business as an S corporation (also known as sub-chapter or sub-S). This structure permits a small business corporation to treat its net income as though it were a partnership. One objective is to overcome the double-tax feature of taxing corporate income and shareholder dividends. Another purpose is to give the shareholders the benefit of offsetting business losses incurred by the corporation against their income.
Only closely held corporations, that is those with 35 or fewer shareholders, may make the S election. All shareholders must consent to the S election, and only one class of outstanding stock is allowed. A specific portion of the corporation’s income must be derived from active business rather than passive investments. No limit is placed on the size of the corporation’s income and assets.
If you make an S election now, at some future point you may wish to revert to a full corporation for tax advantage reasons. This is permitted, but the corporation may not be able to re-elect the S vehicle for several years once the S election is reversed. This is to prevent small corporations from changing frequently to maximize tax advantages. Since S forms of incorporation are not recognized in all states, you should obtain further information from your professional advisers.
2.5 Limited liability corporation (United States)
A limited liability corporation (LLC) is a form of doing business that combines the limited liability for loans and lawsuits of a corporation with the “pass-through” tax benefits of a partnership. Pass-through taxation means that the business is taxed only once — at the member/shareholder level — rather than at both the member/shareholder and LLC/corporate level.
S corporations are also eligible for pass-through taxation, so why form an LLC instead of an S corporation? Because certain limitations are placed on S corporations that do not affect LLCs.
For instance, an S corporation must not have more than 75 shareholders, and the shareholders must be individuals, estates, or certain types of trusts. Corporations, partnerships, LLCs, and nonresidents may not be shareholders in an S corporation. All these entities, however, can be members in an LLC.
Another limitation placed on S corporations is that they may have only one class of stock. As a result, the financing options are limited. S corporations are not good tax shelters because deductions for losses are limited to the shareholder’s basis in the corporate stock.
LLCs have an advantage over S corporations when it comes to foreign investors. Because an S corporation cannot have nonresident shareholders, it is unable to have much interaction in the fast-growing international business market. Also, LLCs, unlike S corporations, are not subject to additional partnership tax status qualification requirements. LLCs must simply meet partnership tax requirements. LLCs need not elect partnership tax status and then be continually vigilant in order to retain such status as S corporations must.
For more information refer to the Self-Counsel book How to Form and Operate a Limited Liability Company.
3. Start-up Costs
Now that you’ve got your name and your structure, you’ll need money. Start-up costs for coffee bars can range anywhere from $80,000 to $225,000 for a typical 1,500 sq. ft. (140 sq. m) site. Start-up costs are obviously dependent on a wide range of factors, including —
(a) leaseholds required,
(b) tenant improvement dollars (if any),
(c) equipment, and/or
(d) initial marketing budgets.
These factors are all discussed in the following chapters. Make sure to adjust your start-up budget to meet the requirements of the site once you have secured one. In Chapter 4 we discuss in detail how to choose a site for your coffee bar and tell you how to determine what the ongoing operational costs for your site will be.
Keep your start-up costs separate from your operating costs. This is particularly important during the first month you are open. For example, a phone hookup is a start-up cost. The cost of having that phone operating that month and the charge for any long-distance calls you make in the regular course of operating your business are operating costs. Keep a separate file for all your start-up receipts. (See Chapter 15 for a discussion of operating costs.)
The cash required for your venture can come from a variety of sources: your personal savings, relatives and friends, banks, private investors, and, sometimes, the government. Most business funding is a combination of the above. Review each option discussed below and think about which ones will work for your business.
But before you think about borrowing money, from whatever source, keep in mind the risks involved. Understand the damage that irresponsible borrowing can have on a business. Unnecessary debt cripples a business, eliminates options, and weakens its ability to survive. You may not be able to escape it entirely as your coffee bar grows and prospers, but if you must borrow, borrow only what you need and only when you need it. By following this simple rule, you ensure two things: a stronger business and a calm state of mind.
3.1 Personal savings
If you have enough personal resources to run your business until it yields a profit, go for it. You will have no anxious lenders to account to, no financial responsibilities other than to yourself and your business — and no bank interest to pay. There is no better, or less stressful, way to start a new enterprise than debt free.
3.2 Relatives and friends
Money from relatives and friends usually takes the form of a loan. The money is lent on trust and accepted with good intentions. If the business is successful and the money is repaid promptly, both parties remain happy and satisfied. If not, the borrowed money can become a long-lasting contentious issue. There is always a danger in mixing money with a personal relationship, well-meaning as both parties might be, and it is wise to consider carefully before asking for such a loan. If money from relatives and friends is an option open to you, give the possible consequences serious thought. Is your business worth the risk of a friend or family member’s money?
If you do start your enterprise using money from friends and relatives, it will no doubt be your intention to pay it back through the profits of the business. Before agreeing to the loan, think about a backup payment plan should your business be unable to repay the debt.
The terms and conditions of the loan should be fair and negotiated in a businesslike manner. Be scrupulous in honoring the trust that is inherent in such a loan. Prepare a proper promissory note that outlines all the terms and conditions. (Promissory note forms can be purchased at most stationery stores.) Most important, be as certain as you can of your ability to pay it back on time and in full.
3.3 Commercial loans
Banks are the most common source of start-up funding. Take the time to develop a business plan and package the loan request in a complete and professional manner. Try to meet with the commercial loans officer prior to presenting your request. Ask them ahead of time what they will be looking for and the types of questions they will need answered. Many lenders will conduct a lengthly interview asking you detailed information about everything from your concept and your target market to your financial projections five years down the road so be prepared! Keep in mind that with a 50/50 business success rate in the first five years, financial institutions will be hesitant to loan you money if you are a start up and if you are buying an existing business, will generally not finance any good will.
3.4 Personal financing
Often, taking out a personal loan is the most direct route to cash for your business. Simply borrow the funds you need under your own name. While you need to have sufficient collateral to cover the loan, you do not need to advise the banker on all details of your business venture.
Later, as your business and your ability to pay off debt increase, switch to commercial borrowing. This type of loan is generally term financing: money received in a lump sum with