Steps to Start a Business

Although specifically these steps will vary from state-to-state, they should generally be the same:

1)      Write a business plan and a “franchise prototype” operations manual.

2)      Begin forming a professional team – key players include an attorney, accountant, banker and an insurance agent.

3)      Obtain an EIN at irs.gov or use your SS# if sole proprietorship or a single owner LLC.

4)      Select your entity type (S-Corp, LLC, sole proprietorship, etc) and file the appropriate entity paper-work with your attorney.

5)      Get your state sales tax id if you are going to be selling items and collecting sales tax.

6)      Register with your county clerk if you are if you are a sole proprietor, DBA.

7)      Obtain a city business license if you will be conducting business within city limits or if your offices are housed within city limits.

8)      Open a business checking account using either your EIN or SS#.

9)      Depending on your type of business, you may run into other zoning regulations: fire, food handling, zoning, building inspections, etc.

10)   Secure liability insurance and other coverage appropriate to your business using the insurance agent on your professional team.

11)   Build your “accounting infrastructure.”  Either purchase Quickbooks and enter your information yourself or hire a bookkeeper.  Use the accountant on your professional team to help with end of year tax filings.

A Business Plan Outline - click to enlarge

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Building a Small Business That Warren Buffett Would Love,available at Amazon.comorBarnesandNoble.com.

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Below is an excerpt from my upcoming third book My Happy Assets - Taking the Last Steps to Financial Independence.

If you like what you read, check out my first book, My Happy Assets at http://www.myhappyassets.com/ only $3.99 and the complete second book, Small Business Coffee Hour, Three Essential Ingredients for a Successful Business at http://www.smallbizcoffee.com/, only $3.99. Happy Reading!

www.myhappyassets.com

Let's Cover Your Assets

Okay John,” I said, “earlier I said there were four major classes of assets to invest in in the game of financial independence. What are they?”

“Let’s see … I believe rental property, dividend paying stocks, covered call options, and a business. Did I get those correct?”

“Yes, exactly right,” I said.

“Do I get a cookie or a gold star?”

“I also mentioned Buffett-style investing. Remember, Warren Buffett sees the retained earnings of a company as his cash flow in a sense. He uses Return on Equity to gauge his return in an investment. Warren takes a paycheck from his company at $100,000 a year. This allows him to pay his bills and in our world, creates his financial independence. He leaves the rest of the capital in the company to compound, mirroring the strategy of the companies he invests in … they leave the earnings in the company. Warren figures where else can he get a return of 25% a year except in a company that is generating 25% in earnings a year? His financial statements as it relates to cash flow looks like this:”

“Keep in mind that Buffett uses his income from his business as his personal cash flow to pay his bills. The rest he leaves in the business so his business can his assets. Our mission is to get you to the point of financial independence, the point that Buffett has reached with his income, and then you can make the same decision with the excess cash flow. You can reinvest your money to compound and grow a substantial net worth or use it for cash flow. Additionally, Buffett does it through a business that makes stock equity investments in other companies. You can choose to do it through the best asset class that suits you.

How to Get Money Out of Your Investment Property Tax Free Through a Refinance

One of the key things to remember in refinancing an investment property is to evaluate what the cash flow level will be after you refinance, assuming that you are already cash flowing out of the property. 

An example:

You originally bought a $100,000 property that cash flows at $250 a month with a $429 loan payment.  (30 year fixed rate at 5% with a 20% down payment for a principle of $80,000).  After five years, through improvements to the property and appreciation, the property is now worth $150,000.  The bank will give you up to 80% equity in the new loan.  So after five years, you have $76,537 equity in the property:

• You have paid down the original mortgage to $73,463

• The value of the property is now $150,000

• $150,000 – $73,463 = $76,537   

Thus, the bank will give you $61,230.

If you add this new amount to the balance of the original mortgage, your new loan is $134,693 ($61,230 + $73,463) for a payment of $723.  Thus, your positive cash flow of $250 becomes a negative cash flow of $44!:

• The new payment minus the old payment gives us a difference of $294:

• $723 - $429 = $294 

• This difference minus our cash flow gives us a negative cash flow of $44:

• $294 - $250 = ($44)

You may want to consider not refinancing the full 80%.  If you merely did 50% you would still get to withdraw $38,268.50 tax free while incurring a new payment of $600  allowing you continue cash flowing at $79 a month:

• Your new loan is $111,732 ($38,269 + $73,463)

• Thus, your new payment is $600

• Thus, your cash flow is $79

o       $600 - $429 = $171

o       $250 - $171 = $79

Remember, that tax free money equates to $76,537 in earned income since by the time all is said and done, earned income is taxed at 50%.

