Financial Pitfalls to Avoid With Your Startup
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Whether you’re a financial novice or a Boglehead who regularly consults NerdWallet, it’s very easy to make some costly financial mistakes with your startup. In this article we’ve laid out the 9 most common mistakes we’ve seen from early-stage startups, ranging from the basics through some more advanced considerations. More specifically, this post is intended for U.S. startups that have their own legal entity, such as a corporation or LLC.
The basics
OK, hopefully these aren’t entirely new, but let’s start with the financial basics because you don’t want to get these wrong.
1. Don’t mix your company’s money with your money
Mixing your assets and your company’s assets can create important legal and tax headaches for yourself and your company. This is called “commingling,” and it can cause a bunch of problems for you later on down the road. In particular:
- Generally, the stockholders of a corporation or LLC are protected by what’s called a “liability shield,” which legally separates you and your company. More importantly, debts that your company owes are separate from debts that you personally owe, thanks to this liability shield. If you’ve commingled your company’s assets with your personal assets, you could lose this important liability shield protection.
- If you don’t properly track and document your company’s financial activities separately from your own, you could potentially owe a bunch more in taxes (because the IRS could decide that the personal things your company is buying for you is actually compensation you haven’t been paying taxes on).
So if you have just one takeaway from this article, it’s this: please don’t casually spend company money on your personal expenses.
Now, it is common to do it the other way around: for a company’s employees to make purchases on behalf of the company and to then be reimbursed shortly thereafter. If you go this road, we strongly recommend using expense reporting software like Expensify to track and reimburse the expenses—it might seem like overkill at first, but it’s much better than tracking things in a spreadsheet.
In our experience, startups are usually happiest using one or more corporate credit cards to make most of their purchases and minimizing their number of employee reimbursements. That way, everyone’s happiest: you get a clean separation of work vs. personal expenses, your employees don’t have to lend the company money, and you get great tracking about what the company is spending money on.
2. Always use a payroll system to pay employees
Maybe you think that you don’t have the time to set up a payroll system or you think that the payment that you want to make is “only a small amount”, but you’ll create a mess for yourself if you pay employees without using a payroll system. Carefully-calculated tax withholding payments and form filings are due shortly after any wages are paid, and there’s basically no way that you’re going to want to do this all by hand. When you pay an employee through a payroll system, it will help you with these payments and filings. Gusto is probably the best payroll provider for startups on the market today.
If you have an employee move to another state, be sure to update their address promptly in your payroll system and take care of any resulting registrations that you need to do in that state. If you have the wrong address in your payroll system, you’ll make the wrong state tax filings and can cause headaches for yourself and the employee.
3. You still have to file corporate tax returns, even if you made no money
Even if your startup had no revenue, you still need to file taxes for it. If your company is a C Corp and operates on a calendar fiscal year, the federal tax return deadline is on or around April 15.
The best way to get your business taxes completed on time is to hire a tax preparer well in advance who can help you with your specific situation, including your state taxes, whose deadlines and requirements vary by state; here’s one federal tax deadlines summary chart.
We suggest hiring a tax preparer by December or January and getting them your books early, to beat the seasonal rush. Before your taxes can be started, you’ll need up-to-date books for your company for the year. (Keep reading for our advice on bookkeeping.)
Intermediate tips
4. Corporate income tax isn’t your only obligation
State and federal tax returns and payroll filings aren’t the only government filings required of your company—there are actually a whole slew of other requirements. For example, if you are a tech startup based in San Francisco (but incorporated in Delaware as a C corp), here are some other fees and filings to have on your radar:
Delaware specific:
California specific:
- California statement of information, which is separate from the franchise tax that’s paid alongside the state tax return filing
San Francisco specific:
- San Francisco business registration
- San Francisco gross receipts and payroll expense tax
- San Francisco business property tax
Federal:
This is not a comprehensive list, and a good tax preparer should be able to help you figure out what your obligations are.
5. Collect needed W-9 information before you make a qualifying payment
Businesses need to file a form called 1099-NEC every year for certain payments that they made in the course of their business that year. Filing 1099s at the end of the year isn’t difficult as long as you have the necessary information on hand.
