What financial mistakes should I avoid when running an early-stage startup?

It’s very easy to make financial mistakes when starting up a business. Even the most experienced founders make them. This advice only applies to U.S. startups that are set up as a corporation or LLC.

Start with the basics. You know these, and you might not need them, but… if you get any of them wrong, it’s a mess. It’s especially a mess for a new business.

A Clean Split of Personal and Business Costs

Keep all your business money separate from any other money, and don’t mix the cash. This is called commingling. It’s not only a bad idea, it’s fraught with legal and tax complications. Mixing business and personal money can cause problems. Let’s see how:

For the most part, the owners of a corporation or LLC are legally protected if the company can’t pay its bills. That’s the liability shield. But commingling can take that away from you. That’s one reason it’s a problem.

If you’re sloppy about keeping your business cash and personal cash totally separate, then you could wind up paying more income taxes because the IRS may argue that the company was buying personal expenses for you and thus the value of those items was “income” that you didn’t pay taxes on. Are they actually business purchases? Or are they a tax-free way to give the owner of the company money? Whoops. Yes, this is an entirely real thing.

The one lesson to remember is to never, ever, use company money for personal spending.

It’s very common, and fine, to buy things for the company and then get reimbursed right away after. That’s no problem. Where the problem comes in is that if you use a spreadsheet and sloppy payments to handle expenses, then you’ll have trouble knowing what the company really owes. Use expense software, not spreadsheets. Even if it feels like overkill. (It’s not overkill.)

This is the setup that makes everyone happy: a clean split of personal and business costs, employees aren’t “loaning” the company money, and you can see what’s spent by the company.

Taxes and Payroll

You need to pay employees with an actual payroll system, even if it’s just one of them, and even if it’s the end of the month and you just want to get the payment done. The exact amounts of withholding, and required government forms, come due soon after you pay people. It’s hard to do by hand. A payroll system will help you make sure that the right amount of taxes are withheld from each paycheck and sent to the government on time.

If an employee moves to another state, update their address in payroll immediately. Don’t let it slip through the cracks. Otherwise you’ll be filing all the wrong state tax forms for the business. You might have to register in that state and handle all the new things.

You have to file tax returns even if you didn’t make any money. For example, if your business is a C corporation on a calendar tax year, your federal tax return will be due around April 15th.

The best way to make sure you’ll file your returns on time is to hire a tax preparer ahead of time. Deadlines, forms, etc. change by the state.

If you’re looking for a tax preparer, try to hire them by December or January. They get busy. Send over your books early. Then they can work on your taxes when they get a free minute. Note that they can’t start until your books are done.

Even beyond taxes and payroll, small businesses have all sorts of government filings. For example, a San Francisco-based tech startup that’s a Delaware corporation has to file these:

• You will need to do an annual report in Delaware. You’ll also need to pay a “business entity tax.”
• California will need a statement of information. It’s not the same as the franchise tax you pay with your state return.
• In San Francisco, you’re required to register with the city.
• In San Francisco, on top of everything else, there’s a gross receipts tax and a tax on payroll.
• Then there’s also the San Francisco business property tax to think about.
• The federal government needs 1099-NEC forms.

This isn’t a comprehensive list, but a good tax preparer should be able to sort through which ones apply to your business.

Each year, you’ll have to file those 1099-NEC forms for certain payments, and it’s easiest if you have the information on file.

If you wait until January to go asking vendors for W-9s, some of them won’t remember. Many businesses ask for a W-9 before they pay a new vendor, so if you set it up early, you have less chasing to do at the end of the year. So if at all possible, get the information as you go.

Which vendors need a 1099? Not all payments require a 1099 but your tax preparer will tell you which ones do, or you can read the instructions that come with the form. The most common case is payment of $600+ in nonemployee compensation to an individual, estate, partnership, or LLC taxed as partnership.

Keep up Your Books

You should make sure someone is always keeping the books. Three reasons it’s important to keep up your books:

If you don’t keep up your books, then you won’t be able to do your taxes. That’s the first reason.

Keeping the books also matters because you’ll probably need to give a financial statement to someone like an investor, landlord or business partner. You’ll want financial statements once you have investors, so you might as well start now.

The third reason to keep up the books is that having records helps you figure out what you’re spending, and then cut costs based on it.

When you spot a problem in your books, fix it. You can literally save thousands of dollars right out of the gate just by finding a problem and fixing it.

Doing your own bookkeeping can be very expensive.

If you think you can just do the books on the side, think again. It’s very time consuming, and even full-time finance people often hire outside to help with the day-to-day. Hire a provider. A great bookkeeper is worth paying for. A good bookkeeping firm can save you a lot of time and frustration.

If you have a trusted bookkeeping partner, you’ll have a lot of time and energy free to run the business.

Also, if you’ve raised a lot of money, you should spend time finding a decent interest rate. At 1.5%, $2M earns $2,500 a month and $10M earns $12,500 a month. It’s worth the time to find a decent deal.

Default business checking accounts and savings accounts pay far, far less interest on your cash. You can get a competitive rate from some banks if you ask.

Another way to save: if your business qualifies, you can claim a research and development tax credit that, since 2017, can be used to offset what you owe in payroll taxes. What this means is that even if you didn’t make money, you can claim the credit on your taxes.

With the right tax preparer, it’s easy to see if you qualify for the R&D credit, and how much. There are some qualification rules but generally you have to have qualified R&D activities, be under 5 years old, and under $5 million gross receipts in the year you claim the credit. If you don’t look to see if you qualify for tax credits, you could be losing out on a lot of money.

If you’re eligible, you and your tax preparer can calculate the R&D credit on your federal tax return. Once it’s filed, your payroll provider can help you apply the credit against your payroll taxes.

The credit can offset up to $250,000 of payroll taxes per year. That’s a huge chunk of cash if you have it coming.