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PRE-STARTUP EFFICIENCY - Series (Updated with part 3 on May 3, 2017)

By Curt Harrington


I.   BACKGROUND:

A.  GOVERNMENT CONFUSION & LACK OF CONCERN FOR INDIVIDUALS

I'm not happy with the assistance and direction given by organizations that purport to "guide" entrepreneurs and startups. Governments (local and federal) dispatch their tax organizations to tell new business to pay tax. They dispatch their labor departments to tell new businesses who they can hire, when they can operate, what wages they have to pay, what overtime rules apply to name a few. Cities, counties and states have devised all manner of permits, licenses, fees, rules, regulations and other barriers to entry. These rules and barriers disfavor startups, and place all businesses in a much more precarious position than they otherwise would be. Lenders and their affiliates can be equally discouraging, either by issuing a soul crushing rejection, or by making ridiculous demands or by stating what they believe to be a minimum amount for a good chance of success.

Some clever government departments offer "one-stop shopping" for business startups, so that the startups can preached-to and warned about all the things they have to do to "comply" with all the many rules and regulations of all branches of government. All of the "guidance" is provided in an un-even-handed manner. As an example, we have been taught and believe that American Citizens can provide work as employees or independent contractors. Yet the IRS has a Voluntary Classification program for facilitating conversion of an entity's independent contractors into employees, but there is no program to facilitate the conversion of employees into independent contractors.

These goals are opposing. From IRS' viewpoint, the presence of an employer to insure that employment taxes were recorded, set aside and paid is positive. To further that goal it would make sense to lower the regulatory demands on employers (so that more people would be willing volunteer to take on the responsibility of being an employer). However, because employers are penalized with regulations that drive up the cost of having employees, and employers often seek independent contractors to both reduce cost and to enable greater flexibility. Employment regulation is only one example of hundreds and was cited as an example having widely known parameters.

In general, government facilitates "signing you up for responsibility", but does little or nothing to relieve your inability to cope with it, and nothing to help you cope with the dozens of systems you may have "signed up for either by making a paper application or by performing some act. For example, once you sign up to enter a state's sales tax system, you are on the radar, assumed to be operating within that system, you will be expected to file returns and will be audited if you do not file. Your activity and profile will be examined, measured and "assessed." A normal steady-state expenditure total for having and running a business would include, rent, salaries, insurance, equipment, tax and regulatory filings.

If someone didn't understand the subtleties of all of the "junk advice" they get from government due to government's communication activities to "help & inform" startups they have a high likelihood of approaching the startup process in much the same way as one would rush into a wood chipper. You see, government doesn't care if you fail. If you could demonstrate that your business could at least survive if it could be free of some rules and regulations, the government couldn't care less. Their real position on your failure is that "you can always bankrupt yourself and start over."

Is it fair? No its not. We have seen Tesla get some outstanding tax breaks from Nevada to encourage Tesla to build its plant there. According to an article in "http://www.theverge.com/2016/2/8/10937076/tesla-gigafacory" Tesla received $1.3 billion in tax incentives, 20 years of free sales tax and 10 years free from property tax. Are the smallest startups able to "get a deal" like Tesla? NO. Startups get "no deal at all." The state will always pretend that they want you to get into business, then heap requirements on you with no plan or logical method of introduction. Then the state will sit back and see if you sink or swim. Bankruptcy is the authorities' method of finalizing failed ventures.

We have too many rules and regulations -- that much is clear. But you would think that the authorities would go a little farther to try and help new startups to choose a path that gives that new startup at least a minimal chance to survive. After all, one more small business owner that has even minimal success is still one less on the public assistance rolls. Starting with "you need to do this," "you need to do that," doesn't help the startup person. More importantly focusing upon borrowing money to have the startup business begin at high volume, only exacerbates the potential disasters that can occur. Starting small can help identify problem areas that can grow from small to cripplingly large.

No one is anxious to tell budding entrepreneurs what to do to protect themselves from lenders, taxing authorities and from government. Government especially will not warn you. No one is presenting a frank discussion of what needs to be done first, second, third, etc. Government and lenders want you to be fully liable well beyond the topic of the business startup and aimed toward bankruptcy should anything not go 100% right.

 

B.   POSSIBILITIES FOR BUSINESS INNOVATION STILL EXIST

In general, the ability for a dreamer to enter business and blaze their own path still exists, but continues to narrow over time. As this society has become more socialist and controlled, there are more restrictions on the paths left open. A major issue for business continues to be over-regulation's role in killing small business and limiting our nations growth. Laws and rules seem to continually surround and then pressurize the citizenry. Example: IRS rules increasingly require workers to be classified as workers while other rules require employers to adhere to regulations requiring them to give workers advance notice of plant closings, time off, strict work time rules and other restrictions.

Each good entrepreneur seeks to enter business for passions related to excellence in manufactured good and provided service. They don't enter the market place to become masters of regulations knowledge. Every moment distracted from maniacally obsessing over the quality optimization of their products and services yields a greater chance of failure. Those that want our economy grow and wish for personal financial reward are in hope of reduced regulation.

Whether we like it or not, excessive regulation is presently a fact of life. But for government to simply take all of the combined details of regulation and punitively shotgun them at people who are thankfully independent minded enough to want to be in business for themselves is not fair nor efficient. Even worse, this method leads to failure from which many people are no longer willing to risk trying a second time.

To make things more ironically worse, the futurists had been promising a brave new flexible world brought to us by the immediate communication available from the Internet. The Internet has brought its own regulation and threats of regulation. Email robots hijack our messages, mischaracterize them as spam and block our communications. Government wants to tax the Internet while it tracks all of the communication and commerce. Computer records are now the main attraction for supplying civil and criminal law enforcement evidence. Its easier to hire help in foreign countries that don't have our oppressive labor regulations. Our youngest citizens move about during the day mesmerized by mobile computing devices that obscure the danger of minimized awareness of the their immediate surroundings.

 

C.   MASTERING THE TECHNICAL (MONEY MAKING) ASPECTS

In my own patent and tax practice I resist the bulk "processing" of potential clients that make initial contact with me. I want to find out about their knowledge of their product, much before they identify what it is. I ask the unit cost for significant production, which is something the entrepreneurial inventor should have a firm understanding. However, the bulk of the callers have only a glint of any of the technical details of a wished-for, predominantly undiscovered invention. Callers often do not see that their "ideas" for products are so unexplored that they constitute little more than a punishment homework exercise for any licensor foolish enough to pay to take it on.

Further, when an inventor finishes an invention, that inventor knows WHY the invention has economic advantage and should be able to quantify the advantageous aspects of the invention. When those aspects are known and form the claims of the invention, the inventor at least has a chance to ask for a monopoly on those aspects of the invention that contain value. A true inventor, looking to capture the wealth represented by the economic advantage of "technically how" the invention is made less expensively and/or of a higher quality, will not fail to master this detail.

For the non-technical aspects of a business, the question might be "why would customers choose me instead of my competitors". Trying to answer this question by sinking an investment to form an overnight business and taking a first guess is economically foolish and personally disastrous. The time for trial and error should be long before business start, if possible. Surveys would be a good start; so would interviews with your potential customers and those close to your future competitors.

Both technical and non-technical businesses should have an identifiable & quantifiable business or economic advantage over existing businesses in the business field they are entering. In some cases the business advantage might be reduced overhead, or a virtual non-full-time work force, or a just-in-time product delivery, to name a few. A person that is only "interested" in an industry can work for someone in that industry, perhaps until they have a depth of knowledge that allows them to identify some economic advantage they could apply upon entry into that business field. Nearly always, a form of obsession is required -- the originator should eat, sleep, dream, think, and worry over the new product or new service about 25 hours per day. Wanna bees never do, and they would do well to just "get a job".


D.   AVOIDING ENTRY ON A LARGE SCALE

This is the core idea of this article. To what extent can activities can be tried on a limited scale in order to facilitate "testing" of the startup BEFORE lines are crossed that invoke liability and insolvency? The following include a series of lists will probably not be on point to your particular startup, but perhaps elements discussed will spawn some ideas that might be useful to you. There are so many of these and they are so non-hierarchically related, that it may make sense is to introduce and talk about them in no particular order, except for the investigation phase and the decision to file for intellectual property rights phase, BOTH of which should occur before actually starting up.

E.   INVESTIGATION PHASE (DO NOT TALK TO ANYONE ABOUT YOUR NEW PRODUCTS OR SERVICES OF THE NEW STARTUP)

(1) Learn everything about the technical details of the product(s) or service(s) your business will concern, including all technical aspects, materials of construction, the degree of automation for each material of construction, how effective the product is, the cost of added capability, identity of substitute product(s) for your product, and the value added for each phase of product production from its raw material beginning to its market display packaged with instructions at the point of sale.

(2) Learn about the expectations for your product to change in future based upon other technologies that can enhance its core utilities, and then try to project an innovation that meets, exceeds and beats the expected future evolution of your product and service. This will be engineering-intensive for new products, and will also likely be market and service oriented for products that have an associated support service.

(3) Learn how competitors in your proposed startup obtain their supply, whether sources can be readily replaced, are foreign or domestic, and what is normally done for second sourcing. The goal here is to learn of ways to help isolate your business from volatility before you enter the market, rather than the much more painful task of needing to change at a time where a change occurs so late that it costs the existence of your business.

(4) Learn manner and distribution topology for competitors in your proposed startup's goods and services, especially with regard to the ones on the rise and the ones on their way out. Is distribution direct, or through distributors? Is there any advantage to self-distribution? Is catalog placement a preferred method? What about Amazon-type websites and Amazon-type distribution (important for avoiding sales tax liability)? Does your industry depend upon maintenance and warranty contracts? How much individualized interaction is required for either sales or service and/or both?

