You might recall over a month ago sitting in your living room and deciding this was the year, the year that you finally acted on your entrepreneurial spirit by starting your business. But weeks later, you are still not sure where to start or what your first step should be. Arguably, your most important first step is to create a business plan. Your business plan should describe your idea, detail your operations, and clearly discuss your expectations for the business. Creating a plan will enable you to see potential risks with your business, thereby allowing you to make revisions before making foreseeable mistakes. A good, well-written plan can double as a marketing tool, which will enable you to attain the other most important item for your business – capital.
Capital can come in two forms – debt (loans) or equity (ownership). Both can be hard to obtain when you are first starting out. If you decide that you prefer to sell ownership interest by soliciting investors, then you have to consider the type of formation that will work best for your company. For example, certain business forms limit the number and type of investors that can have an ownership interest. Additionally, you have to consider your method for seeking investors, the type of investors you are willing to have buy into your company, and the amount of capital you intend to raise. These factors, among others, affect whether you violate any securities laws and regulations. Generally, the act of offering and selling ownership interest in a business is subject to securities regulations unless a qualifying exemption applies (and it often does with small businesses). Regardless of your business form, you must file the proper documents required by New York State to show legitimacy to potential investors.
And then there is the four letter word that we both love and hate – debt (or a loan). Applying for a loan from a traditional bank usually requires an annual statement showing business income for one year, which is practically non-existent for a start-up. In such cases, friends and family can be good resources. While you may not feel the need to do so with your mom who will give you the world or your best friend since kindergarten, it is important to document loan transactions because they are treated differently than income under the US tax code. Failure to evidence the transaction may result in a re-characterization of the funds and result in higher tax liability. So how do you document loans from your loved ones? Simple – treat the transaction like any other business deal. You should draft an agreement that establishes terms for the loan. It is also a good idea to refer to your business plan to get a sense of when you can start to repay and also to give your “lenders” an idea of what they should expect. Borrowing from your loved ones doesn’t necessarily mean that you are excused from making disclosures, but rather when you tug on their heart strings, hopefully at the other end is a huge purse.