Stock Can Help Raise Money But At A Cost

If your new company is in need of capital, stock can provide you with the opportunity to raise money. Owners can then use this money to fuel business growth, allowing them to do things such as:

• Rent an office
• Purchase equipment
• Pay employees
• Pay debts

The downside, of course, is that incorporators are giving up a portion of the company when they issue stock. Each stock is worth a percentage of the company, as pre-defined by the board. However, the stock is also representative of the value of the company. Say, for instance, a new corporation issued stock at $1 per share. They decide to release one million shares. This means that they value the company at $1 million.

As a new company, this is likely not the case. Investors will request to see the company’s financials and realize that incorporators have overvalued the company. So, when a new corporation issues stock, it should be sure that the price per share and total shares are proportionate to the value of the company. Also, owners should remember that the more shares they issue, the more they will dilute their own holdings.

Common Stock V. Preferred Stock

If your new corporation is interested in issuing stock, you’ll also want to consider which type of stock to grant. Owners have the choice of issuing either common stock or preferred stock. Common stocks pay shareholders in both valuation and dividends. Rising share prices will create value for investors. Additionally, common stockholders receive proportionate votes on corporate issues, such as electing directors to the board.

Owners will want to keep this in mind when issuing stock because it can determine the future of the company. For instance, if one individual holds more than 50 percent of the shares that have been released, he or she can single-handedly control the company. So, for instance, if owners wanted to issue stock to raise capital, they should be careful not to provide investors with more than 50 percent of the shares. Otherwise, they’ll give up control of their new corporation.

On the other hand, there could be significant concerns about transparency were owners to hoard more than 50 percent of the shares. This could give the perception that each person’s vote is not equal and that those buying into the company will have no say in its direction because the owners are still in charge. This is a delicate balance that owners should be mindful of when issuing common stock.

The other option owners have is to issue preferred stock. When an individual owns preferred stock, they too own a share of the company. However, preferred stock pays a dividend that’s already been predetermined. The profits that a preferred stock pays are typically rather exorbitant and more substantial than the dividends that common stock pays. The other significant difference is that preferred stockholders do not vote on corporate matters.

The other significant difference between common stock and preferred stock should hopefully never have to come into play but is worth noting nonetheless. If the corporation were to go under and assets are liquidated, preferred stockholders would be able to redeem their shares before common stockholders. This means that preferred stockholders have a better chance of mitigating potential losses than common shareholders.

New corporations also do not have to issue one class of stock exclusively. Many new businesses choose to issue both common stock and preferred stock. The board of directors is in charge of issuing stock, although incorporators may need to provide a breakdown on the shares they wish to release on the Articles of Incorporation.

Is There An Alternative To Issuing Stock

Some owners may not want to give away ownership of the company but would still like to raise capital. In this case, owners may want to consider selling long-term debt in the form of bonds. When a company does so, it agrees to pay investors their money back, plus interest. For instance, a corporation could raise cash by issuing $1,000 bonds with a five percent rate. This means that the corporation will need to pay the investor $1,050 when the bond expires.  

Issuing debt could be beneficial because the government considers the interest that the corporation returns as a tax-deductible expense. Some investors may find bonds attractive because there is less uncertainty than with shares.

Bond-holders know precisely how much money they’ll give, how much they’ll receive in return, and when they can expect payment. However, bond-holders do not vote on corporate matters, so they do not play an integral role in defining the company’s direction. Another critical thing to consider is that the corporation can issue bonds at any time.

Technically, it can issue stock at any time it wants as well. But most corporations elect to only issue stock once, as doing so multiple times dilutes the value of shares that investors have already purchased. If the sole purpose is to raise capital for the company, new business owners could look into issuing long-term debt initially and then issuing stock at a later point when they are financially stable.

Key Reminders When Issuing Stock

If your company decides to issue shares, one of the other critical things to remember is the stock ledger. The stock ledger keeps track of every transaction of shares. It helps promote transparency and could prove beneficial for future investors. A new corporation will want to keep a detailed stock ledger that shows every purchase, sale, and distribution of shares the board has made throughout the company’s history.