Real Estate Versus Stock Investing

Ten Advantages of Real Estate

 

1)      Cash Flow

 

The chief thing here is that the property is self-maintaining as far as expenses go.  It is a business model in itself – the income minus the outflow equals the cash flow.  The expenses should first all be covered for the investment to make sense and secondly the property should generate a cash flow in order to add icing to the cake of property appreciation.  When comparing real estate investing to stock investing, it is important to not only compare the national average real estate appreciation rate of 6% to the historic average stock market return of 10%, you must also factor in the cash flow received.

 

In addition, this is passive cash flow.  Although you might have to handle tenant issues or arrange for repairs or do them yourself, your physical presence is not required 100% of the time in order to generate the income.  In the stock universe you would have to generate this via dividends.  Although this is not impossible to do, you must find healthy yields to match the cash flow return you would receive on a piece of real estate and monitor the stock for dividend cuts or “going out of business” drops. 

 

Once your passive cash flow is equal to or greater than your expenses, you are financially free.

 

2)      Control

 

In the stock universe you do not have much control over how the companies you own are managed – unless of course you are Warren Buffet.  Sure you get a proxy vote but unless you own a large percentage of shares, this won’t amount to much.  If you own Coke stock you could buy up all the Coke at your local super market in an attempt to ratchet up sales but I think we would both have to agree this would be futile.

 

In the real estate universe you can manipulate rents, you can screen tenants, you can landscape, you can throw a new coat of paint on the walls, you can physically drive up to the property.  If rents drop in the area by $25 you can adjust accordingly to keep your vacancy rate low.  If they go up, you can raise.  In real estate you have much more control over the investment.  In stocks, you can monitor and maintain control over the buy and sell decisions. 

 

This also seems to comment on the passivity of the investment.  Without a property manager, the more control you exude over your piece of real estate, the less passive it becomes.

 

3)      Appreciation

 

Real estate on average appreciates 6% nationally.  Although this has not been the case recently, when comparing apples to apples I am taking the long-term view for both stocks and property.  Stocks appreciate by an average, long-term rate of 10%.  Real estate at 6%.  Also, the beauty of real estate is that a tenant is paying down the mortgage and essentially buying the asset for you over time.  The problem with the simple 10% versus 6%  rate comparison, from a property investors point of view, is that it does not take leverage into consideration.

 

4)      Leverage

 

If you put $20,000 down on a $100,000 property and it generates $3000 a year in cash flow, what is your rate of return?   It is 3000/20000 or 15%.

 

If the property increases in value by 6%, how much have you gained?

 

Answer:  $100,000 x 6% = $6000.  

 

How much of a rate of return is this over your initial investment?

 

Answer:  6000/20000 = 30%

 

When you add this to your $3000 of cash flow, your true rate of return is $9000/$20,000 or 45%.

 

If you took that money instead and invested it in a stock mutual fund, how much rate of return would you expect?  Answer:  10% over the long haul.

 

Stocks 10%

 

Real Estate 45%

 

‘Nuff said.

 

5)      Depreciation

 

This is one of those lovely phantom tax deductions you get to claim at the end of the year that will turn your rental money into 0% tax money – your earned income is taxed at 50%, your portfolio income or dividend income is taxed at 15 – 20%, your passive or rental income can be taxed at 0%. This is how.

 

You get to depreciate residential real estate property over 27.5 years and commercial over 39 years.  If you cash flow $20,000 out of your property but have depreciation of $25,000, you have a tax loss of $5000 and no tax is paid on income.  Sure, one could argue that the property is actually depreciating and generating a real repair cost, but that should already be factored into your income statement under repairs and maintenance.

 

The Depreciation Equation:

 

(Total Asset Value – Land Value) / Depreciable Years = Annual Depreciation

 

6)      Refinance

 

If you increase the property value you can refinance it and withdraw the money tax free.  Say you finance a $200,000 property and through a property improvement plan (you lower the vacancy rate, you increase rents based on a rent premium for ground floor apartments) the property is now worth $250,000.  You can now refinance the property at $250,000 pay off the initial $200,000 and withdraw the $50,000 tax free.