(5) Is the product or service highly custom, highly individualized product, or is it subject to mass production (like coated candies) and it be done in an automated fashion? How much human interaction is necessary to build a loyal customer base? Is the product or service amenable to being supplied in both non-custom and custom forms for special needs? Regardless of whether static custom or static bulk, is there movement right now in the direction of more custom or less custom sales? What are the costs associated with a more custom manner of business?

(6) Can the product or service be conformed to serve the promotional industry? Promotional industry involves give-away of items that produce a marketing effect, either by an advertising writing on the item, or some direction or reminder to the entity purchasing and then giving the item away in hope that the item will generate future business.

(7) What is the minimum scale for entry into the business? Is the product or service of the proposed startup amenable to be supplied with just-in-time supply? Does the return on investment in the industry dependent upon scale of operations? Is it possible to identify factors effectively reduce barriers to entry at a lower scale?

(8) Are greater numbers of competitors entering your proposed startup at this time, or are you potential future competitors dwindling? If competitors are entering how is the product or service of the proposed startup going to be superior? If dwindling, how will the product or service of the proposed startup revitalize the industry?

(9) Find the industry groups and look up and read their publications to learn their controversies and concerns. Become embedded into the knowledge and configurations of the business of the product or service of the proposed startup, while maintaining an enhanced ability to think outside and all around the box in order to maximize the number and quality of strategically superior possibilities for the new business.

(10) Attend all trade shows related to the product or service of the proposed startup talk to EVERYONE and get to know all of the gossip, rumors, potential facts, trends, new products. If the show goes 3 days, 8 hours per day, do 24 hours of talking & write it down. Attending takes time and sometimes money, so every moment should be spent meeting people and talking with them. Discover what catastrophic mistakes have been made. Find out who is leading the increase in market share expansion.

(11) Read and understand security interests (forms of liens securing debt) for the product or service of the proposed startup, so that you will know & understand the rights in any goods you create, import, store, keep as inventory, buy, sell, take on consignment, and much more. As an example, security interests have different rules and different recording locations for real property, patents, copyrights, general inventory, and farm machinery. Find out. Look at what others are doing.

(12) For each potential competitor of your product or service of the proposed startup analyze the quality and availability of raw materials, cost of transport, cost of manufacturing each component part of the device, where improvements could be made to enable a lower price and a higher quality, find out the exact monetary value of an improvement to higher quality, analyze the cost of packaging, instructions, & shipping.

(13) For the product or service of the proposed startup, determine the usual current industry need for insurance for the liability associated with products and liability for consequential damage flows where the current products product or service of the proposed startup could foreseeably affect other products or services. If the new startup will present less liability make a note to pitch for a reduction in liability insurance rates to insurance companies (after startup begins if the product is confidential during pre-startup).

(14) Do a complete after tax profile for every jurisdiction (state, city, county) in which you would be willing to locate your business headquarters and that includes your personal residency. Even if you are closed-minded all but one location, do the analysis anyway as it is important for you to know how much its costing you to be closed-minded. Such a profile may even help you in determining what your competitors actual costs are.  A complete profile includes rental space, purchased space, space improvements, employee wages, worker's compensation insurance, employee leasing, all types of liability insurance, equipment differences, real estate tax (personal and business), personal property tax (personal and business), regulatory & tax filings, and the periodic need for appraisals and inspections to name a few. Many more hidden fees and taxes may exist for each jurisdiction that are not easily known.

(15) Transportation infrastructure may be limited in some locations. This includes the frequency and time required for shipping, receiving, emergency deliveries, overnight delivery, and travel to and from shipping & receiving centers. If the product or service of the proposed startup includes any significant critical time, supply or delivery element, the probability of occurrence of such element needs to be compared to the capabilities associated with the location selected. This can change over time as the transportation infrastructure reacts to growth, shrinkage, or simply management decisions of the infrastructure units.

(16) Geographical customer density should be considered based upon ability to serve an area of customers. Take to account shifting concentration, and the most economic way to deal with customer expansion and contraction along with geographic shifts. Rights in a local office have an expense and deductibility of mileage and other expenses effect.

(17) Does the new product or service impact the best available standards for its function? If it does, getting government to recognize it and then adopt the higher standard that your product or service enables may lead a situation where only your product will be acceptable to be used. Combining this effect with at least a partial monopoly achieved through intellectual property protections could come close to putting your new product or service on a success autopilot. Develop a close relationship with your local assembly member, state senate, congressperson, and U.S. senator to accelerate the standards process.

F.   AT THE CONCLUSION OF CONFIDENTIAL INVESTIGATION AND JUST BEFORE STARTUP BEGINS (DO NOT TALK TO ANYONE ABOUT YOUR NEW PRODUCTS OR SERVICES OF THE NEW STARTUP)

(1) Evaluate the product(s) or service(s) your new startup will use for intellectual property treatment:

(a) Utility patent filing for critical steps or structures will give the startup an advantage. Rights must be obtained from the true inventors. Claims should focus on those advantages. A regular utility patent will be confidential as to publication for 18 months, enabling you to limit and shape the information you give to your competitors.

(b) Design patent filing for any aspect of a unique, fanciful "look" or "appearance" characteristic that the product structures has that will give the startup an advantage. Rights must be obtained from the true inventors. Also consider these for 3-dimensional (2-dimensional drawing) trademark filings later on, and especially after 5 years of sales / use. Consider the focus of each design filing to separately capture rights in each attractive new aspect of the product, & avoid lumping everything into one application.

(c) Trademark. Select a word mark that preferably has 5-9 letters and which is preferably not descriptive in any way, not anyone's name, not a geographic designation, not found in any dictionary of any language, and is not similar to a trademark name of anyone else (remembering that spell-alike, sound-alike, look-alike, names may be considered similar or alike). Also remember that money spent defending an original trademark is not deductible while the ownership of the mark is maintained; that there is personal liability in personally owning a trademark; that capital gain benefits on the sale of a trademark have capital gain value to a flow through entity (personal too, but personal is to be avoided due to the liability) upon holding it for one year; and most importantly remember that the longer that customers linger over advertisements of your non descriptive mark the greater fame it can achieve in a shorter time.

(d) Evaluate the business for trade secret protection steps that involves considering the product, process, customer confidentiality agreements, customer lists, your expected organization and staff, and the procedural steps within your organization to treat the materials you wish to keep secret, as secret in accord with your internal policy. Protection of this category is multifarious, and will require changes to policy as its emphasis shifts and as that which is considered "adequate sequestration steps" changes.

(e) Copyright should also be considered, but keep in mind that for non-music copyrights, that (1) its not an asset in the hands of the creator, (2) capital gain capability requires purchase to establish a basis, and a one year holding period, and (3) that in the U.S., copyright litigation is a "loser pays the winner's court costs and attorney fees" (applies to a registrant plaintiff where filing for copyright protection within a time period after publication was done, and that this rule also applies to defendants usually without any special filing or time periods).

II.   Pre-Startup Efficiency - Distribution & Sales Tax
  
A.    Touching or Not Touching Product

This deals with whether you or your entity has any ownership interest of any product (or service) from the time it is made (or contracted to be performed) until it passes to the final customer. Several liabilities occur if you have "touched" or become involved in the product or service along the way.

(1) Touching Product

First, if there is a lawsuit for products liability or negligence, you or your entity or both may be named in the lawsuit. If you have assets (house, car, bank accounts & more) subject to lien or levy, you may lose them. (The same can happen if you personally own or control the trademark under which the goods are sold --->i.e., whether or not you "touch product.")

Second, if you are in the chain of ownership, you will be highly likely subject to sales tax, predominantly for products, and more rarely for services. This includes your buying or making items and then selling items. A very few number of services may be taxed as if it were a product, so checking a state's obscure rule for your product or service is highly recommended. I will use the word "goods" hereafter with the caveat that it includes services taxed as goods.

If you do "touch product" and are only selling to re-sellers, you will have to obtain and keep on file a current, valid, sales tax re-seller certificate for each and every re-seller to which product is sold. If you sell to the ultimate consumer of the goods, then you are squarely within the sales tax system. If you sell goods to re-sellers that do not provide you with a current resale certificate, you will be treated as if you sold to an ultimate consumer. Without proper and provable records, goods may be taxed multiple times on their way to the consumer.

A common trap, for example, could be a street vendor that picks up an extra case of orange juice for a pal and charges the pal the exact amount the vendor paid for the orange juice. Without a sales tax certificate from the pal on file in the street vendors records, the street vendor is treated as if he sold that case of orange juice at the vendors normal retail price, as many state agencies will fill in the "normal markup" as a presumption. The assumption is invoked even where the sales taxing agency knows the Pal later sold the juice, and paid the full sales tax to the state. The result in this case was that the juice was sales taxed twice even though one of those two final sales included the correct tax for consumer sales.

Unless a tax problem rises to the level of a criminal tax evasion, it will be a "civil" case. The problem with civil cases is that the burden of proof is "more likely than not," also known as ( 51% to 49%). This means that the taxing authorities don't have to prove (as in the orange juice example above) that the goods were sold without payment and collection of tax. If the taxing authority can show that its more likely than not that a sale occurred without either a re-seller certificate on file or a return and paid tax, the taxing authority wins.

Further, there are a multitude of rules that carry presumptions, such as presumptions within each state's sales tax administrative rules. The only way to overcome the presumption that those rules provide to the state taxing authority, is to keep exacting, essentially error-free records. If there are any inconsistencies in those records, or gaps that allow using the rules to create presumptions against the sales taxpayer, the sales tax auditors will exploit them. The continuum between (1) no records, (2) bad records, & (3) excellent records probably has a maximum danger with (2) bad records. Bad records can invite an assertion that they are bad from incompetence or they are bad because of incompetent fraud cover-up.

