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LAST UPDATE: 2/16/2014

The Advisor
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MONEY, FREE FOR THE ASKING
by Eva Rosenberg, EA
Copyright (c) Eva Rosenberg, August 2, 1997
First Publication: Tripod.com http://www.tripod.com/money/taxbytes/

Painful Lessons

I've watched people struggle through the quicksand of trying to raise funds via promises from venture capitalists, run the hurdles of SBA loan applications, produce mounds of paperwork for bankers, all of whom ultimately turn them down.

These processes teach some people an enormous amount about their own business and industries by forcing them to create detailed business plans. Others gain nothing but bitterness and foul tempers. However, many of the those who develop thorough plans, go on to great success, despite the financial obstacles placed in their paths.

Quick and Easy

What's if you don't want to waste your time with all that nonsense? Is there a shortcut that can provide you with risk-free money? Money that you don't necessarily have to pay back? Tax-free money to use 100% to grow your business? Money that could make you substantial profits? If there is, then let me at it!!!!

The source is called "INVESTORS." I know. You think it's complicated and risky and how do you go about gaining their confidence and what's if they lose all their money, you'll feel so guilty and responsible, you'll never sleep again...

OK, so let's re-phrase that - "SMALL INVESTORS." No more than $1,000 - $2,500 per person. You'd be surprised how many people would be willing to part with a such small sum for the opportunity to make 2,3,10 times that much money. And with a sum that small, if you fail, no one person has lost so much that it hurts.

Step right up! Everyone's a winner!

If you already have a small business, you have satisfied customers, clients, patients, etc. If you approach each person face-to-face, many people will be pleased to pop for this small sum. In addition,
 

  • $$ It gives them a vested interest in your success ~You succeed - they profit.
  • $$ You will be their vendor of choice for your product or service.
  • $$ They will be more eager to send you referrals.
  • $$ They will be more eager to open doors to better, less expensive suppliers.
  • $$ They will spend more money with you at each visit or opportunity - because they are investing in themselves!
At the Starting Gate

If you are just planning to start a new business, then you'd darn well better know who your customer base is going to be. (Do your marketing research. That business plan isn't such a bad idea, either.) Otherwise any money you do raise will be run out surprisingly quickly - before you make your first sale.

Once you've targeted your market and suppliers, go talk to them about investing.

Getting Greedy

Your main problem will be that several people will offer you more than the small $1,000 - $,2500 investment. Why is that a problem? Because, as long as the investment is insignificant you have these advantages (not necessarily in this order):
 

  • $$ No individual owns enough of your company to tell you how to run it.
  • $$ No one person loses enough money should you fail to hate you for it.
  • $$ It takes too many people to band together to oust you from your own company.
  • $$ The more people who invest, the more additional business you can generate.
  • $$ You don't have to sell enough to lose a controlling interest.
  • $$ With such a small investment, you can give each person a very small Portion of your business
What's The Payout?

How much you raise depends on the form of your business. You can raise a few thousand dollars to a quarter of a million dollars ($250,000) or more, with as few as 100 investors! (I'll just bet you know 50 or 100 people you can convince to part with a few measly bucks.) Convincing 50 - 100 people to participate should take you less than two months.

Needless to say, (but I will anyway) sit down with an "Investment Team" consisting of a skilled tax professional, a business attorney and a business insurance broker to plan out the optimum business format at the lowest cost and risk.
 

  • $$ If you create an S-Corporation, depending on the state you're in (California is still limited to 35 shareholders), you may get 35-75 shareholders without any complicated SEC filings. That translates to $35,000 - $187,500!
  • $$ If you form a General Partnership (GP), which is the easiest and cheapest business entity, you have unlimited partners. The main problem with a GP is that all the partners are responsible for all the business's debts, errors, lawsuits, etc. So, this is not a wise option.
  • $$ However, a Limited Partnership (LP) has all the benefits of a partnership's simplicity, but limits the investors' liability to the amount of their investments. This was a very popular format for the popular "Tax Shelters" of the 1980's. As before, check with an attorney about the limitation on the number of partners in your state.
  • $$ Another popular new vehicle is the Limited Liability Corporation (LLC). The main danger with LLCs is that if your business crosses state lines (or operates on the Internet, which crosses international boundaries) you may not have limited liability if you do not comply with the specific laws of each state, country, principality sheikdom or other national entity. For example, in California, LLC's are quite a nuisance to set up an operate. California even charges a tax on the Gross Income of the company. That means, even if the company lost $50,000.00 it might have to pay the benevolent State of California $1,300 if its sales were as little as $250,000.00.
Bottom Line

If each investor gets stock, you can give them each one share per dollar ($1 par value) You can raise $250,000.00 by selling 250,000 shares of stock. Sounds like a lot? Not if you issued 1,000,000 shares! You will still own 75% of the company. (Or you can issue one share per $1,000.00. Then you sell only 250 shares, but issue 1,000 shares to achieve the same ratio - depending on state's/SEC laws.)