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Defining Private Stock

Private stock is beneficial for those corporations who are not yet ready to go public. Contrary to popular belief, an overwhelming majority of United States corporations are private. Less than one percent of corporations in the US are public.

Releasing private stock involves trading ownership in the company in return for equity or capital. If you’ve ever watched an episode of “Shark Tank,” you have likely seen investors and business owners negotiate a “loan” for a percentage of the company. Terminology such as, “I’ll give you $20,000 for a 10 percent stake in your company” is likely referring to a private stock exchange.

This is noticeably different than stock that a public-traded company issues. If a corporation is public, they must first go through an initial public offering. During this time, anyone can purchase shares. Purchasers will likely invest in common shares, which gives them the right to vote at corporate meetings. Public corporations do not have much control over who purchases common stock, while private companies do have control over who buys their common stock.

Raising Capital V. Giving Up Ownership

If a new corporation is private, owners will face a dilemma. They will need a way to raise capital to fund their new operations. However, doing so will likely require them to contact investors who will be seeking a share in their company. Owners must weigh how much of the company they are willing to give up. It’s a common catch-22, in that founders must give up ownership to grow the company.

If owners do decide to issue private stock, they should be careful about how much they release. They likely won’t want to give up more than 49 percent of the company’s valuation. Otherwise, outside investors would have a majority stake in the company, allowing them to determine the direction in which the company will go. Giving up a majority stake in the company could prove your dreams to be over before they even started.

There are some alternative options available, such as issuing long-term debt in the form of bonds. In this scenario, investors provide you with initial upfront capital. The corporation agrees to pay the entirety of the loan, plus interest, upon expiration of the bond.

However, this too has its downsides. For one, it may not be an attractive option for investors, especially if they believe in your company. Additionally, it could be harmful to a new business to add significant debt to its balance sheet in the early stages. Although it could provide owners with capital, the long-term debt could reduce their chances of acquiring money from other sources, such as a bank.

Who Invests In Private Stock

If they are looking to raise capital, many owners first seek out their friends and professional network. If that proves unsuccessful, owners could perhaps target individuals flush with money, such as:

• Angel investors
• Small business attorneys
• Bankers
• Trusts
• Insurance Companies

Even though the issuing is not public, the Securities and Exchange Commission still maintains strict regulations regarding who can purchase private stock. These regulations are not as tight as they are for those going through an initial public offering, but it’s still vital that companies follow them nonetheless. Otherwise, your new corporation could be hit with stiff fees and penalties.

The SEC requires private investors to be “accredited.” This refers to wealthy individuals who make more than $200,000 per year or have a net worth exceeding $1,000,000. Your corporation will not need to file paperwork with the SEC upon completion of the transaction. But, was the SEC ever to investigate your company or if the company were ever to go public, they’d check to ensure that all private investors meet eligibility requirements. This is not a risk worth taking.

What Paperwork Should Owners Provide During A Private Stock Sale

Upon selling private stock to accredited investors, corporate owners will need to provide and complete relevant paperwork. It’s also critical that the business maintains this paperwork in a safe location. The corporation will also need to create a stock ledger in which they’ll log the transactions. It’s perhaps in a new company’s best interest to store the completed paperwork with the stock ledger.

The corporation will first need to provide its bylaws. Many investors will also request to see similar documents, such as a copy of the Articles of Incorporation and the corporate bylaws. This will demonstrate that the business is operational and compliant. High-quality documents can also lend significant credibility to your company.

Corporations will also likely want to provide a Private Placement Memorandum. This document explicitly explains the terms and conditions the company is offering to prospective investors. The best way to think about this document is as a flyer or brochure. The report will highlight critical aspects the company wishes to share with investors. It could also touch on how much capital the company is looking to raise and the reason for doing so.

Once an investor has agreed to buy into the corporation, owners will need to provide a Subscription Agreement. Essentially, this is the contract that between the company and the investor that completes the sale. The Subscription Agreement must highlight how much capital the investor is providing and the percentage of the company they’re receiving in return.

