Costly Mistakes Made with Your Business Entity

Investing in a powerful tool and not using the tool properly does not make a lot of sense.

I know when it comes to running a business, it requires multiple hats to wear, and very often, you are off and running on 10 different projects, calls, appointments, presentations…and perhaps the very foundation of your business may be in jeopardy.

Here are the top costly mistakes I have seen made over the past 23 years:

1. Not completing the transition from a sole proprietorship to a separate legal entity.

If you started a business in your own name for a few months before you formed an entity, odds are part of what you did you completed as an individual, and you need to connect the dots to the new entity. If you filed a DBA (doing business as) with yourself as the applicant, that needs to be canceled and re-linked to the entity.

That means your entity needs to be the applicant, not you! If you don’t do this, you still are exposed to unlimited liability and filing a Schedule C with higher audit potential. The next point is to open a bank account in the business’s name, not just keep the account in your personal name. Use a business credit card in the entity’s name, not just your personal credit card, and keep track of expenses.

You will want to minimize the amount of debt that shows up in your personal name.

Update all affiliate programs, vendors with your new entity information, so any income is going to your business entity, not to your name personally.

Update your websites, business cards, letterhead with the new name of your business. Another important tip is to make sure your website complies. Most are not. I would recommend simple software with all the legal agreements you need on your website or blog.

2. Funding concerns. 95% of businesses fail within 5 years, and undercapitalization is the #1 reason.

The pattern I have seen is that small business owners hope for revenue to come in as the primary source of money to grow their business. What happens if your revenues are off or don’t come in at all? You may be working on that great new product, and all your e-mails go out, and no one converts. That is a real problem.

The key is to model success. Almost all successful companies do not use only their own money to grow. I know you know the concept, “OPM,” other people’s money, yet are you doing that? Are you only self-funding your business on your personal credit? Did you know that the business credit bureaus will start creating a file once the entity was filed?

They scan the Secretary of State’s records to create a file with any new filings. They look for the name of the business, the start date, and name of the officers/managers the address…

If you are not paying attention to how you fill out forms with the business address, business license, state forms, you can create disconnects in the database.

In one business credit bureau, NCP has spelled four different ways. The NCP part is the same, but one way has “Inc.,” one has, “Inc.” other has, “Inc” and the last one is “Inc.”

Did you notice the differences between the comma and the period? That created four different files! Don’t make that same mistake.

Unlike personal credit bureaus, business credit bureaus are very difficult to fix any mistakes. They have their own set of rules and are not set up for changes after mistakes happen.

This creates a problem for developing credit for your entity because you basically have one shot at the apple to get it right the first time. Banks and vendors are very interested in the financial strength of your company. Now joint venture partners can check you out for free to determine who is stable in your operation.

You may be losing business and not knowing it. It is really a must to be financially solid in your business, and your developing business credit is a must for your long-term success.

3. Safe and risk assets. Mixing asset classes is a major risk to your wealth that is unnecessary. A risk asset is an asset that would cause liability to your entity. That may be a business, real estate, equipment, again, anything that may cause liability to an entity.

A safe asset is one that does not cause liability to an entity, like cash, ownership of another company, investments…If your business falters and you need to rely upon your safe assets to recover the short term, why unnecessarily put your safe assets at risk? It happens all the time.

4. Not clear on who does what? A partner can help you grow a business quickly and destroy it even faster if you are not on the same page.

Very similar to being married. I have been married for 24 years with three girls, and it is a lot of work and requires meetings and discussions to do the best to be on the same page.

Business like marriage can be very exciting at first, and you really need to communicate well with what you are looking to accomplish. The fun part of the business is discussing how you will bring in revenue and all the possibilities that can happen with profits. The part that isn’t fun is the expense side of the ledger.

First, you must agree upon what is actually considered an expense: do that include cell phones, travel, meals…? What happens if revenues are way off, and there is not enough money to pay each partner, and you need more capital from each partner to keep it going? This can be a very uncomfortable problem.

It is best to presuppose the challenges ahead of time and see if you can calmly discuss them and develop solutions that make sense. If you can’t get to first base on the uncomfortable parts before you get started, that is a bad sign, and perhaps you should NOT be a partner. In fact, odds are the business is doomed to fail if you can’t get through some of these basic uncomfortable discussions from the start. Now, that does not mean your partner is telling their spouse the same story. That can and often does create more issues.

Having as much in writing from the start and a business plan in place makes the most sense. Almost ALL, not all, but close, partnerships that refuse to take the time to put things in writing fail. It is like clockwork. If anyone wants to start a business with you and refuse to put things in writing, run.

Most of the time, the only one that makes money in that situation is the attorneys after the partners sue each other. Take the time to be clear and put it in writing.

Follow Scott for timely strategy updates