 

7)      Asset Protection

 

Two things here:  insurance and incorporation.  If a stock drops 50% in value, what protection do you have?  Perhaps a stop loss order or a put option?  If your investment property burns down, what protection do you have?

 

Answer: insurance

 

Also, the second form of protection is incorporation.  Traditionally an LLC has been the most advantageous for property investors.  By placing your property in this bucket you shield your personal assets should any one come after you with legal action.

 

8)      1031 Exchanges

 

You can roll over property gains tax free by buying bigger properties using a 1031 Exchange.  The capital gains do not go away – they are still there.  But, by using a 1031 exchange, you can continue to roll those gains into bigger and hopefully better properties tax free.  If you finish and choose not to hold the last property or roll it, you will have tax consequences.

 

9)      Hedge Against Inflation

 

Because real estate is a tangible asset, it will generally rise at the rate of inflation or higher.  Historically inflation has been 4.1%.  That means real estate, with its average, historical appreciation of 6% has beaten inflation by nearly 2%.

 

10)  A Physical Asset

 

You can actually walk up to a piece of property.  You can inspect it, you can visit the tenants, you can see cracks forming in the walls.  With a stock, in a lot of respects, it exists out in the ether.  Sure if you own Coke you can drink a Coke and you can go visit Coke headquarters in Atlanta.  But the investment truly lives throughout the intricate business model which you do not directly manage.  A property on the other hand, can be managed directly by you.

 

 

To sum up there are many advantages to real estate investing over stock investing and many analysts neglect to make a fair comparison between the two.  Many merely compare the 6% appreciation in real estate to the 10% return in stocks.  What they are chiefly leaving out are the benefits of passive cash flow, leverage and depreciation.  Once these three factors alone are included in the mix, it is clear that real estate has some unique advantages over stocks.  I do not wholeheartedly endorse real estate investing alone.  I believe one must have a diversified investments strategy and for me, diversification does not mean investing in an assortment of mutual funds.  It means investing across asset classes including both real estate as well as stock investing.  

How to Franchise Your Small Business Part Two

Profitability is important.  Again, you are going to have to show a healthy bottom line in the initial business in order to a) successfully sell the model to potential franchisees and b) to even justify the replication of the model – why repeat something that is not working in the first place?

The income you can expect from your franchised business will come in the form of franchise fees, royalties, promotional advertising, vendor rebates, supplies and equipment sales.

You are also going to need to set up “equipment channels” with suppliers.  You need to direct your franchisees to the same bucket of suppliers and set up a contractual discount for the equipment.

Does the cookie cutter already work?  It’s important to already have multiple, successful locations of the existing business before going on to full-blown franchising.  Again, the operations manual must be in place and easy to implement and it should detail how each part of your business works: How are customers greeted, how is the food prepared, what colors are used in the business, what accountability standard is there to guarantee the customer experience is consistent.  Everything must be documented. You also must create training programs for franchise owners, managers and employees.

Online resources are available to provide you with a franchise consultant.  Google on Franchise Consultant and make sure you spend adequate time researching the short list.

It is important that your business have a unique model.  If you own a hamburger stand how does your hamburger stand differ from every other hamburger stand located across the country.  You must have a defined, differentiation factor for your business, detailed in the operations manual of course.

Make sure you register and patent your intellectual property.  You need a good patent attorney to register your trademark and intellectual property to be used throughout the franchise.

Treat the Business as a System 

Summarily, you are replicating the existing success of your business.  Your goal is not to work harder and longer hours.  Your goal is to own the system through which your business model is disseminated.  Thus, you need to step back from the role of hands-on management you have more than likely held and you need to see your role as that of a conductor for the orchestration of the franchising. 

Once the franchise has successfully blossomed and a team is in place, you need to determine how your role can become more and more passive. The key here is that you are receiving franchise fees, royalties, promotional advertising, vendor rebates, supplies and equipment sales revenues due to your franchising.  You are not creating a full time job for yourself unless of course you choose to take an active role.

The Regulations are a Two Way Street

The Uniform Franchise Offering Circular (UFOC) has to be filled out and there are other regulatory hurdles to be cleared.  Although these hurdles are chiefly designed to protect the franchisee, they also protect you as the franchisor should the franchisee begin running the business in a way you disapprove of.