If the tax authority wins, and if a tax is assessed and not paid, it can THEN move to a criminal level, but the question of whether or not the tax should have been assessed in the first place is generally not at issue -- only the intent to evade the tax. The state takes a well known position that if the taxpayer believes that the tax should not have been assessed that the taxpayer should have challenged it early on in a civil tax proceeding. Generally a criminal proceeding will only admit a challenge to the tax if it affects the intent of the criminal defendant.

Third, the sales tax authorities can apply the previously court-tested and established techniques from its agency rules to boost sales tax liability. They can accuse the seller of "shrinkage." They can accuse a product of having a rate of profit return that is "too low" compared to other products and use that as a showing of "fraudulent shrinkage" in order to construct a sales tax liability for products that you may have never sold, or that were lost through theft. Any lack of records and tracking by the taxpayer will be used against that taxpayer (as is typical).

This means that if you enter the business of "touching product" and selling you will have one of two levels of tasks. There will be (1) a large set of record keeping tasks for direct sales to consumers, (2) a more modest task of keeping re-sale certificates and in keeping detailed sale invoices that completely identify the re-sellers that have supplied you with those certificates, or (3) that prove that your sales were both made and shipped to out-of-state buyers.

Even sales to out-of-state buyers could be a problem if you draw the attention of a particular state that thinks your presence in their state is high enough to cause you to have a "connection" to that state sufficient to hold you liable for sales taxes in that state. Amazon was threatened by California's Board of Equalization and Amazon caved. So, a starting entrepreneur should consider what they might do if they get a letter from one of the states into which they ship product and how they might respond. Considering this before you commit to starting a business may determine which configuration you take.

Fourth, if a startup enters the usual retail sales tax system the records and liabilities created will persist for several last years after retail sales end. Sales might end through the sale of the business, the cessation of business, or even through a switch to a distribution arrangement that relieves the owner of responsibility for sales tax. Sales tax may, for example, have a four year statute of limitation, even if sales tax returns are filed. The criminal statute of limitation might be longer, which encourages many taxpayers to ultimately pay the tax. Even where a separate corporate entity is used, corporate sales tax liability can be assessed against corporate officers many years after the last sale was made and under varying circumstances (See California Revenue & Tax Code §6829 as but one example). But when audits and civil and criminal coercion happens 4-5 years after the supposed acts giving rise to the tax, it can be more than annoyingly dangerous.

A taxpayer who loses or changes business is usually mentally ready to get rid of everything relating to the old experience. This is human nature, but this tendency can be dangerous. Any type of tax can include late audits and challenges. And no taxpayer wants to re-visit the books of a business that they had gotten rid of, even a short time ago. Plus, where there is no current business that can be shown to the taxing authority, it is difficult to give an impression of the state of the business, how and why actions were taken in the past or the extent to which the business was reasonably managed. All of the above comments indicate that a startup owner needs to consider carefully, before opening, the liabilities of a full consumer sale business whether product is eventually touched or not.

The "touching product" option also raises other types of liability, including liability from disagreements with manufacturers, importers, distributors and retailers. It may be important to have a variety of entities that interact with each other to diversify liability and control. Having a sales company for fulfilling orders that is separate from an import receiving company might be desirable. Having a separate company to own and license trademarks might be another possibility. Having separate entities can also be beneficial when configuring a sales system. 

As an example, what if a product had significant manufacturing advantage where savings could be derived from purchasing large quantities of raw materials requiring long term storage, and what if a storage facility became available in Needles, CA that was so inexpensive that a 1% annual personal property tax became acceptable in an efficiency configuration. A separate California corporation owned and controlled separately might be able to provide raw material storage without creation of an interstate business. What if the business owner were a resident of Nevada? And what if the total manufacturing and shipping costs were minimized by selecting Arizona for that function? What if you did business with a catalog online retailer that shipped through Oregon?

Each of the above entities could be configured for net after tax profit maximization. So many businesses set up and then settle in for the long haul. Optimization can produce shifts that can last moments. It is easy to see someone distracted in a movie and miss the threat by becoming focussed on current circumstances. Each business should continually look for new opportunities and test their optimization very periodically.

After all, Tesla Motors didn't just plop down somewhere and start making cars. Tesla Motors knew the value of the tax and location advantages and bargained with the state of Nevada to get long term, in-place consideration. First-time startups don't have this type of bargaining power and thus must recognize that it may be subject to quick changes until it attains a size large enough to exact long term concessions as a prerequisite to its longer term commitments. But every company should always calculate the benefit of every commitment and the cost of every exiting disassociation from every commitment.

In short, when you configure your business to "touch product" you have a great deal more power, and perhaps can control the upstream and downstream flow of product more exactly. You also have a great deal more liability -- through laws related to state employment, contracting, consultants and independent contractors, sales tax, income tax, transportation, inventory storage, product liability, risk capital, response to competition, and much more.


(2) Not Touching Product

Points of control become a bit expanded with respect to the "touch product" category as there is some security in having the ability to see and control the product you are selling. When you don't "touch product", you will usually rely fully on others to perform actions. Contracts and licenses are normally used for control. Your ability to "watch what others do" may become limited. Your right to "watch what others do" will depend upon (a) what others will agree to, and (b) the honesty of those others. This is not to say that the devastation of being cheated is any less when there are more or fewer nodes from which cheating can be carried out.

Cheating

Consider an overseas sourcing to a U.S. retail establishment. Cheating can occur by:

(a) manufacturer makes 4 units for sale to someone else for every unit sold into your supply chain;

(b) manufacturer shares the plans to make your product with another manufacturer and they make a product that looks quite different externally, but has the same interior mechanism and/or principles;

(c) manufacturer you approach says that the product can't be done or that it will cost an outrageous amount, then, after you go away they begin to make the product for themselves;

(d) manufacturer is contacted by someone in YOUR distribution chain to make product directly for them which are exactly the same and blended in with your supply of products causing your volume to decrease, even though the supply chain node has higher sales, and you can't discover it;

(e) someone in your distribution chain keeps two sets of books, and you get to see the set the IRS sees, and that distributor will never show the real books because they are cheating the IRS AND you;

(f) members of your distribution chain are committing "bait and switch" by advertising your product, but convincing customers to take a product of inferior quality and price based upon a pretext of being out of stock;

(g) distribution nodes report damaged articles or returns and are sent back to upstream distributors, and other mechanisms of product flow mismatch number differences;

(h) anyone in the distribution chain can decide that since they are in the business, and if your product is successful, they can have your product made overseas and "blend" it in to your chain, OR that they can simply make and sell a competing product;

(i) someone in the distribution chain reports damage to your product in shipping and gets a phony invoice from a liquidator and reduces your payment;

(j) one or more of your ultimate retailers might approach your manufacturer in order to do one of the following: (1) cut out the distributors, (2) cut you out of the loop, (3) save money on shipping by making a larger shipment, (4) generate a tax reducing foreign cash pool based upon transfer pricing manipulation, (5) finance a separate business entity (likely foreign) to go into competition with your product, to name a few; and

(k) all of the above might be done whether or not you have dozens of patents and the above might occur years before any patents are examined or granted.

Control can be increased by contractually retaining the right to inspect production records, accounts, production inventory, and the production method of the producer. Some producers may not agree to allow it, and others will keep a separate set of books to defraud or mislead many people, not just one person. Further, invoices from the manufacturer, importation sending source, the importation customs broker, distributor, and retail sellers, should all be compared for consistency.

B.   Controls

The best form of control is a combined trade secret and patent agreement that outlines exactly what technical aspects are to be protected (trade secret) and claimed (patent). Two nice effects can be had by doing this in combination. The first is that trade secret agreement can be very broad, and include a scope of coverage against the licensee that signs the agreement that may effectively lock the licensee out of any dealings related to the product or the licensor's later creations. The second nice effect is that the details of the product as embodied in the patents can be increasingly protected over time both as patent claims are allowed and as subsequent continuation-in-part patents are filed.

A second, additional form of control can be derived from trademarks and/or service marks associated with the goods, especially where high quality coupled with the "advance" market head start. Being the first on the market with a product coupled with continual improvements can maintain and sometimes extend the value from "staying ahead of the curve." That is not to say that a competitor cannot offer a different product or service under another name. An entrepreneur should at least not chose a trademark or service mark stupidly to give a knock-off competitor an invitation to mimic a very bad mark. My own rule of thumb guidance is to choose a trademark and or service mark that has (1) no descriptive meaning whatsoever (written or sound), (2) is not found in any English or other language dictionary, (3) not close to an existing trademark or service mark owned by someone else, (4) is not a human's last or first name and (5) is not a geographical designation.

A manufacturing & selling competitor knows that even if they are stealing from a legitimate company's good will, that they especially don't mind the relatively reduced risk of moving close to a descriptive, geographic, confusing, mark that may even be similar to a popular mark of a third party but which doesn't relate to the manufacturer's & seller's goods and services. Competitors know that trademark suits can be a tremendous, inefficient, waste of after tax capital. Competitors also know that a guerilla entity, such as a fly-by-night spot marketer can be extremely expensive for a legitimate manufacturers & sellers to take on.

In a duel, the legitimate manufacturer & seller is risking capital it needs to operate and market. The knock-off artist larceny is based upon spending almost nothing for advertising and benefiting from advertising expenditure of the legitimate manufacturer & seller. In some cases the goods can be completely useless (so poorly made that they break on the first use) and thus they defraud the public and the legitimate manufacturer & seller while subjecting the legitimate manufacturer & seller to public derision. The smarter and stronger that the legitimate company's trademark is, the less likely that the very worst competitors will try to move-in and take advantage.