Lastly, the corporation should require the investor to complete an Accredited Investor Questionnaire Form. This serves as a type of “background check” that allows companies to ensure the investor meets the requirements set forth by the SEC. If an investor is not willing to complete this form, it could raise a red flag to the corporation. The Accredited Investor Questionnaire Form can save companies from significant problems in the long-term.

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Why Should You Open a Business Bank Account?

We often hear from owners of single-member LLCs or S-Corps, in which they are the only member. These individuals often express that they don’t feel the need to open a business bank account. They indicate that with online technology and smartphone apps, they can track their business transactions easily. However, we feel as though this is a significant mistake that new business owners tend to make. A business bank account typically provides a:

• Credit Card
• Savings Account
• Checking Account
• Merchant Services Account

Merchant services accounts allow companies to accept credit and debit cards as a form of payment. This is one of the most prominent benefits of opening a business bank account. If you plan on selling goods, this is likely a given. However, those selling services could also gain an advantage from a merchant services account.

For instance, imagine you form an LLC that provides consulting and marketing services. In the past, you may have requested that your clients pay you via PayPal, Google Cash, or wire transfer. With a merchant services account, you provide them with a much more convenient payment method.

A business account could also prove to be beneficial over your personal account because it offers limited personal liability protection. Your personal assets will never be at risk. Additionally, business accounts can help protect your customer’s information. For instance, many merchant services accounts go out of their way to preserve purchase information.

Secondly, a business account is significantly more professional than a personal account. Not only does a business account demonstrate professionalism to customers, but it also does so to employees. For instance, business owners could secure an employee credit card for those in the finance department, allowing them to handle day-to-day transactions. This would not be possible if you were to use your personal account.

Lastly, using a business account could protect your credit. Your company’s credit card may have a line of credit significantly more substantial than your personal credit lines. Plus, if you need to make a large purchase for your company, such as new equipment, you won’t have to tap into your personal credit line. Any late payments will impact the company’s credit, not yours.

What Do You Need to Open a Business Bank Account?

If you would like to open a business account, the first thing you’ll need is an Employer Identification Number. You can obtain this number from the Internal Revenue Service, which issues one of the numbers to each company in the United States. This number is exclusive to your company.

Realistically, you should obtain this number regardless of whether you plan to open a business bank account. The number is necessary to pay taxes and hire employees. However, it’s also required to open a business bank account. The bank officer will ask you to provide this number before processing paperwork. This is the bank’s way of ensuring that your company is compliant. It also links your company’s financials to your tax information.

Once you have secured your EIN, you can call or visit various banks. Banks could also ask you to provide other information, such as your Articles of Incorporation or your corporate bylaws. It would be in your best interest to have these documents on hand when visiting, just in case.

We also recommend that you be upfront with your banker when telling them about your business practices. This will allow your banker to hone in on the best accounts for your company. For instance, we do not believe that companies should manage things such as payroll, taxes, income, and expenses for the same account. Your banker can set up accounts that fit your business needs. Don’t have employees? No need for a payroll account – you get the picture.

What to Look for in an Account?

There are a couple of factors you’ll want to consider when determining which bank is best for your company. First and foremost, you should not limit yourself exclusively to your personal bank. Many entrepreneurs are enamored with their own bank and choose to open a business account there if nothing else other than convenience.

However, they could be missing out on excellent rates or perks when they fail to evaluate all options. Your personal bank could be the perfect starting point, but we also recommend that you assess numerous banks so that you can determine the best fit for your company. Each company’s situation is different, but some of the things you’ll want to consider when opening a checking or savings account include:

• Interest rates
• Introductory offers
• Credit rates
• Early termination fees
• Transaction fees
• Minimum account balance fees

If you plan to open a merchant services account, you’ll need to consider another set of criteria. For instance, you’ll likely want to determine the discount rate, which is the percentage that you’ll pay for each transaction. The discount rate is typically around three percent.

Similarly, business owners should compare the transaction fees, which represents how much they are charged on every transaction. Other criteria include the Address Verification Service fees, monthly minimum fees, and ACH daily batch fees.  

Speak with a Financial Professional

Opening a bank account for your business is a necessary step that owners should take immediately after incorporation. However, the process can be overwhelming, especially since entrepreneurs may not have any experience with business accounts.