This is such a simple way to raise money. It just takes some guts and little Chutzpah. But, if you can't sell the people you know on your own business, how can you ever expect to have sold the SBA, the banks or venture capitalists? Nu, so what's stopping you from raising all the money you need?

Worried about tax consequences?

No matter what business form you create, all the money you receive will be capital or equity. You pay no taxes on those funds. You can transfer a sole proprietorship's assets to most of those entities without creating any tax consequences. However, if you transfer assets (equipment, cars, buildings) with loans against them into the new business, you might face cancellation of indebtedness income. So just use your new-found money to pay off the loans before transferring them.

Another little tax benefit, even though your profits may increase, you'll be able to share the tax burdens with your new partners. Just be kind and distribute enough draws, dividends, or repayment of capital so they can pay their share of your business's taxes.

Keeping My Promise$$$

At the beginning of this article I promised you three things:
 

  • $$ Risk-Free Money - small investors understand that they can only lose small. Nobody gets too upset over small change. DO NOT approach anyone to whom $1,000.00 - $2,500.00 is a significant sum!
  • $$ Money you don't have to pay back - funds used to purchase stock or shares of partnerships are not loans. They don't have to be paid back if the company shuts down. However, if you make a profit, you will share it with your investors in proportion to their ownership of the company. (If you can double your profits, I am sure that you would not object to giving away 25% of your windfall to the people who made it possible. You would still be at least 50% ahead.)
  • $$ Tax-Free - we just talked up about that up above. All the money is capital. So you can use all of it for the growth of your business. The legal and accounting costs are minor in comparison to the cash flow you receive.
Just a bit of legalese

First of all, remember, this is a just an outline of an idea. Not all the tax and legal benefits and pitfalls can be covered in such a brief column (in fact, it's already too long). So, seriously, get some good professional advice specific to your business.

Raising money from private individuals with whom you are personally acquainted or doing business is called a private exempted offering. There are rules to follow to make sure you don't fall afoul of the SEC and the U.S. Securities Acts.

Before you even talk to potential investors read the information provided at the following sites. Then, you'll have an inkling of what questions to ask your Investment Team before you go promoting.
 

  1. Private Offering Overview http://www.eifn.com/privover.htm
  2. Private Securities Offerings on the Internet by Michael D. Stovsky http://www.cyberlaw.com/privoff.html
  3. Excerpts from GOING PUBLIC 101 A Guide for the Perplexed, by Jack Ben Ezra http://www.benez.com/capscape/101.cfml
For sources of U.S. government funds and other resources, you might want to read the new 4th edition of : Free Help From Uncle Sam to START YOUR OWN BUSINESS or Expand the One You Have By William Alarid Contact: Puma Publishing Company 800-255-5730 or http://pma-online.org/list/2083.html - Puma Publishing

It contains excellent resources and contact phone numbers for money, bidding opportunities, licensing, trademarks, data sources and international trade. I am still plowing my way through the wealth of data it contains.

Endnotes:

    1. SEC = Securities and Exchange Commission. They have stringent rules about public offerings and publicly traded investments.

    2. Within reason. At some point, you start facing SEC issues again - speak to an attorney for details.

    3. Tax Shelters - They have a bad reputation primarily because so many promoters used them simply to create fraudulent tax reductions. Many of the ventures never had a profit motive. The investors not only lost all their investments, but faced severe tax penalties, which often cost them two or three times their original investments.

    4. California's Franchise Tax Board charges a minimum $800 for all LLC's, LP's, Corporations, etc. Only general partnerships and sole proprietorships don't pay. So, LLC's will pay the $800 + $500 gross receipts tax on $250,000 = $1,300.00.

(Eva Rosenberg, MBA is an Enrolled Agent in Encino, California. A frequent guest on radio and television talk shows, she is also a sought-after speaker on tax and small business issues. Her practice focuses on small business, non-filers and problem tax audits. Please submit questions to evarose@earthlink.net. If you have questions about commerce on the Internet, Eva moderates the I-Sales Help Desk. For a free subscription, send a message to: i-sales_helpdesk@gs2.revnet.com with the word - subscribe - in the body of your message).



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