Just starting a business? Your top 10 organizational questions answered

What do founders wish they knew when starting out? As Pilot’s head of product for small businesses, I get to hear firsthand, talking to dozens of our customers. I also co-founded a CPG coffee company that scaled to national distribution of our products at retailers like REI and Whole Foods Market, so I can layer in some personal insight. 

Here’s how I’d sum it up: While every small business is unique, your questions when starting out probably aren’t. Everyone has to make a similar set of mundane yet meaningful decisions about what structure to choose or how to file taxes. Many of those decisions won’t cause you to succeed or fail at this early stage, but some of them can help you optimize for the future.

My advice: Do your research, talk to others in your industry, but don’t get tied up trying to make a “perfect” decision. The reality is that things change and the right decision today may not be the right one for a future iteration of your business. 

Below, I share some insight to answer the 10 most common questions I hear from our customers along with my personal experience.

1. Should I set up my business as a separate entity?

The benefit of having a separate entity is all in the name “corporation”: It comes from “corpus” which is Latin for “body.” You are essentially creating a new “person” aka entity that can do things like enter into agreements and open a bank account on your behalf while protecting you. 

It can also protect others you work with. The Romans invented companies so several people could act as one to fix aqueducts and split the payments, and that’s still basically how they work.

Here are just a few of the benefits as I see them:

• Limited liability protection—when you operate as a separate entity, you are generally not personally liable for debts or lawsuits.
• Fundraising—if you plan to raise funds, investors will prefer investing in a separate entity rather than in the individual.
• Possibly taxes—benefits vary depending on your entity type, but benefits usually come in the form of lower tax rates or deductions. However, tax codes change and there are many ways to file taxes, so it’s no guarantee. Some businesses are better off without an entity.

Forming a company isn’t free. There are downsides:

• It costs money to form an entity and register it with federal, state, and local governments.
• You may need to apply for licenses. 
• It can add operational overhead like additional annual state filings, maintaining by-laws, or keeping meeting minutes.

It really comes down to the question, do you plan to meaningfully grow or work on the business? If yes, you likely want to set up a separate entity so you can benefit from limited liability, can raise money, and can explore tax advantages.

2. What entity type is best?

There are five main entity types you can choose to operate as. What’s best for you depends on your business and personal goals with the company. This is a highly summarized version that’s meant to be a quick guide. For further details, I recommend talking to a CPA or legal professional.

The five company types, more or less in order of protection:

• Sole proprietorship, aka no entity—This is when you simply report your business income on your personal tax return. In this version, there is no separation between the business and you, so no protection. You’ll likely need to pay a self-employment tax of 15.3% on “business” income and pay quarterly estimated taxes.
• Limited liability company (LLC)—This is the next step up. It’s an official entity with an employer identification number and, as the name implies, limited liability. The owner or group (“members”) still pay taxes as individuals. An LLC often requires less ongoing administration than a C-corp. But if there are many members, taxation may be more complicated as each person must track their capital accounts or the amount of money they have in the business. 
• Partnership (LP or LLP)—Mostly for professional organizations like accounting and law firms. Like LLCs, partnerships do not pay income taxes directly, but rather pass through profits and losses to their partners, who file their own personal tax returns.
• C-corp—a classic corporation which provides even greater separation than an LLC, managers have nearly no liability. If you’re a startup looking to raise venture capital, your investors will likely insist you create a C-corp in Delaware, where business laws are friendly. C-corps issue shares, have board members, and must keep notes of their meetings. 
• Nonprofit—Nonprofits are purpose-driven entities that must reinvest excess profits in the mission. So, unlike an LLC, an owner cannot take money out as they please. Nonprofits can be tax-exempt, but they must prove it and still may have to file proof of income and expenses.

If you’ve heard of S-corps, it’s worth knowing that it’s not actually an entity type, but rather a way you elect to be taxed. It means you pass income, losses, and deductions along to shareholders—which if you are the sole owner, means yourself. C-corps and LLCs can both elect to be taxed as S-corps.

Read how to convert an LLC to a C-corp → 
Subscribe to Pilot's Tax Compliance Calendar→ 

3. Can I operate my business in a state outside of where I registered it? 

Yes. Many founders do. 

The requirements for every state and type of business vary, but most states require you to register and possibly, pay state taxes. Whether you need to pay taxes or not depends on if you have a physical presence in that state (e.g. property or employees) or qualify under a complex concept called economic nexus. 

Said another way, if you have employees, property, or make a certain amount of sales in a state, you likely need to register as a “foreign entity”. This is fairly easy to do from most state websites.

4. What taxes do I need to pay?

This all depends on the company structure you choose, how you elect to be taxed, and the nature of your business. There are taxes at multiple levels—federal, state, or local. Typically, bigger cities like San Francisco or New York City have a city income or business tax as well. Some (but not all because there are many!) of the main taxes to be aware of for businesses are:

• Business income tax
• Self-employment tax (for LLCs)
• Employment taxes
• Payroll tax
• Sales and use tax
• Excise tax

How can you build for tax efficiency from the start? A few ways. Investigate deductions, claim qualified expenses, and claim tax credits such as the earned income tax credit, the home office credit, the R&D credit, and so on. Also consider using tax loss carryover (sometimes called tax loss harvesting) where you apply losses from one year to a current or future year. 

All of these are good reasons to talk to an accountant.

Read: When is it time to stop doing your own taxes? →  
Read: How to file in many states →

5. What is the best way to pay myself?

This is also a good question for an accountant. It depends on the entity type. As an LLC, you can simply schedule an “owner’s draw” and move money to your personal account. As a C-corp, you’d need to pay yourself as an employee or contractor.