A third form of control can be obtained through industrial design (design patent) & trade dress protection. The term "design patent" is a term related to external fanciful protection for a useful article that in other countries is termed "an industrial design." Much of the benefit to the term "patent" relates to the fact that it provides for a same treatment for infringement and taxation as a utility patent. Further, the U.S. trademark system can be combined with the design patent system to grant initial protection based upon novelty and non-obviousness of a design, and then transition to formal three-dimensional trademark protection if justified, with such transition facilitated by such initial aegis of patent protection.

Trade dress is a protection for the external appearance of a product that has come to be known as identifiably linked to a source of the nature and quality and identity of the goods' appearance. It arises without registration. It is in effect the ability for consumers to identify the source of the quality of the goods based upon their fanciful exterior structure arrangement, rather than upon function. The classification of physical exterior arrangement varies greatly by each manufacturer & seller. Some use an arrangement of controls on a machine, while others might use a presentation box in which the goods are sold (like a blue "Tiffany" box). It can generally include aspects that are not necessary for the function of the item and is trademark-like in that buyers associate that fanciful (meaning non-functional) aspect of the goods with one particular source.

The fourth main area of control is contracting. The biggest problem with contracting is the reasonableness requirement and the limitation to actual, expected, out of pocket damages. Some say that contracts are deliberately of limited liability because they were meant to be "flexibly used" (thus I avoid the word "broken"). Remember that contracts are used by the courts to either attempt to award the prevailing party the benefit of their bargain that accrued during the contract, or attempt to put the parties in the same position they had before the contract was executed.

Long term exclusivity and punishment of non-exclusive dealing are not dealt with very well in straight commercial contracts. There is an outputs-and-requirements contract, that can be used to give some transactional exclusivity, but it contemplates each party having the capability of output for the contracted-for outputs and the capacity to accept and pay for the contracted-for inputs. Any failure of this type of contract is often measured based upon alternative sourcing or liquidation of product on breach, and thus would seem to at least suggest that the parties line up some form of alternate market or capacity in the event of a breach.

If patent and trade secret factors can predominate in your startup, associated contract provisions should be relatively simple to further enable the startup business to quickly move on to some other party should complications arise. Where patent and trade secret factors are not present, contracts may end up being more bilateral. Bilateral contracts can take more money and time to free the parties up for other relationships that move product. Moving and controlling product is the main goal of the legitimate manufacturer & seller.

When you do not touch product, you are not in the chain of ownership and thus should not normally invoke sales tax liability. However, the relationship that you have with those that are in the chain of distribution will cause the money passing to you to be ordinary income. Tax advantaged capital gains rates may normally be obtained by having a utility or design patent coupled with an exclusive license to some member in the chain from which your income is derived.

However, the sales tax analysis should be performed with several goals in mind, namely: (1) your personal tax liability, (2) minimizing distribution system sales tax liability, and (3) distribution (non-tax) cost minimization. Further, you need to understand whether your direct connection to the distribution system closes off your access to the upstream members of the system. For example, if you have a deal with a catalog company to pay you a personal (ordinary income) royalty for every item sold through the catalog, you may be shut off from inspecting the manufacturing site, shipping warehouses, and much more. It may even be that the catalog company has arranged to benefit from the manufacturer shipping significant amounts of the product elsewhere. Not much more to say than this: Any arrangement that increases you ability to verify and control is better.

Trademark licensing generally always creates ordinary income and it also generally requires at least some inspection of the nature and quality of the goods. To the extent that trademark is an applied sticker with your trademark name, you may have weak protection for manufacturers that sell your product out the back door without the stickers. At the other end of the spectrum, a product housing that includes your mark integral to the mold for the product housing is better. A product that has an overall shape and multiple themes relating to your trademark is even better still as it is a deliberate incorporation of trade dress into the product.

Another topic that is a little beyond the scope of this distribution topic is a startup's plan to compensate entities in the distribution scheme while maintaining some control over retail price. Where a decision has been made to sell on the internet direct, profit will be high, but market penetration will be lower. A long distribution chain with profit to an importer distributor and then to retail may be subject to a direct distribution competitor. Its a delicate balance and there are no easy answers, but it is highly likely that the lowest price will help to keep competitors from market entry. Patents and trademarks can do many things for a product stream, but it should be understood that their power is not absolute and that they provide a differential or "gradient addition" to your deterrent capabilities.

Consider a weak patent that could protect one dollar per item price difference in the market. Assume all other things (Return on Investment, packaging, distribution costs) to be the same. In free market competition you can offer the product for $15 and there will be no entering competitors. Consider that when your price exceeds $16 that competitors will enter the market. Now consider that you have a patent that enables a $16 price and that competitors will enter the market only if your price is $17. Thus the patent has a value differential of $1.

You should not consider any IP as an absolute prohibition that cuts off others automatically. Product can get into the geographic area covered by the IP in many ways. Some ways are undetectable. Other ways are configured so that legal action may be made expensive through the inability to "chase" the infringer. There is also the question of patent insurance cost, and the fact that actions are limited until a patent issues. Trademark is different, but also usually has limits on deductibility and is thus more expensive on an after tax basis. The above example uses exact dollar values for educational purposes only. In reality it is a series of probability curves that can interact with each other in a variety of ways and for a variety of reasons, many of which are not related to the products themselves.

If patent & trademark protection is possible, remember that it is most powerful at points further down the supply chain, because product residency is easier to detect, and because the inventory of products themselves create liability for the infringer. Put simply, proof of the magnitude of infringement against an infringer that keeps no inventory and no records is extremely difficult. Someone from outside the U.S. that plans to move product through different paths at different times (such as periodic drop shipping from different locations based upon orders collected overseas from the internet) would be difficult to detect, and difficult to undo after having occurred.

The ideal goal is to collect a check periodically during the year from which you would currently pay not more than 25% income tax. Its not always possible, especially in the low budget days of experimentation and exploration to see if the startup can be created, thrive all the while being optimized during growth and through its obsolescence stages. It requires "brain to the grind stone" thought, consideration, questioning, and out-of-box thinking.

III.   Looking Out For The Startup Entrepreneur

Index Table Pg
(01) Introduction
(02) Sole Proprietorship As A General Base Case: Debts & Liabilities
(03) Sole Proprietor Relationship with Others
(04) Tax Liability for Sole Proprietors
(05) Knee–Jerk Punishments - For Not Coordinating Timing
(06) Doors Open
(07) Sole Proprietor Attracts the Most Pain
(08) Sales Tax Balancing
(09) Spreading your name about the Possible Liability it Creates
(10) First Specific Example to Begin Thinking about Position
(11)A Basic Example Diagram
(12) Diagram
(13) Diagram Key
(14) Distributed function configuration similar to separate businesses
(15) Ordinary Income
(16) Capital Gains
(17) Allocation
(18) Relaxing the Condition for Every Block to be Separately Owned
(19) Bankruptcy Inside or Out
(20) Insurance
(21) Bankruptcy Effects
(22) Control
(23) Sole Proprietorship Generally
(24) Rent Example
(25) Corporations and Partnerships
(26) Summary

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(01) Introduction

Most people associated with "startup" don't care if you survive or not. Taxing authorities want you to pay tax whether you make enough to survive or not, or whether you lose everything you have worked for. Lenders don't want the startup to survive if they will not be paid back with interest and would just as soon sell your kitchen utensils to pay themselves back. Investors don't want the startup to survive if they won't be paid back in accord with their expected interest, and would be happy to repossess your books and power tools if they could get some sort of gain out of the transaction.

This is difficult to explain because a different business configuration can produce different results. Some of the main problems include personal liability, tax liability, bankruptcy triggering, but most of all control. Each problem is associated with a variety of outcomes. Better resolution of the problems depend upon early realization of direction and guidance to get there. Configurations chosen should be based upon articulable advantages associated with those configurations.

In some circumstances, even the most well thought out arrangements can fail for any variety of reasons. Failure can occur due failure to consider worst case scenarios. One of the more insightful ways to positively affect outcomes is to begin with the ultimate short-circuit that unifies maximum risk and liability, namely the sole proprietorship. The sole proprietorship enables an over-simplification view that can be used to illustrate reasons to take steps to minimize risk and maximize survivability.

(02) Sole Proprietorship As A General Base Case: Debts & Liabilities

Default: "Sole Proprietor Startup Entrepreneur is Liable for Everything"

Just about every entity choice presentation starts with the sole proprietorship example, and then runs through all the forms of entities along with the differences in each one. But in terms of helping startup entrepreneurs look out for themselves, many of the subtle differences in entities with similar protective characteristics is not nearly as important as simply preserving the wealth and continuity of the entrepreneur directors. So many who provide goods and services to startups know that the startup may not be survive the year, will try and talk the entrepreneurs into becoming personally liable rather than help the entrepreneurs look out for themselves. This article aimed at arming startup owners with the knowledge to look out for themselves.

A sole proprietor is a lawfully present human being that decides to personally start a business in conformance with all of the precepts of federal, state, county, & city law (i.e. 100% compliant with all laws). It may be easier to start a sole proprietor business elsewhere than the United States. The U.S. federal tax rate is high (about 40%) and many state tax rates can also be high (California is about 13.3%). Foreign country tax rates may be lower (Mexico is about 30%). Whenever a combined federal and state tax rate is high, a business is likely to generate less money and have greater risk of failure. Failure to survive especially occurs under adverse conditions, where money generated which could otherwise help to insure survival will instead be involuntarily minimized.

Entry into a business involves commitments and costs that will be high or higher at the start of business than while business is proceeding at equilibrium. So, it is more advantageous to time expenditures at startup than later on. Money available for expenditures is reduced by the prevailing tax rate. Choosing a low tax jurisdiction creates a greater survivability scenario.  A high tax jurisdiction, and a high regulatory jurisdiction creates a greater probability of failure. A low income tax rate may be critical for survival. Different jurisdictions also have different rates & amounts for wages, worker's comp, leased facilities, parking, commuting, timing and availability of delivery of raw materials, warehousing, utilities, waste removal, property tax rates, business license, telephone, internet, cost of maintaining a household, fuel (& fuel tax), and special product taxes to name a few. (example: California Lumber Tax).