The account that you open could have long-lasting implications for your company. We recommend speaking with an accountant or similar financial professional who can provide advice and guidance. This is an investment that many entrepreneurs find well worth making.

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Protect Yourself From Liabilities

As an independent contractor, you expose yourself to tremendous liability. Clients would be able to go after all of your assets if something were to go wrong with a deal, including those not related to your day-to-day contracting obligations. This includes things such as your:

• Savings account
• Personal vehicle
• Home

However, working under the LLC umbrella practically eliminates this. That’s because the business organization is responsible for its own debts and liabilities, even if you are the sole owner and only employee. This, in turn, protects your personal assets were anything to go wrong with a contract. Were your business to have debts, the clients typically cannot come after your personal assets.

Simplify Taxes

One of the most significant benefits that self-employed contractors can gain when forming an LLC is the fact that their taxes will become much more straightforward. LLCs offer pass-through taxation. This means that the owner can claim anything the company earns on their personal income statements. LLC owners won’t have to worry about double taxation, as they would with a C corporation.

So, owners will end up protecting themselves from liabilities without having to give up any income. And, taxes become easier to file because LLC owners merely report a profit or loss on a Schedule C, which they attach to their personal income returns. The Internal Revenue Service, for tax purposes, views LLCs just as they do general partnerships and sole proprietorships.

Additionally, LLC owners can opt to be taxed as an S-Corporation, which would allow them to reduce their self-employment tax. Depending on how much money you earn as an independent contractor, this could be in your best financial interest. We strongly advise you to seek out a trusted account or similar financial professional who can advise you on the tax implications of registering as an LLC.

Credibility

Forming an LLC demonstrates to clients that you are professional and that you take your work quite seriously. Think about how much better it looks if a customer were to call, say, “John Doe’s Content Marketing LLC” as opposed to “John Doe.” This is especially true when the LLC could direct the client on how to wire money to their business account. The bottom line is that other companies will take you more seriously if you form an LLC.

Open A Business Bank Account

Registering as an LLC also allows self-employed contractors to open a business banking account. Currently, you may find it easy to keep track of employment funds. Perhaps you’ve allocated a personal credit card and account strictly toward self-employment income. If so, this is excellent, as you’re already on the right track.  

However, if your business were ever to grow, it would be difficult to add a non-family member to this account. A business bank account allows you to do so. It also allows you to track everything much easier. No longer will you forget small expenses or miscalculate income. With a business banking account and credit card, you’ll have a detailed financial report at the end of the year of all business income and expenses.

We’ve spoken with many self-employed contractors who said that before creating an LLC, they did not put much time into running cash flow statements or similar financial analysis. But once they started a company and opened a business bank account, they found it much easier to calculate figures such as their profit margin.

Also, remember that the IRS can audit you at any time. With a dedicated business bank account, it’s significantly easier to go back and track your financial history during a given year. This becomes much more challenging if you’re using a personal bank account for your business funds.

You Can Accept New Forms Of Payment

One of the other significant financial perks to opening a business bank account upon forming an LLC is the fact that you can accept new forms of payment. For instance, you can allow clients to pay with a credit card. They could also wire the funds to your business account directly. Some corporations have regulations about wiring money to a personal bank account, which is why this would be nearly impossible if an independent contractor chose not to create an LLC.  

You Could Gain New Clients

Lastly, 1099 contractors could want to form an LLC because it could put them in touch with new possible clients. Unfortunately, many companies have grown weary over the past couple of years of using 1099 contractors. This is primarily because the IRS has caught companies using the 1099 designation to skirt employment requirements, such as FICA taxes and health insurance. Now, many companies have said they won’t work 1099 contractors as a result.

Allow Someone To Handle Your Administrative Needs

When forming an LLC, one of the requirements is that you designate a registered agent to serve on the company’s behalf. The agent receives all legal correspondence on behalf of this company. Registered agents could prove to be integral to a company’s success. Hiring a quality registered agent could allow you to focus strictly on business dealings, instead of having to worry about tracking down relevant forms and information.

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