Can it Still Profit?

Remember, a franchisee’s income statement is going to face extra cost that the original business did not: chiefly upfront franchise fees and royalties.  Can the business still make a profit in the face of these extra expenses?

Fees, Fees and More Fees

It’s not going to be cheap getting your franchise model up and running.  You are going to have to shell out for attorney fees to create the UFOC and get the franchise registered, accountant bucks in order to prepare financials, marketing fees to promote the franchise to franchisees, training fees for both manuals and the staff and for other systems to run the franchise.  Depending on the size of the business, this could conservatively run to a quarter of a million dollars. 

How to Franchise Your Small Business - Part One

1) Your Business Must Have Proven Success That Can Be Replicated

Before franchising, Subway had 16 stores with a healthy profit.  They reasoned that if 16 stores could be successful then 16,000 would be as well.

2) It Takes a Team

You need to have a strong team in place.  Each aspect of the operational structure of your franchise needs to be covered.  Someone should be accountable for the Product, Legal, Systems, Communications and Cash Flow.  You need an Org chart.

3) The Franchise Proto-type

How will you replicate your business experience in each location?  First you must have a defined, predictable experience.  You must develop your businesses “franchise proto-type” manual.  This includes your operations/policies-procedures manual as well as an accountability standard you will use to ensure the experience is predictable from product to décor to service to marketing.

The System

There is nothing more important in your business than creating a system that works and then sticking to that system. The system runs the business. People are secondary. They run the system. The system is clear-cut and clearly defined. The system takes all discretion, all opinion, and all argument out of the mix and therefore no decision can be made on a whim or made by somebody whose judgment is affected by a particular mood at the time. The system has been put in place because it works and therefore it only needs to be followed blindly by the people who run the system for your business to work. And you don't even have to be there to watch them do it! You are no longer your business and it will not disappear if you are not there. In fact the system can be - and should be - operated by people with the lowest level of skill (otherwise how could you have another 5000 businesses like it). They only have to follow procedure to achieve the consistent, predictable results which are entirely pleasing to everyone from your customers to your employees. 

The system is the solution to the problems that have beset all businesses since time immemorial! The free time that you've always wanted, that you listed as part of your Primary Aim will now be available to you.

Managers with little management experience, staff with ordinary skill levels, yet the business thrives on a major league basis because attention has been paid to every detail in the system so that the highest levels of discipline, standardization, order and cleanliness apply in a way which guarantees that customer expectations can be fulfilled in exactly the same way on every occasion. McDonalds' Franchise Prototype was a masterpiece creation and it set the lead for others to follow.

“When you start a business, develop it as if it is a franchise prototype: Systematize everything you do in your business, from how you answer the phone to how you handle customer complaints to how you market and sell your products and services. Document the processes by writing step-by-step sequential procedures.”  - Dick McCormick,  Biz Success Weblog

 

This creates across the company consistency.

 

It provides for shorter training times and allows you to cross-train more effectively.

It allows for a less skilled, less costly person to meet your objectives because the process just needs to be followed as laid out.

“Document your processes if you haven’t already. Put them in a procedure manual. BEGIN with your MOST important systems, those that most affect your customers, those that are the mostexpensive, those that are the most complicated and most likely tocause problems or confusion.

Once the system is documented and in place, you can go back and review the process to see if there is a better way of accomplishing the same thing. Periodically ask yourself if you are accomplishing what you want to accomplish. When you review the process, flow chart it. Evaluate the process and determine 1) If there is any step you can eliminate, 2) If you can develop a more effective sequence, 3) If you can physically position things (paperwork, materials, machines or …) for a better flow , 4) If you are duplicating anything in another process someplace.” – Dick McCormick – Biz Success Weblog

 4) Time to Shell Out the Bucks – Get a Franchise Attorney

Yep, sooner or later you are going to have to pay some legal fees.  You need the expert advice of an attorney, particularly one with franchising experience.  You are going to have prepare an assortment of legal documents including the Uniform Franchise Offering Circular to be viewed by potential franchisees and state and federal government entities.  If this guy cannot be your franchise consultant as well then you probably need to find one.

