Posted By: Julie Shenkman In: Entrepreneurship
Brainstorm: tax-free money for the asking.
I've watched people struggle through the quicksand of trying to raise funds via promises from venture capitalists, run the hurdles of SBA loan applications, produce mounds of paperwork for bankers -- all of whom ultimately turn them down.
These processes teach some people an enormous amount about their own business and industries by forcing them to create detailed business plans. Others gain nothing but bitterness and foul tempers. However, many of the those who develop thorough plans go on to great success, despite the financial obstacles placed in their paths.
The Quick and Easy Route
What if you don't want to waste your time with all that nonsense? Is there a shortcut that can provide you with risk-free money? Money that you don't necessarily have to pay back? Tax-free money to use 100% to grow your business? Money that could make you substantial profits? If there is, then how do you get your hot little hands on it?
The source is called INVESTORS. I know, you think it's too complicated and risky to go about gaining the confidence of investors — and if they lose all their money, you'll feel so guilty and responsible, you'll never sleep again...
Okay, so let's re-phrase that — SMALL INVESTORS. No more than $1,000 -$2,500 per person. You'd be surprised how many people would be willing to part with such a small sum for the opportunity to make 2, 3,10 times that much money. And should your new venture fail, no one person loses so much that it hurts with a sum that small.
If you already have a small business, you have satisfied customers, clients, patients, etc. If you approach each person face-to-face, many of your regulars will be pleased to pop for this small sum. In addition:
- It gives them a vested interest in your success — you succeed, they profit.
- You will be their vendor of choice for your product or service.
- They will be more than eager to send you referrals.
- They will be more eager to open doors to better, less expensive suppliers.
- They will buy more from you at each visit — because they are investing in themselves!
At the Starting Gate
If you are planning to start a new business, then you'd darn well better know who your customer base is going to be. (Do your marketing research. That business plan isn't such a bad idea, either.) Otherwise any money you do raise will run out surprisingly quickly — before you make your first sale.
Once you've targeted your market and suppliers, go talk to them about investing.
Don't Get Greedy
Your main problem will be too much money. Several people will offer you more than the small $1,000 - $,2500 investment. Why is that a problem? Because, as long as the investment is insignificant, you have these advantages (not necessarily in this order):
- No individual owns enough of your company to tell you how to run it.
- No one person loses enough money to hate you for it, should you fail.
- The more investors you have, the less likely they will band together to oust you from your own company.
- The more people who invest, the more additional business you can generate.
- You don't have to sell enough to give up a controlling interest.
- With such a small investment, you can give each person a very small share of your business.
What's the Payout?
How much you raise depends on the form of your business. You can raise a few thousand dollars to a quarter of a million dollars ($250,000) or more, with as few as 100 investors! (I'll just bet you know 50 or 100 people you can convince to part with a few measly bucks.) Convincing 50 - 100 people to participate should take you less than two months. Needless to say (but I will anyway), you should sit down with an "investment team" consisting of a skilled tax professional, a business attorney, and a business insurance broker to plan out the optimum business format at the lowest cost and risk.
- If you create an S-Corporation, depending on the state you're in (California is still limited to 35 shareholders), you may get 35-75 shareholders without any complicated SEC filings. That translates to $35,000 - $187,500!
- If you form a General Partnership (GP), which is the easiest and cheapest business entity, you have unlimited partners. The main problem with a GP is that all the partners are responsible for all the business's debts, errors, lawsuits, etc. So, this is not a wise option.
- However, a Limited Partnership (LP) has all the benefits of a partnership's simplicity, but limits the investors' liability to the amount of their investments. This was a very popular format for the popular "Tax Shelters" of the 1980s. As before, check with an attorney about the limitation on the number of partners in your state.
- Another popular new vehicle is the Limited Liability Corporation (LLC). The main danger with LLCs is that if your business crosses state lines (or operates on the Internet, which crosses international boundaries) you may not have limited liability if you do not comply with the specific laws of each state, country, principality, sheikdom, or other national entity. For example, in California, LLC's are quite a nuisance to set up and operate. California even charges a tax on the gross income of the company. That means that even if the company lost $50,000, it might have to pay the benevolent State of California $1,300 if its sales were as little as $250,000.00.
[Note: if you want to set up any of these entities, IncCentral will take care of your LLCs and incorporations at a great price.]
The Bottom Line
If each investor gets stock, you can give them each one share per dollar ($1 par value). You can raise $250,000 by selling 250,000 shares of stock. Sounds like a lot? Not if you issued 1,000,000 shares! You will still own 75% of the company. (Or you can issue one share per $1,000. Then you sell only 250 shares, but issue 1,000 shares to achieve the same ratio, depending on state's/SEC laws.
This is such a simple way to raise money. It just takes some guts and little chutzpah. But, if you can't sell the people you know on the merits of your own business, how can you ever expect to have sold the SBA, the banks, or venture capitalists?
Now, what's stopping you from raising all the money you need?
Worried about tax consequences?
No matter what type of business you create, all the money you receive will be capital or equity. You pay no taxes on those funds. You can transfer a sole proprietorship's assets to most of those entities without creating any tax consequences. However, if you transfer assets (equipment, cars, buildings) with loans against them into the new business, you might face cancellation of indebtedness income. So just use your newfound money to pay off the loans before transferring them.
As another little tax benefit (even though your profits may increase), you'll be able to share the tax burdens with your new partners. Just be kind and distribute enough draws, dividends, or repayment of capital so they can pay their share of your business's taxes.
Keeping My Promises
At the beginning of this article I promised you three things:
- Risk-Free Money — small investors understand that they can only lose small. Nobody gets too upset over small change. DO NOT approach anyone to whom $1,000 - $2,500 is a significant sum!
- Money you don't have to pay back — funds used to purchase stock or shares of partnerships are not loans. They don't have to be paid back if the company shuts down. However, if you make a profit, you will share it with your investors in proportion to their ownership of the company. (If you can double your profits, I am sure that you would not object to giving away 25% of your windfall to the people who made it possible. You would still be at least 50% ahead.)
- Tax-Free — we just talked up about that up above. All the money is capital. So you can use all of it for the growth of your business. The legal and accounting costs are minor in comparison to the cash flow you receive.
Now, all you have to do is keep your promise. Even though, under these fund-raising arrangements, you have no legal obligation to repay any money, you are ethically responsible to these generous folks. So, make sure that you do your homework. Know where your customers, clients, gigs, and sales will come from.
Just a Bit of Legalese
First of all, remember, this is a just an outline of an idea. Not all the tax and legal benefits and pitfalls can be covered in such a brief column. So, seriously, get some good professional advice specific to your business.
Raising money from private individuals with whom you are personally acquainted or doing business is called a private exempted offering. There are rules to follow to make sure you don't fall afoul of the SEC and the U.S. Securities Acts.
Incidentally, for certain professionals, it may be tricky to use this method. Certain professional licenses prohibit "partnering" with anyone who is not similarly licensed. There are ways around these rules. After all, the Big Six accounting firms now have "partners" who are not CPA's, but rather consultants in various areas.