The above differences can all be expressed in terms of monetary cost. There are other restrictions in which cost is not a factor, either because the cost is standard nationwide or because the restriction causes goods or services to be unavailable. Restrictions may also occur in the same circumstances & places, or because the needed material is prohibited in certain areas. Delivery of raw materials may be much slower in more rural settings. However, prohibitions on availability, purchase and use of certain items routinely used in manufacturing can cause a business to suffer any number of challenges. Some of the bad effects can include being forced to end the business, or switching to inferior components of manufacture that meet state (and federal) requirements. Other bad effects can be controlled by changing the manufacturing location, shipping out and returning product in middle of its manufacturing process so that its forbidden processing will occur elsewhere, or much worse.

It makes sense to consider all the restrictions above that are already in place; AND to try and consider the probability of jurisdictions that might adopt such restrictive policies. Such restrictions are a significant reason why U.S. federal and state governments, by their overburdensome regulations, have effectively awarded overseas jurisdictions with a monopoly for industries that had previously flourished in the United States.

(03) Sole Proprietor Relationship with Others

Considering a sole proprietor as a base case makes a good starting analysis for examining steady state (and quasi steady state) "normal," "legal" environments. This is contrasted by individuals that have ulterior motives for taking action, usually to take advantage of others (such as fraud, extortion, and other illegal actions).

One of the best ways to think of a sole proprietorship in terms of its non-separateness, is to imagine a single person that is an employee of company X (company X is unrelated to jewelry), but who also sells jewelry at trade shows and expos on weekends. Money earned as an employee goes into a personal account. Money earned in the jewelry business could simply go into the personal account, but is better to go into a separate account to make it a little easier to track and file the schedule C at the end of the tax year. Regardless of whether the money is kept in one account or two accounts, as to an outside person, the money that the sole proprietor has in all accounts is at risk of being taken by outsiders (such as a court money judgment that is levied against the taxpayer).

Different outsiders have different rules under which they can take the sole proprietor's money. A traffic accident victim must bring a lawsuit and get a judgement and then collect upon the judgement. A tax authority has the ability to simply levy any account of the debtor (without having to sue) and simply take the money. A bank creditor at the bank where the sole proprietor's accounts are held can take the money through offset and/or recoupment. None of the aforementioned creditors are limited to any bank account based upon the status of the sole proprietor as an employee or as a self employed business owner. There are no limitations on reaching any bank account based upon a made-up name.

If the sole proprietor's employer sues for embezzlement from company X, that employer can collect from both the employer's business and personal bank accounts. A disgruntled jewelry buyer whose skin turns green can sue and also collect from both the business and personal bank accounts. What if the sole proprietor has a local bank account for convenience in a city of the supplier of jewelry materials? If any of the aforementioned creditors find it, they can take money from the account. What if the supplier maintains a separate local bank account as a trust for the sole proprietor? If any of the aforementioned creditors finds it, learns its nature as a trust account controlled by contract by the sole proprietor, any of the aforementioned creditors can get an order to serve on either the supplier or from the bank and also take money from the account.

Any bank, will not help to do anything that benefits you -- AT ALL. If you walk into a bank and ask to open a separate account titled "Jewelry", they will force you to open an account with YOUR social security number. In essence, they make you open a separate personal account, knowing that its separateness of existence has no effect on others.

What if you ran the business strictly in cash, and kept a detailed but separate set of books, and kept all the operating money in a separate envelope? If the business is making money, the fact that you used a dollar or two of other money to get started and paid it back to yourself, should not have any effect. The money in the envelope has to be disclosed as one of your general assets if you declare bankruptcy. Given the fact that the bank will not let you have a truly separate account with its own tax ID number without having to create another taxpayer (corporation, LLC, etc. ), this fact alone encourages the envelope method. This is especially true where California's $800 annual minimum LLC fees are due on an accelerated basis and begin to be paid for the following year (by estimated payment) just a few months after the first year's $800 minimum fee is due. Of course, whether separate envelope or separate bank account, the sole proprietor is liable for every possible liability regardless of the origin and path to that sole proprietor.

(04) Tax Liability for Sole Proprietors

The taxing authorities hold the individual liable for (a) tax liability associated with the sole proprietorship, (b) tax liability as an employee of someone else, (c) a combined highest tax bracket rate from a combination of the income streams, and (d) will typically try to block any expenses associated with employment as an employee from deduction in a sole proprietorship business. Put another way, the tax liabilities for an employee-startup entrepreneur are collective, but the cross advantages that might result from the forced "mixing" aspects of two income streams are limited under the tax rules. Conversely, because the separate sole proprietor business has a higher marginal tax rate, the value of the tax deductions are higher. Another trap, especially if a taxpayer works a job and has a side business, is that the business may be ruled a "hobby," if it doesn't show a profit. If it is ruled "a hobby" the IRS will eliminate the ability to deduct expenses.

(05) Knee-Jerk Punishments - For Not Coordinating Timing

California punishes new business startups in this way. What this means is that the knee-jerk reaction of running out to get an LLC set up can drain funds including an average first fiscal year payment of $1200 and more. A more business friendly approach would only tax LLC's once they had declared a start of business, or filed a tax return. Many LLC's are formed and never used. Even when a business never starts, California still wants $800 per year to keep the corporation alive and functioning. I know of many such LLC's whose ONLY business activity was to pay $800 annually to the California Franchise Tax board, because they have not yet started.

(06) Doors Open

If so many LLC creators and annual minimum tax payers were so premature that business never started, then what is a better threshold to trigger starting business? Our federal tax laws indicate that only when a business "opens its doors" for regular customer service and sales, may it deduct current business expenses. This is a good suggestion, although a simplistic threshold target. Expenses for a new business that has not "opened its doors" generally have to be capitalized and written off over a 5 year period, perhaps shorter. This could mean that taxes, fees, other money for expenses & startup might not even be available to be deducted right away. Putting off or minimizing these types of startup expenses could be advantageous. Is it possible to delay & minimize as many expenses as possible until the "doors are open?" Why not?

There is a lot to do before the "doors open". Don't be so anxious to "open the doors" when there are unperformed, low profile, low cost, preparatory activities that can be done. What is the proper extent of experimentation and market testing that might also occur before business has begun? If these activities were done on a shoestring, can it be said that any significant expenses were occurred "before the doors were opened?" That might depend on the characterization and location of the door opening. Test showings of the product, or limited amounts provided as samples or for sale on a spot-basis might start the status of "in business" for deduction purposes, but might not render the startup to be "in business" with respect to a given jurisdiction. In the beginning semi-pre-sales phase, the more unrelated people you can get to help sample, test market, and become order takers and potential distributees, the better. But it may be preferable to leave yourself out of the chain of privity if possible, but the answer to this question will depend on the identity of the product or services.

(07) Sole Proprietor Attracts the Most Pain

Most of the societal rules tend toward creating liability for the sole human being entrepreneur. That same sole human being entrepreneur can struggle to take steps to reduce that liability. However, at the same time, steps should be taken to avoid multiple, superfluous, and un-necessary entry into a potential liability generating system of a state where you might eventually not operate.

Premature or unintended entry into a tax or regulatory system carries implied presumptions. If you sign up for a state tax permit, isn't it a good likelihood that taxable sales will have been made there? This is especially true years into the future when your records that would provide factual support have been long tossed out. The same might be true for a state trademark, the implication being that the goods of the applicant entered the state at some point in time. A federal trademark listing a human owner carries a strong presumption that the applicant owner had some control of the goods and services sold in relation to that mark. What about securities sales, real estate, insurance? The list goes on and on.

Its natural for someone going into business to want to generate paper work in advance, thinking that they are reducing liability of risk of being accused or charged with taking action before the required paper work or permissions have been granted. In addition, licenses and permits may be relatively inexpensive, and the idea that doing paper work early will help show proof of intentional compliance is a powerful suggestion. Permitting and licensing should be done, but at a time when its certain that the jurisdiction will be utilized. Put another way, it may be more preferable to get permission to do business in a jurisdiction when you are certain that you won't be doing business elsewhere.

(08) Sales Tax Balancing

If a company supplies goods to a single buyer company that does business in two states, and where the two states are foreign to the state in which you are incorporated, you will probably treat the two states as equivalent foreign states. You will ship to them by exporting from your own state and you may probably not act to collect and pay over sales tax to the states in which you are shipping. Most states have a use tax, and you would normally rely upon the buyer to pay its own use tax. If one of the two states is you home state, it can change the picture drastically. Because the buyer company does business in your state, you will likely have to collect and pay over tax for goods you send to both states where the same company is purchasing the goods. If the buyer company is in reality two corporations, one in your state and one in a foreign state, perhaps you can treat them differently if they act independently in ordering.

What if you reorganize to that 3rd state, and what if you continue a selling relationship with the above company? If you have sales tax licenses in the old home state, the old home state might expect that you submitted to that states jurisdiction for all purposes. This means that when you sell into your old state, the taxing authority may expect you to collect and remit sales tax. That pursuing and punitive expectation can rise to the level of a criminal threat. Other combinations are possible. Study the Hyatt case to see the extent that a state income tax agency will go.