The best way to obtain this information is to collect it as you go, rather than retroactively trying to put it together after the end of the year. Specifically, many businesses will request a Form W-9 from any vendor who might later require a 1099 before paying the vendor for the first time. Collecting this information up front when the relationship is being established helps ensure that you have the information when you need it; otherwise you could later be stuck trying to track down this information from unresponsive vendors who you paid many months ago.
Your tax preparer can help you with determining which vendors require a 1099, but the requirements are also laid out in the 1099 instructions. The most common reason to need to file a 1099 is if you pay $600 or more in non-employee compensation to a non-corporation (e.g., an individual, estate, partnership, or LLC that’s taxed as a partnership).
6. Make sure someone is paying attention to your books
There are three critical reasons to have proper financial records for your company:
- You’ll need books for filing taxes
- At some point you’ll probably need to provide financial statements to a third party, such as a potential investor, landlord, or business partner.
- Your financial records contain important information about your business that can save you money
The first two items above are fairly self-explanatory but many people underestimate the value that they can derive from the third: you’d be surprised at how often we see mistaken double charges, sometimes for large transactions like rent. Getting these corrected can immediately be a savings of thousands of dollars.
7. It’s probably a costly mistake to be doing the bookkeeping yourself
I’ve made this mistake before at my first startup, so I know how tempting it can be to try to do your books yourself. In the abstract, it doesn’t feel like maintaining financial records for the company should be a huge burden, and you might convince yourself that doing the work on your own helps keep you closer to the details of the business.
Unfortunately, the reality is that reliably maintaining high-quality books is surprisingly time-consuming, and it’s not the best use of your time. It’s a burden even if you’re an expert at it, which is why even full-time financial professionals tend to hire a third party bookkeeping firm to take care of the day-to-day bookkeeping. A good bookkeeping provider will make sure that the process is conducted the way that you want while saving you time and frustration.
(Plus, if you know that a trusted partner is taking care of the books, you can instead focus on running your business.)
Advanced tips
8. If you’ve raised significant money, get a competitive interest rate
Why bother? Depending on how much money your company has raised, getting a competitive interest rate can easily be worth your time. An interest rate of 1.5% means that a company that has $2M in the bank can generate $2,500/month in interest and that a company that has $10M in the bank can generate $12,500/month in interest.
Unfortunately, your business bank account won’t give you anything near that rate with your default checking and savings accounts. But some banks do provide a way to obtain a competitive rate if you know how to ask.
9. If you qualify, claim the R&D tax credit to save up to $250,000 (!)
As of 2017, your startup may be able to claim a substantial R&D tax credit, which you can apply against your payroll taxes, if you qualify. (The fact that the credit can be applied to your payroll tax is what makes this really interesting, since you save money even if your company didn’t generate a profit that year.)
The best way to determine whether your company is eligible for the R&D tax credit and how much credit your company can claim is to work with your tax preparer, but you can get a sense of what counts as “qualifying research and development” on the tax credit’s Wikipedia page. At Pilot, we’re transparent about how the R&D tax credit qualification process works and we also offer resources on how to evaluate an R&D tax credit provider. In addition to conducting “qualified research and development” activities, your company basically has to be less than five years old, and has to have made less than $5 million in “gross receipts” in the year you’re applying for the credit.
Assuming you are eligible for the R&D tax credit, here’s how it works: you and your tax preparer work together to figure out how much credit your company can claim on its federal tax return, and then after that federal tax return is filed, your payroll provider can help you actually apply the credit against your payroll taxes.
You can potentially save up to $250,000 per year in payroll taxes with this credit.
Curious to learn more?
These are just a few of the financial pitfalls that you can avoid with your startup. To learn more, contact us to chat with an expert who can help you and your growing startup get the bookkeeping, tax prep, and financial expertise every startup business founder needs.
Disclaimer: We’re three-time startup founders and startup finance enthusiasts, not lawyers, financial advisors, CPAs, or tax preparers. This article is not legal advice, financial advice, or tax advice and isn’t meant as a substitute for consulting your own qualified advisors.
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