The way you pay yourself does affect your tax liability. You can, for example, contribute part of your pay to a tax-deferred retirement plan. Or if you’re an LLC that reaches a certain revenue threshold, you may save on taxes by converting to an S-corp and paying yourself as an employee and taking the remainder as distributions.

How much should you pay yourself? The average small business owner makes between $83k and $126k according to Bankrate. Though a better question may be, what can the business afford to pay you? It’s difficult to determine your salary until you have stable, recurring profits.

Once you do start paying yourself, only pay yourself what the business can afford. Many small business owners get in trouble by pulling out money whenever they feel like it, which can leave the business without enough cash to pay vendors.

According to a report we publish each year, here are what venture-funded startup founders pay themselves:

Read the salary report → 

6. What's the difference between gross profit margin and net profit margin?

This is a great question, and one I wish I’d have known the answer to sooner. 

First of all, you can find your gross profit margin and net profit margin on your profit and loss (P&L) statement, also called your income statement. 

Gross profit margin is what you’ve made after you deduct direct costs of producing products or services but before subtracting all other expenses like marketing, overhead, and taxes. It’s a reflection of how profitable each item you sell is.

Net profit margin is what’s left after all costs are accounted for. It’s often referred to as the “bottom line” because it’s literally the last line of your income statement. Net profit margin is one of the most critical financial metrics for a business because it tells you how much money the business is actually making (or losing) after all other costs. 

To figure out your margins well enough to make decisions, you need a reliable set of financial statements along with a well-built financial model. You can start with your own DIY version in Excel or Google Sheets, but you’ll eventually want to graduate to a more professional one. A true financial model enables you to plan out scenarios to understand how different strategies can impact the financial future of your business. 

Watch this webinar on how to build a financial model with one of our CFOs: 

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7. How can I improve my cash flow?

To improve your cash flow, four tactics to start with are:

1. Make more sales
2. Collect on payments faster
3. Pay expenses slower 
4. Get a loan

As a quick reminder, “cash flow” is a measure of how much cash you have on hand. Or more specifically, how much is left at the end of a particular month after all inflows and outflows. It may go without saying, but you want more coming in than going out. 

You can improve your cash flow by:

• Increasing sales—both volume and order size
• Negotiating net terms with your customers—aka asking them to pay faster
• Setting up processes for catching and following up on late payments
• Paying vendors less quickly—extending your net terms
• Paying contractors less quickly—say, twice monthly
• Taking out a loan while you catch up on invoices

I recommend getting highly organized around your “accounts receivables” process—aka the notes you send asking for payments, the automated reminders they get, and the steps you follow if they don’t pay on time. Pay serious attention to this. Many owners end up in a feast-and-famine cycle because they’re owed plenty but they didn’t collect.

Read: Cash management strategies for startups → 

8. How will I market my business? 

This is a crucial question. I recommend figuring it out before you launch your venture. Very often, a good idea alone is not enough. Half of small businesses fail in the first five years  and the number one reason is they weren’t making enough sales.

You should become obsessed with the concept of “distribution”—how do you get your products in front of the people who are ready to buy them? It involves a tremendous amount of experimentation.

For example, at my company Kuju Coffee, we targeted outdoor consumers, told the story of drinking great coffee in the great outdoors, and made it a priority to be in all the same places as outdoor lovers (like REI).

You can think of marketing as a Venn diagram. In one circle, there’s what you want to offer. In the other, there’s what your buyers want. Your job is to figure out what’s in the middle! Then turn that into a checklist of actions you can repeatedly take.

Here are a few examples from various industries: 

• As a consultant: Schedule coffee catch-ups with your network. It’s all about people knowing you and you being top of mind.
• As a marketing / creative agency: Post online about your client’s successes. The better you make them look, the better you look by association.
• As a recruiting firm: Market your open roles—it helps your clients, but also tells everyone what you do.
• As a food and beverage company: Do more pop-ups—it’s a great way to get live feedback and test messages while also marketing.

9. How do I know when I need to hire?

Here’s the big lesson many business owners learn: Hiring someone to help won’t necessarily free you up. It might actually take more of your time, at least in the short term, because you need to train them. Unless of course, you’re hiring a very experienced person such as taking on a business partner. 

I would almost always recommend experimenting with contract hires and part-time people first, to reduce your risk. See how far you can get with a virtual assistant before hiring a full-time admin. 

That said, some advice if you must hire:

• Startups: Hire according to a carefully laid-out product roadmap. Hire for specialties—hire people smarter than you to do things you cannot. And only hire when the pain has been acute for a while. 
• Small businesses: Hire when you have the cash to cover their salary for the full ramp period, say 3-6 months. Hiring in anticipation of growth is risky so focus on customer-facing and revenue-generating roles that’ll make you more money.

Hiring someone to help won’t necessarily free you up. It might actually take more of your time, at least in the short term

10. How do I keep track of my business’ revenue and expenses? 

When getting started, a spreadsheet is often enough. But as your business gets more complex, I recommend getting set up with online accounting software since it gives you on-demand visibility into your finances. There are plenty of options out there but the most common is QuickBooks. 

Accounting software usually requires some amount of accounting knowledge to set up, so I recommend finding an expert. I did it myself for the first year, and upon reflection, it was not the best use of time.

If you’re looking for a bookkeeper, Pilot can help you set up QuickBooks as part of our setup process.

What other questions do you have? It’s an exciting journey that you’re on and I would love to keep in touch. Feel free to drop me a note with your thoughts or topics you think I should write about next: hello@pilot.com.