Tax Tips for Pre-Revenue Startups
Generally speaking, entrepreneurs launch businesses with the goal of the company breaking into the black at some point. Positive cash flow and then going revenue positive is a crucial milestone for any startup. It can be a bit daunting to figure out how to handle the money once your firm has earned it. What strategies and tax tips for pre-revenue startups would be wise to use? How can you, as an entrepreneur or an accountant, help startups transition from pre-revenue to revenue mode?
Enter the accountant to save the day. Most accounting professionals know of their status as business Swiss Army knives and trusted business advisors. Entrepreneurial founders making their first foray into business management might be a bit in the dark about the myriad of ways that accountants can help set up shop. A good accountant’s skills include a little bit of numbers, a little bit of regulatory whiz, and a little bit of therapist. Just as early hires at a startup often find themselves wearing many hats, the modern accountant’s multifaceted approach to financial management can help guide startups on many levels and prevent many issues. And while neither entrepreneurs nor accountants can say with any certainty how balance sheets will look in the future, an accountant can help a founder be ready for whatever comes down the pike.
Tax Tip One - Recognizing Future Revenue
Before a startup can take steps to prepare for going revenue-positive, a business needs to know at what point that will happen. For companies that invoice clients, sales numbers do not necessarily equal cash flow. Accountants can guide small business owners on developing payment terms. Terms provide leeway to create and retain a customer base yet provide steady cash flow into a company’s coffers. Getting a process in place to follow up on outstanding invoices can help ensure that cash is, indeed, coming into the business. You must have profits and money to ensure that your other business expenses get covered.
A primary concern during normal times is occupancy costs. The costs of an office space or warehouse can be a significant cash flow concern. Many see this expense as expendable now that thee COVID-19 pandemic forced a period of work from home. Re-thinking the need for office space is especially true for companies on the cusp of going revenue positive. Commercial leases are for five to 10 years. Even with a few months of rent abatement during the pandemic, those back rents eventually come due.
Further, rents tick upward every year by a few percentage points. Many new entrepreneurs might not realize the impact of proper accounting compliance with a lease. If you lease a place to do business with the option to acquire at the end of the lease, IFRS guidelines for GAAP compliance requires creating a lease schedule. This schedule provides the total amount due each month and the appropriate depreciation and interest expense.
Tax Tip Two - Predicting Business Expenses, Now and Later
Speaking of property rental, when going revenue positive, startups must take steps to ensure their investment. Part and parcel of that protection are paying for business insurance, such as general liability coverage and owner’s insurance. Most of these costs are incurred and paid for either upfront or monthly. However, it would be best if you amortized them over the life of the policy. An accountant for a new startup needs to set up the books so that the business’s profit and loss statements don’t take the hit for an entire year’s worth of insurance in one month.
And some business expenses are just an exercise in predicting the unpredictable. Imagine you just launched a new Etsy store. There are lines on your cash flow sheet that make sense to an entrepreneur. Amid the stress and excitement of running a new business, an entrepreneur might overlook expenses such as office supplies or raw materials for creating the inventory items for sale. Also, depending on how much you are selling, your shipping costs might go up or down.
Negotiating an appropriate volume rate can save you big money. If you negotiate incorrectly, what you first thought might cost $8 to ship might cost $22 or vice versa. For most businesses, that kind of change in a material cost-line item can make the difference between being profitable or breaking even. It could make the difference of losing money on the sale. Frequently, this information hides in the numbers. An accountant can spot this discrepancy and bring this up as a place to cut costs. A harried new business owner might not even realize the leverage they could wield. Most vendors are more than willing to cut deals for long-term volume customers, compared to one-off, walk-in customers.
Tax Tip Three - Identifying the State (or Municipality) of Your Business
While it might seem obvious, early-stage businesses need to register in the state where they operate. Many entrepreneurs hear that incorporating in Delaware, despite living in and primarily working in New York, could have tax benefits. Yet the paperwork involved might not necessarily mean that move makes the most sense. In this instance, the business should register as a foreign entity in the state where it primarily operates, New York. Additionally, it will need to stay in compliance with any annual filing requirements for both jurisdictions. More registrations follow: businesses that sell taxable goods need sales tax authorization and account numbers, plus any applicable business licenses. Right off the bat, an accountant can advise the course of action that will be most efficient in terms of paperwork and being tax favorable.
Tax Tip Four – Don’t Let Sales Tax Be Your Nemesis
Once that business is up and running, there comes that special issue of sales tax. It’s perhaps the most prominent tax concern for a revenue-generating small company that sells consumer goods or services that are taxable. And, if you do not report sales tax or make the payments, it often comes with hefty penalties, an audit, and being on the radar of the local / state sales tax department. A small business owner can spend hours reading through the rules and still miss some nuance. If your accounting software product can calculate sales tax, or if you are using sales tax software to automate the calculations and reporting, the 12,000+ U.S. sales tax jurisdictions are more likely to be handled properly. Proper sales tax calculations are even more critical if you have nexus with eCommerce.
Alternatively, entrepreneurs can save themselves some headaches and find a tax accountant to navigate the regulations in their city and state, as well as any destination-state shipping taxes. New small business owners might not realize or forget that sales tax rules and rates can vary widely not just from state to state, but also from city to city. Within the five boroughs of New York City, the sales tax is 8.875 percent; elsewhere in the state, rates might be as low as 4 percent. In Chicago, sales tax rates are 10.25 percent, though Illinois state sales tax rate is 6.25 percent. States might even have reciprocity with sales tax; in any case, this means paperwork that an accountant can handle with expertise.
Tax Tip Five – Accountants Understand Tax Relief Programs
With the sales tax issue identified, state and local tax authorities can offer great help to new businesses, such as waiving income taxes for the first year of business. Consult your local small business or economic development office for tax relief programs. Tax incentives for individual municipalities and hiring thresholds abound. There are grant programs for entrepreneurs and new startups. Many states and cities offer tax credits for businesses if the startup anticipates growing by a specific headcount in a set period. Some towns and states will even provide forgivable loans once you meet the agreed growth milestones. An accountant who has deep experience working with startups will, more likely than not, be familiar with commonly used programs in the area. So ask one!
Accountants Provide Street Smarts and Legal Tax Tips for Pre-Revenue Startups
Accountants will have a sense of local costs in a city or region. Examples include the going rate for expenses such as capital, property, and supplies.
For example, a street smart accountant familiar with New York City knows that market. Perhaps they have seen multiple failures at a particular location. Maybe the business is on the wrong side of the street for a subway commute. Consider the value of the information if a prospective boutique owner knew that the projected sales were $50 per square foot. It would be even more valuable to know that the average cost is $75+ per square foot in Manhattan. An accountant can advise on what items and how much stock to put on the floor. Operating considerations such as item price points or on seeking potential lower-rent locations for the store could be part of the accountant’s expertise.
Along similar lines, an accountant with local savvy can advise the well-intentioned, but perhaps naïve, entrepreneurs. Accountants can help entrepreneurs know when they are at risk of getting ripped off. For example, accountants can review contracts. I often quip that accountants can do much of the same work as lawyers, though for cheaper rates.
Considering the hours of paperwork, bookkeeping, and regulatory compliance issues, paying for accounting expertise should be a high priority for new entrepreneurs. Can you see how these tax tips for pre-revenue startups benefit your business and your customers? On that note, the question should not be whether a new startup can afford an accountant. The question should be: how can a startup afford NOT to have an accountant?
Background provided by Adnan Akhand, CPA and partner, accounting services, BX3