages.
- Keep a clean money trail. If the company is short on money, transfer some from your personal account. If the company made profit and you’re pulling it out – transfer money into personal account. If you paid your company’s expense – document and obtain reimbursement. If not sure – think how it would’ve been handled between you and Exxon. Do likewise.
- Avoid cash. It may be convenient, but it’s awfully hard to document and later prove to the IRS. Why make it harder than it is? If paying in cash is unavoidable, at least secure a signed receipt, preferably with a matching invoice.
- Try to use your business name as much as possible. Write lease agreements, invoices, and contracts from business. Have your buyers and tenants write checks to your company. In reality, sometimes business name will not work – as may be the case with many title companies, insurers, and lenders. In this case, treat everything as if the company name was used. For example, if your tenant made her check out to your personal name – still deposit it into your business account, because it belongs to your business. If the mortgage is on your investment property, pay it from business account, even if the loan (and maybe title) has your personal name on it.
In short, if you want your creditors and your enemies (including the IRS) to treat your company as a separate entity, you yourself must treat it as a separate entity first.
4. How do I pay myself?
This question is not as difficult as you may think. Usually, you end up paying all the business taxes, not your company – unless you form what is called a C-Corporation. These taxes are calculated on whatyour business made, not on what you “got paid” out of the business. Whether or not you move money in and out the company account, your taxes will be the same.
What it means is that you do not really have to formally “pay” yourself. If the company makes money, you can simply transfer the profits from the company account into your personal account, at any time. Just remember the “transfer” part. Never pay your personal expenses from the company or take out cash.
Can it be more involved than this? Of course. You can set up a formal payroll system – with paychecks, tax withholding, and benefits. Sometimes, it makes sense to do that. However, when your business is young, it creates unneeded complexity. Make some money first. There is always time to complicate things later on.
5. What type of business entity is best for real estate investors?
I knew you would ask. Just read this article.
6. Is there anything else to worry about?
I bet you know the answer. There are always more things to take care of. If you focus on setting everything “just right” from day one (as some gurus suggest) – you may be spending your time, energy, and money on the wrong thing. And before you know, you may end up with a “perfect” company that does absolutely nothing. I’d rather see you operate an “imperfect” but highly profitable business.
I have a very thorough and methodical friend who once decided to take cycling. Being who he is, Jim did extensive research, he subscribed to cycling magazines and ordered the best gear from the most reputable suppliers. He kept accumulating all this great stuff, so one day he could finally hit the road, perfectly equipped. Before that day came, Jim’s super-cool (and super-expensive) new bike was stolen from his garage. I bet he still keeps those $200 special-order cycling gloves in his closet, never worn.
Don’t be Jim, please. Get yourself some kind of bicycle – and start riding.
Just take care of what really matters: proper separation of money. Otherwise, you may cancel the very existence of your new company. So, get into a habit of separating the money – right away. Beyond that, concentrate on your business, and may it exceed your wildest expectations!