(09) Spreading your name about the Possible Liability it Creates

To further stretch your thinking about spreading your name everywhere and prematurely: what if someone is injured using a product your company sold, and there is a common trail of information that implicates your presence in a jurisdiction, either personally or as a corporate entity?
Think about the effect of:
[1] a state trademark registered in that jurisdiction.
[2] a DBA (doing-business-as) filing in that county or state jurisdiction.
[3] a state, city, or county jurisdiction sales & use tax.
[4] a state, city, or county jurisdiction permit to solicit donations.
[5] a state, city, or county jurisdiction business operation license.
[6] Occupational licenses (accountancy, acupuncture, architects, athletic commission, automotive repair & testing, barber, cosmetology, behavioral science, cemetery, funeral, chiropractic contractor, court reporter dental, electronic & appliance repair, engineers, land surveyors, geologists, geophysicists, hearing aid dispenser, home furnishings, landscape architects, medical board, midwives naturopathic medicine, occupational therapy, optometry osteopathic physicians, pharmacy, physical therapy, physician assistant, podiatric medicine, private, post-secondary & vocational school, professional fiduciary, psychiatric technicians, psychology, real estate license, real estate appraiser, registered dispensing optician, registered nursing, respiratory care, security & investigative, speech & language pathology & audiology, guide dog license, structural pest, veterinary medicine & technician, & vocational nurses.
[7] Other various licenses and permits that vary wildly by jurisdiction.

If a startup grows to the size of IBM, the effects of early licensing and registration can be overcome with the excellent records, board minutes, decisions and more that are made deliberately and formally. The problem occurs when the startup is overburdened, and does not keep records. Even worse, it can occur years after the records have been tossed. I've had people call me about audits and assessments on businesses that have been dead over five years. The business ex-owner is reduced to begging and pleading with the tax authority because the paper work has been trashed five plus years ago. The business ex-owner sets about to beg banks for copies of accounts closed years ago, and then sets about looking for every scrap of paper and affidavit from anyone willing to make a statement on when the business closed.

People don't like spending time and money to "wind up" and formally terminate businesses that they are not interested to operate. Winding up a corporation or partnership, surrendering a license, or resigning a professional membership are the ways that society expects things to end. It makes better sense to keep the best records of organizations you quit and resign from because it allows to a best and complete record to be made of the circumstances of that termination. Remember that regular business records made by someone with knowledge at the time the record was made is good evidence because it is an exception to the hearsay rule.

Here is another reason for not signing up to anything unless it is certain that it is necessary. When you sign up for various licenses and privileges and duties, you will have further spread your identity, liability, and presumption of entry. Of course, you may have also spread your money unnecessarily where application fees and periodic annual fees are required. Where you create these identities, liabilities and money spent unnecessarily, there might also be created more time and effort attempting to prove later on that you were not availing yourself of the rights and responsibilities of doing business in those jurisdictions during all the times when you were under official recordation.

Remember, with increased usage of the Internet, any record of your identity and activities is amplified. It may be bad enough that every email and comment sent can be tied to you, as records have become more public, any available filing tends to stay around forever. As an example, a federal trademark filing, regardless of whether the trademark is registered will remain a permanent record. It cannot be removed without an overriding compelling reason. If a business person makes the mistake of applying for a trademark in their own personal name for a time before the trademark is transferred to a corporation, there will be a permanent record that the specifier of the quality of the goods was a human. Since ownership of a mark or is considered to be responsible for defects in the product, the human owner will go on record as responsible for at least some product in circulation. A plaintiff's attorney would be foolish not to name the human found in the trademark record in a product liability lawsuit. This will at minimum require a motion to remove the human trademark owner from any lawsuit filed against the human entrepreneur.

Its not unusual, in cases where a lot of money is at stake (like the Hyatt case) where fights between states develop over the right to tax and tax liabilities for deals that may have been entered into when the entrepreneurs may or may not have been resident in a taxing state.

There are many ways to structure distribution and to diversify responsibility and reduce associated risk. Even where responsibility is diversified, an entrepreneur must set the configuration to survive. Every scenario should be considered. In most cases, the entrepreneur will be in a control position, with control of incoming money (active) or have some tax advantaged controls on the business (passive). In a diversified active structure, having control over incoming cash flow is most important. In a passive structure, where income may depend upon cooperation of at least one other person, a variety of controls should be employed.

(10) First Specific Example to Begin Thinking about Position

One active example with a diverse set of generally unrelated people, can provide strength. For Example, what if the U.S. citizen startup entrepreneur lived in Las Vegas. A licensed a manufacturer in Oregon was authorized to take orders and ship product to a distribution center in Wyoming. Then distributors in each state contact retail stores to facilitate ordering of the product from the Wyoming distributor. As the Wyoming distributor fills orders, a percentage of the orders as a royalty are sent to the Las Vegas entrepreneur. Lets assume that the cash flows are $1 million to the distributor, $300,000 to the manufacturer, and that the entrepreneur receives $200,000 of which $100,000 is from the Wyoming distributor and $100,000 is from the Oregon manufacturer. Oregon manufacturer uses just-in-time production inventory techniques.

A Few of The Possible Advantages:
[1] Entrepreneur probably avoids self employment tax of about $20,500 due to the fact that the business is passively controlled.
[2] Federal ordinary income tax, single citizen, will be about $19,800 if this venture is the sole source of income.(overall 10% federal tax) ( If the entrepreneur were a maximum rate taxpayer, the tax would be $81,000, for an overall rate of about 40.5% )
[3] No state tax because Nevada has no state income tax.
[4] Contracts made with the distributor and manufacturer may include:
(a) outputs and requirement contract for exclusivity
(b) loyalty to entrepreneur's various IP that might include patents, trademarks, trade dress, trade secret, non-disclosure contracts, control and ownership by the entrepreneur of plans, designs, production specifications, variances for different purposes, non-compete agreements, requirements on manufacturers and distributors employees including their identification, periodic refreshing & reaffirmation of these agreements. Insurance is utilized to protect and defend the parties as needed, including bond to insure trade secret and non-compete obligations, possibly including manufacturer & distributor employees
[5] All players are U.S. citizens and thus (a) withholding, (b) FBAR (c) FATCA, & (d) duties don't come into play.
[6] Amount of goods on-hand at the manufacturer can be controlled by contract and thus risk of loss of goods via fire, or court judgement can be minimized. Separateness of the manufacturer also helps isolate and separate the entrepreneur from the manufacturer.
[7] Because the contracts are short term, the ability of the manufacturer or distributor to seize control of the right to produce upon bankruptcy of the manufacturer or distributor is extremely limited.
[8] The distributor is responsible for distributing other unrelated or semi-related products and has responsibility for sales tax.
[9] All other things being equal, and so long as shipping out of any state does not require the collection and remittance of sales tax to the target state (without more definite contacts), it makes sense to ship out of a sparsely populated state to minimize the work associated with sales tax charges, accounting, & remittance only for goods sent to buyers inside the shipper's state. Of course, much may also depend on the size of the distributor and whether they have made any foolish deals with the various states (as Amazon has done).
[10] Where a good control arrangement is made with both the manufacturer and the distributor, the entrepreneur need never "touch product" ( become a part of the chain of privity ). If title to the products is never taken, some additional measure of isolation is obtained.
[11] A trademark held in a separate entity could license the distributor to sell under that name. The separate entity might have only the trademark assets and may appreciate over time, with some limited liability, if the warranties, disclaimers, and insurance policies are set properly.
[12] A trademark held in a separate entity can be used to help the separate sale of a separate line of business. A trademark can help control the product with a buyer that buys the separate line of business over time. Other intellectual property devices can serve a similar function.
[13] With some planning substitution of either the manufacturer or the distributor can be efficiently executed.
[14] The distributed structure can allow sale of a separate line of business to a large or small entity. Control is maintained by three or four points of contact, namely, contract with the manufacturer, contract with the distributor, trademark licensing from a different entity, and personally held patents, if possible.

(11) A Basic Example Diagram

As a second example a drawing is provided to illustrate one possible configuration for illustration & education purposes only. This diagram contemplates a company can obtain products, but not in a "just in time" quantity format. In other words, it has become necessary to order products by the container load such that a single container of products may cost $500,000, as might be the case for foreign imports where the purchase quantity might be a complete container lot. For domestic production, costs may be dependent upon setting up for a minimum volume run. The problem with a stock of goods is that it requires a prepaid investment to acquire the volume, and also may require insurance against theft loss.

An operating company will typically have the highest profile and the highest potential for loss. An operating company usually will have liability to customers, intellectual property liability, liability to suppliers and distributors, employment law liability, liability to banks, credit card merchant liability, and potential antitrust liability. Some of these liabilities will depend upon whether the operating company is selling product to other distributors in addition to selling it themselves direct. Selling purely to distributors will reduce overall public profile, sales tax involvement and reduce price maintenance liability. Selling only directly will reduce the need to plan for price maintenance that would be difficult to maintain with a distributor price discount to enable a distributor to make a profit.

Personal creator trademark(s) ownership has liability because the owner of a trademark is considered the determiner of quality of the goods and services provided under the trademark. Trademark can include (generally going from broad to narrow) a name, a logo (preferably without words), logo with words, geometric shapes, pictures and un-registered rights in trade dress or palming off, to name a few. A good trademark can increase in value to the point it can become a major asset. It may preferably be held within a separate corporate entity. An LLC is often preferred since it enables pass-thru treatment for sale of the trademark, and enables capital gains on sale to flow directly into the pocket of the entrepreneur.

A patent does not typically have an associated liability to the owner of the patent. The patent is enforced by stopping people from manufacturing and stopping a product normally is not associated with product liability. A creator that keeps title to the patent also keeps the potential for capital gains on direct sale. Both patents and trademarks can be used to create increased capital gains on sale, and can be used as security where a business or separate line of business is sold in exchange for time payments, income stream payments, or other types of delayed completion.