5) You’ve Got Some Convincing To Do

Now you must sell your idea.  It is time to find potential franchisees and present your sales pitch.  You also need to look over other franchise prospectuses and see how they went about the pitch.  You must also follow FTC rules in the creation of the prospectus.

Before It Expires

If the investor's opinion on the underlying stock changes significantly before the written call expires, whether more bullish or more bearish, the investor can make a closing purchase transaction of the call in the marketplace. This would close out the written call contract, relieving the investor of an obligation to sell his stock at the call's strike price. Before taking this action, the investor should weigh any realized profit or loss from the written call's purchase against any unrealized profit or loss from holding shares of the underlying stock. If the written call position is closed out in this manner, the investor can decide whether to make another option transaction to either generate income from and/or protect his shares, to hold the stock unprotected with options, or to sell the shares.

Alternatives at expiration?

As expiration day for the call option nears, the investor considers three scenarios and then accordingly makes a decision. The written call contract will either be in-the-money, at-the-money or out-of-the-money. If the investor feels the call will expire in-the-money, he can hope to be assigned an exercise notice on the written contract and sell an equivalent number of shares at the call's strike price. Alternatively, the investor can choose to close out the written call with a closing purchase transaction, canceling his obligation to sell stock at the call's strike price, and retain ownership of the underlying shares. Before taking this action, the investor should weigh any realized profit or loss from the written call's purchase against any unrealized profit or loss from holding shares of the underlying stock. If the investor feels the written call will expire out-of-the-money, no action is necessary. He can let the call option expire with no value and retain the entire premium received from its initial sale. If the written call expires exactly at-the-money, the investor should realize that assignment of an exercise notice on such a contract is possible, but should not be assumed. Consult with your brokerage firm or a financial advisor on the advisability of what action to take in this case.

What To Do at Expiration
Eventually, we will reach expiration day. What do you do then?

If the option is still out of the money it is likely that it will just expire worthless and not be exercised. In this case, you need do nothing. If you still want to hold the position, you could "roll out" and write another option against your stock further out in time. Although there is the possibility that an out of the money option will be exercised, this is extremely rare. 

If the option is in the money, you can expect the option to be exercised. Depending on your brokerage firm, it is very possible that you don't need to worry about this; everything will be automatic when the stock is called away. What you do need to be aware of, however, is what, if any, fees will be charged in this situation. You will need to be aware of this so that you can plan appropriately when determining whether writing a given covered call will be profitable.

Let's look at a brief example. Suppose that you buy 100 shares of XYZ at $38 and sell the July 40 calls for $1. In this case, you would bring in $100 in premium for the option you sold. This would make your cost basis on the stock $37 ($38 paid per share - $1 for the option). If the July expiration arrives and the stock is trading at or below $40 per share, it is very likely that the option will simply expire worthless and you will keep the premium (in cash). You can then continue to hold the stock and write another option for the next month if you choose.

If, however, the stock is trading at $41, you can expect the stock to be called away. You will be selling it at $40 - the option's strike price. But remember, you brought in $1 in premium for the option, so your profit on the trade will be $3 (bought the stock for $38, received $1 for the option, stock called away at $40). Likewise, if you had bought the stock and not sold the option, your profit in this example would be the same $3 (bought at $38, sold at $41). If the stock was higher than $41, the trader that held the stock and did not write the 40 call would be gaining more, whereas for the trader who wrote the 40 covered call the profits would be capped.

High Yielders for January 2009
Ticker	Yield	Mo CF Per $10,000	Total Capital needed for $1800 mo Passive CF	Total Capital needed for $1500 mo Passive CF	Total Capital needed for $1000 mo Passive CF
PRGN	32.5	$270.83	$66,461.54	$55,384.62	$36,923.08
BCS	28.1	$234.17	$76,868.33	$64,056.94	$42,704.63
PDS	21.43	$178.58	$100,793.28	$83,994.40	$55,996.27
DAC	19.66	$163.83	$109,867.75	$91,556.46	$61,037.64
SFL	17	$141.67	$127,058.82	$105,882.35	$70,588.24
HTGC	16.71	$139.25	$129,263.91	$107,719.93	$71,813.29
DOW	10.63	$88.58	$203,198.49	$169,332.08	$112,888.05
ICF	8.36	$69.67	$258,373.21	$215,311.00	$143,540.67
BDV	7.59	$63.25	$284,584.98	$237,154.15	$158,102.77