Insurance can be important for a number of reasons. In some states, for some business entities, under-capitalization can be an excuse to pierce the corporate veil. Since the operating entity has the highest liability, any cash capitalization represents risk of cash loss. Some non-cash capitalization can be lost through forced sale should the main operating entity have a judgement against it. Where specialized machinery is important, if it is forced to be sold for pennies on the dollar and later replaced, the capital replacement cost will be only a fraction of the cost of re-starting the business. Program files, customizations, leasing new premises, and training are only a few of the additional costs. Anything in a replacement business that is in common with the prior business is one more data point that connects the new business as being but a continuation of the old business.

Insurance can possibly provide for a payout of liabilities sufficient to keep the business going. Premiums are likely to increase, but the payout and increase in premiums take time to occur and an evaluation to continue business in the present form or to make adjustments would be in order. Purchase of insurance is not usually a single policy, but a combination of commercial policies with riders, and other specialty policies. Commercial liability insurance may, in some cases, cover premises liability, some product, liability and more. Specialty policies include patent insurance, trademark insurance, theft loss insurance, directors liability, bonding and many more. Each business is unique in that its insurance coverage configuration is both highly dependent upon its operations, how well it is able to shift liability by a number of mechanisms including contract, isolating the functions of an entity, and by a relation to entities that is tenuous enough.

The diagram is one of many configurations, but it will help in explaining the possibilities for distributing responsibilities, liabilities, and extraction of profit. Note the separation of entities and functions. In terms of isolation, it would be even better if each entity was owned by a different unrelated person or sets of persons, with any interrelationships set by contractual agreement. Each may have its own insurance which may be more inexpensive due to the limited nature of that entities' reach, or more expensive if it is duplicative. Characteristics of each block are set forth in bullet points for a quicker and more complete listing.


(12) Basic Diagram

 


(13) Diagram Key


An IMPORT MANUFACTURE WAREHOUSE:
-Significant volume of warehoused product waiting to be distributed.
-Example: product is economically available as a whole container load.
-Also for valuable raw materials where manufacturing is performed.
-Can hold a significant array of products.
-Multiple Warehouses help diversify potential loss.
-Can be used in conjunction with financing.
-Can employ a 3rd party lien from a lender to help further isolate the risk.

An INTERNET SALES FULFILLMENT block:
-Has a high profile including advertising.
-Is more clearly identified with the product(s).
-Should be kept cash poor to limit loss upon and is the entity that takes in money and delivers represents the main operating entity.
-Is labeled "Internet Sales" because of its internet portability. Other brick and mortar sales facilities may be employed, but must require
(a) different & further isolation entities;
(b) different sales tax liabilities based on situs; &
(c) more real estate liabilities and/or bankruptcy effects.

A TRADEMARK LICENSOR block is shown inputting trademark license rights into the main operating entity.

A PATENT, TM & COMMERCIAL INSURANCE block to the right of the main operating entity block provides patent, trademark & commercial insurance to the main operating entity. Most of the insurance provided the operating entity is likely to be defensive, perhaps with the exception of patent offensive insurance used to financially assist the prosecution of potential infringers. A CREATOR OWNED PATENT block is shown apart from the other blocks to emphasize that it is not involved in the operation and should never be placed into an entity because it destroys the full range of tax benefits for the creator / inventor (preferably the startup entrepreneur ).

A CUSTOMER block:
-May be direct sales to public customers. Sales accounting will involve potential to keep exacting records of sales, sales tax, and remittances where necessary.
-May be sales through one or more national distributors, & expected to eliminate the need for sales tax processing.
-If combining direct sales and national distributors, the potential exists for national distributors to lower their prices and destroy direct sales. This is a problem as price maintenance can create anti-trust issues.

What is the purpose and advantage of this simplified diagram? It can be used to illustrate a number of mechanisms.

(14) Distributed function configuration similar to separate businesses

Potential for separate ownership by unrelated persons. There are rules on "related taxpayers" found at more than one place in the internal revenue code. "Unrelatedness" should be established both inside and outside of the tax code. I each of the Import Manufacturing Warehouse, Internet Sales Fulfillment, Patent Trademark Copyright Insurance, Trademark Licensor, & Optional Creator Owned Patent blocks were owned by a completely different entity, any liability of one block would be less likely to affect the others. These blocks can be set up as separate business with a series of contracts between them. The entrepreneur can choose one or a combination of blocks from which profit may be extracted.

The Import Manufacturing Warehouse block would then become a supplier company selling to an Internet Sales Fulfillment company. A separate Trademark Licensor company might license the Import Manufacturing Warehouse company to produce product under its trademarks and also allow the Internet Sales Fulfillment company to sell products bearing its trademarks. Patent Trademark Copyright Insurance, depending upon what product is being handled and the size of the Import Manufacturing Warehouse, Internet Sales Fulfillment, &Trademark Licensor companies may be separately obtained or jointly obtained under contract. The entrepreneur will preferably own any Optional Creator Owned Patent so that capital gains can be obtained & bolstered for any sale of a separate line of business identifiable within a subset of Optional Creator Owned Patent.

(15) Ordinary Income

In normal operations the Import Manufacturing Warehouse, Internet Sales Fulfillment, Trademark Licensor, & Optional Creator Owned Patent can be configured to extract and pass ordinary income to the entrepreneur that may be passive (to save self-employment tax, at the expense of possibly giving up control of some ordinary business deductions).Trademark Licensor revenue will be ordinary. Optional Creator Owned Patent licensing revenue taken for short terms licenses will be ordinary. Optional Creator Owned Patent licensing revenue for long terms sales of the Optional Creator Owned Patent can be capital gain under operating circumstances, but such arrangement will give rights to other entities in bankruptcy. (See 11 U.S.C. § 365(n)).

(16) Capital Gains

Capital gains on sale may be achievable by the sale of a separate line of business products from one or more of the blocks. Examples include Import Manufacturing Warehouse (molds, specialized machinery, plans, production software),Internet Sales Fulfillment (assets, including advertising contracts, warranty contracts, & 3rd party contracts)Trademark Licensor (sale of enumerated trademarks), & Optional Creator Owned Patent (cash sale of patents held by the entrepreneur).

(17) Allocation

As one example to use contracts to block an entity off, a contracted ownership could entail payment for maintenance to allow a pre-specified profit. What if a an Import Manufacturing Warehouse were set up to provide for purchase of stock at an amount that would pay off a loan from a third party bank, and provide some small profit to the owner of the Import Manufacturing Warehouse? The entrepreneur setting up a given configuration can make choices on ownership for deriving the most benefit, and for setting up contracts and providing a smaller benefit to entities having less risk.

Regardless of the configuration, and especially where Optional Creator Owned Patent is present, possibilities for overseas involvement ranging from license sale to active overseas involvement and exporting is also possible. Details of the structure and relationship will depend upon the character of the product, tariffs, and foreign personnel trust and foreign restrictions.

(18) Relaxing the Condition for Every Block to be Separately Owned

Separate ownership has the best chance for survivability. In terms of choice, a highly passive orientation with strong Optional Creator Owned Patent may enable the entrepreneur to simply occupy this module. Where Optional Creator Owned Patent is strong, then control and negotiating position may be able to supply bargaining power. As between Trademark Licensor & Optional Creator Owned Patent it is best to have Trademark Licensor to be separate and remote so as not to destroy operating capital gains where the patent is sold under a production royalty based upon continuing operations of the buyer.

An entrepreneur can start with a minimum number of entities, but it leaves a residual presumption that control and common ownership continues.

(19) Bankruptcy Inside or Out

A general rule is that when an entity goes bankrupt that it isolates entities exterior to it. The problem often is that its owner is examined closely to see if that entity was drained of resources upon coming under threat of suit or other loss. If it is, a bankruptcy trustee can examine it for a "fraudulent conveyance" action to force the entity or person that took the assets to return them. However, if the Internet Sales Fulfillment entity is kept well drained of assets daily, the ability to mount a "fraudulent conveyance" action will be blunted. Of course, upon initiation of a lawsuit, a decision must be made to stop business in favor of another entity, as every dollar taken out sums into the potential for "fraudulent conveyance" recovery. Further, recent case law has found liability in successor corporations to the extent that they may be clones of entities that stopped business. Therefore it would be a good idea to keep a contingency plan that avoids cloning and provides for some type of changed operation upon the occurrence of a disaster.

Where a bankruptcy of the owners of multiple entities occurs, it is likely that those entities will be sold and auctioned off. Therefore any contingency plan that contemplates the entrepreneur filing for bankruptcy will likely be a disaster. It is further somewhat obvious that diverse, unrelated ownership might provide the best possibility for survivorship of the entrepreneur. In general, the object is to provide fiscal reassurance to the entrepreneur estate while providing a structure that facilitates survival of the business. This objective can be optimized by a mixture of entity relationships and insurance.

(20) Insurance

My own impression of an insurance structure of a single entity is a bit like a layer cake. It occurs in layers because some policies for certain types of insurance can only be obtained with separate insurance policies. The base of the structure should be a commercial liability policy that will insure against product liability, commercial premises (if any) liability, and product defects. Specialized insurance such as offensive patent insurance (to help pay the cost of pursuing infringers), defensive patent liability insurance (to help pay the cost of a charge of infringement by patent holders), trademark insurance (to insure against adopting a bad trademark or a trademark too similar to someone else's similar trademark). In addition there is E&O (errors and omissions insurance) to insure against a corporate's entities mis management & violation of business judgement, and types of bonding insurance to insure against embezzlement, non-payment of payroll & withholdings. Another form of insurance rule has been slow in completing is the "PEO" designation by IRS which enables payroll companies to be treated as if they are the employer for failures in payroll. This "PEO" statute was passed, but the mechanism needed for it to go into service has not, as of the time of this writing, occurred.

Where the type of business is patent heavy and has other signs of assurance of payment, the use of a license-sale can enable the entrepreneur to be completely passive. The patent will typically be licensed to either the manufacturing or sales function. Further, if the patents are strong enough to enable the owner to comfortably remain completely passive, there would be no need to have concerns about owning, controlling or configuring any of the blocks in the figure. The patent owner need only license, preferably from a no state income tax state, and thus create an income stream in which the startup entrepreneur receives checks personally as capital gains and might pay a personal tax rate of 0%, 15%, 20% or 23.8%, instead of the usual maximum 40% for a federal tax rate.

Such a configuration has advantages (keeping the startup entrepreneur out of the line of privity, out of the state tax systems, out of shipping, and at a low income tax capital gains rate) and disadvantages (not as much control over the product, not as much control over policing the market, and no ability to deduct operations and sales expenses).

(21) Bankruptcy Effects

Two main bankruptcy effects for the startup entrepreneur involves (a) the ability to continue control of a product when bankruptcy occurs, and (b) the ability to preserve personal assets and wealth, should a bankruptcy occur.

Licenses between licensors and licensees can be affected by bankruptcy in that they can enable license contracts to be broken against the will of the startup entrepreneur, or can enable others to maintain license contracts despite the wish of the startup entrepreneur to have them discontinued. The type and duration of licenses can determine how they are treated in bankruptcy.

Asset preservation can depend upon the business form. For sole proprietorship, the business cannot be placed into bankruptcy separately without also putting the individual into bankruptcy because the business does not exist as a separate entity. The possibility of bankruptcy of the individual places the assets of the business at risk of being distributed to creditors, either as a going concern or broken up as assets. Personal bankruptcy occurs typically without loss of the ability to continue as an employee (although some professional licenses can be lost or suspended).

(22) Control

Civil actions arising out of divorce can be even more devastating. A spouse can garnish wages and be awarded orders to turn over income earned by the sole proprietor business. A spouse can even get an award of the business outright and divest the sole proprietor of ownership. Spousal support and child support can be formulated based upon a level of projected activity for the business. Any circumstance that takes the sole proprietor away from an ability to supervise the business or work as an employee will cut the sole proprietor away from both streams of income. Even if it is possible to hire someone to operate the sole proprietorship, there will be a loss of profitability, and likely no way to prevent the hired employee from going into business for themselves. Non-compete agreements may not do much to help due to lack of general enforceability or the ability of the non-competition agreement signer's ability to have others to do the actual competition on the agreement signatory's behalf.

Although a sole proprietorship gives the best absolute control over a business in times of owner good health when there is no outside liability, bad health and crisis can result in loss and destruction of the business. Commercial liability insurance is a necessary expense to at least partially defend against some types of liability, but will generally not be effective against owner incapacity or insolvency. With a sole proprietorship, keep in mind that from a creditors perspective, an owner's total wealth, health and well-being are not segregable. Any shortcoming can put everything at risk, and that is what most creditors want. The sole proprietor debtor must keep every aspect of their life solvent and above the insolvency level or they could be subject to losing it all at once -- to the creditor!

(23) Sole Proprietorship Generally

Sole proprietorship is a non-separate business a person runs for themselves personally. A single member LLC is taxed like a non-separate business a person runs for themselves personally, but it can act as a shield to protect a person's personal ownership of money and goods from being taken by execution of judgement. The main tax benefit being that a separate tax return for the single member LLC entity is not required, saving the additional work and time spent preparing a separate additional return. The state charges money to keep the separate LLC entity alive and in effect.

A single member LLC is a separate Entity that the entrepreneur owns outright. Think of a corporation or LLC as examples, but for simplicity lets first assume a single member LLC. There are differences between LLCs and other entities from a tax standpoint that may need to be explored in detail. An entity that is treated as a separate person may act on its own behalf generally. If it is owned by the creative entity, there is some limited basis for providing some separate protection from creditors, but the separate entity can be accessed by any number of ways.

Because the creative entity (typically a person) owns the separate (LLC) entity, any mechanism which transfers ownership of the separate (LLC) entity to an outsider places the assets of the separate entity in the outsider's hands. Absent insolvency, judgement, & bankruptcy, the separate entity's actions are likely to be considered its own. What this means is that so long as no court filings occur, and so long as there is no agreement that short circuits the separateness of the separate entity, it will be as if the separate entity were a completely different person. But note, that IRS rules can treat a normally separate entity as being related for tax purposes, if the right circumstances are present.

One of the big insolvency-related LLC problems involves taking money out of the LLC entity at a time when insufficient funds are left to pay debts, including tax debts. A transfer from the separate LLC entity to the creative entity (typically a person) where it can be shown that the transfer caused the separate LLC entity to become insolvent by the transfer, can be reversed under both bankruptcy and state fraudulent transfer laws. However, during the life of the LLC, it is good to make sure that the balance at any given time is kept as low as possible as anything owned by the LLC could be taken in a lawsuit or levy by tax authorities (especially state tax authorities in the case of an LLC). Keeping the LLC with minimum cash balance, but above solvency, is recommended.

However, to the extent that a separate entity and the creative entity (typically a person) have NO common involvement, the separate entity will generally not be reachable by someone contracting with the creative entity. In bankruptcy, contracts can be taken over and sold, but if the contracts are short (less than a month or a week) they will not practically be taken due to their expiration. If an LLC is treated always as if it is disposable, as if it is about to go away, and keeping it without cash or assets in advance and long before any liability established, the chances of fraudulent conveyance law forcing money to be put back into the LLC is minimized.

(24) Rent Example

An example of keeping an LLC lean might include a creative entrepreneur that creates and owns an LLC that contracts for office space. In that event, the LLC is responsible for the monthly rent, and not the creative entity that owns the LLC. By comparison, a sole proprietor that rents offices is personally liable for maintaining the monthly rent, including liquidation of the sole proprietor's non-business assets (home, car, savings accounts) to pay it.

Where a separate entity contracts with the landlord and fails to pay the rent, the landlord can normally look only to the LLC for the rent. Where the LLC has insufficient funds to pay the rent, the LLC may be technically insolvent & dead. If it has money in its bank account, technically that money belongs to the creditors and the creative entity (typically a person) cannot drain its accounts. If no money is kept in the bank account at the time the LLC incurs a liability, the LLC may be essentially finished (in some states), and only the formalities of wind-up or bankruptcy for the LLC might remain. This provides some protection to the landlord in that an LLC tenant may not simply continue business without paying rent and it also gives the landlord some rights in the LLC's bank account to the extent that it had money at the time a particular rent charge was due and owing. Liabilities that occur after the LLC's bank account has actually been depleted may leave the creditor an inability to be paid. Any money taken out of the LLC's bank account that either causes insolvency or worsens an already present insolvency may result in fraud and a collection suit against both the LLC and the LLC's owner.

Many entrepreneurs that form an LLC to rent business premises let themselves be seduced or brow-beaten to the point they believe that they have no choice other than to make a personal guarantee to the landlord. This occurs even in cases in which the lessee is the entrepreneur's separate corporate entity (such as an LLC). If this suicidal business practice is followed, then as to this transaction, what would have been the object of creating a separate entity for liability insulation to begin with? Why should a lessor have more than one person or entity "on the hook" to pay any amount to be charged or owing for rent? One occupied premises and a single renter can help keep the transaction honest.

There are many examples of contractual relationships that can permit the continued accrual of liability long after one party has left the scene. What is to cause a landlord to be more active in finding a replacement dead tenant if the landlord has a second and third party liable for the rent? Another example is liability for homeowner association (HOA) fees, that may continue even after bankruptcy where the title in the property is not changed to another entity. Does anyone ever stop to consider what charges would continue for automatic credit card or bank withdrawals after a person dies?

Periodic payment arrangements are a real problem and are made even worse by multiple guarantees. It creates a great deal of work and a huge urgency for someone to clean up and shut off payment arrangements and guarantees, and at the worst possible time. No one should agree to anything that has the potential to unleash such exigencies. A normal month-to-month single lessee payor arrangement has enough possibility for continued liability.

(25) Corporations and Partnerships

A multi-member LLC, a limited partnership, a corporation, a corporation with S-status, to name a few, are separate corporate entities both from a tax and non-tax viewpoint. This means a complete set of tax returns for each entity, along with other considerations. Multiple entities owned by one creative entity (typically a person) can suffer a requirement to be listed as a controlled group. One of the main reason to use entities is to maximally insure that complete separateness is maintained. Separateness can prevent a lawsuit against one entity to create liability in the other entities. State jurisdictions under which entities are formed may present the possibility for piercing the "corporate separateness" of any given entity based upon state or federal law. Even the bankruptcy courts in their generally pro-debtor stance, have, at times, declared "new corporate entities" equitably to be a continuation of old fraudulent entities and punish the activities of such "new corporate entities" without a fresh presumption of innocence.

Keep in mind, however, that a simple partnership offers little or no protection as the members of a partnership are liable for the debts and liabilities of the partnership, even if its possible for delay through the use of a "charging order" in some states.

Even the existence of an imposition of controlled group could affect piercing potential depending upon the state of incorporation and/or operation. In a given arrangement of entities, there might also be a propensity toward sloppiness in lieu of keeping operations separate. The payment of a first corporation's bill with the check of the second corporation (such as for convenience) could destroy the separate character of both. But at the other end of the spectrum, where different the creative entities (typically persons) have completely different corporate affiliation, attempts at veil piercing, fraud, common motive, controlled group and transfer pricing (to name a few) begin to become less likely.

(26) Summary

The main idea is that as the startup business is built, (1) don't act prematurely to subject yourself to exposure and affiliation with a jurisdiction; and (2) try to build a startup business that will survive the worst possible lawsuit or liabilities against all related entities, and plan survival through a combination of entity differentiation and insurance.

 

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