3. Types of businesses, structures, models.
Welcome again, in this chapter we will discuss types of businesses, structures and models for your BizBaby.
This chapter is one of the biggest one’s we have so far and it could potentially be a book on it’s own talking about types of business structures and models. We will instead cover only the main types.
Once again, let’s cover the most usual models for small businesses today.
- Providing a Service
- Selling a Product
Providing a Service.
Examples: Haircut salon, shoe repair, home cleaning, clinic.
Service types of businesses usually have higher margins, however they are very hard to scale since it takes human labor to service one customer. For example, doing a haircut almost always will take 20-30 mins for short hair and 1+ hour for a long hair customer. If you have 1000 customers, it will take just 1000 times as long. There is no discount for high volume, in fact, the busier the service, the more expensive it becomes, as a rule of thumb.
Customer loyalty is usually higher than a product type of business, but lower than consultancy. If you found a great dry cleaner who removed stains and hemmed your pants, you might consider going to them, even if you moved to a different area, but not where it becomes a hassle to get there each time.
Selling a product.
Examples: bakery, retail stores, food truck, restaurant.
Selling a product is usually a low margin business. However with the increase of volume, it usually tends to get higher profit margins. It’s more scalable than providing a service. For example, liquor store can sell 100 bottles of wine per day. However, if it got popular and started selling 10,000 bottles a day, it wouldn’t need 100 times more employees, space and cost of inventory. Most products become cheaper with higher volume.
Products usually have lower loyalty than consultancy and service type of businesses, since it’s easier to be implemented by a competition. Liquor store will lose a regular customer, if one moved to a different area, even a few blocks away closer to a different liquor store.
Examples: Tutoring, personal trainer, handyman, bookkeeper
Most consultant/contractor/freelancer type of businesses have a hard limit, that’s usually the time of their operator, who most of the time is also a business owner.
For example, if a personal trainer wanted to increase the number of clients from 1 to 2 per day, it means he/she would need to work twice as long and there is a very clear limit of how many clients he/she would be able to have, before starting to turn clients down. However, consultants don’t have to follow the pricing of other consultants and can negotiate their own price for the work per client or project.
Clients usually have a high loyalty to a consultant that did a good job. For example, a family would send their kid to a tutor who is further away that did a good job tutoring their child.
Now let’s talk about space.
Location, location, location
Almost each type of business can be done/sold online or locally, with a few exceptions.
It’s extremely important to understand pros and cons.
Having a physical store on the street level will get you eyes and some ears through foot traffic, and local listing in Google Maps and Yelp.
However, operating a business from home or a remote, but affordable location, means less money spent on rent and more on marketing.
Doing things remotely also means high scalability. When opening a physical store, you need a person or two to manage it. Having 2 stores requires twice the rent and twice the labor.
Years ago I decided to open a chain of physical laundry and dry cleaning stores and after opening 3 locations, only 1 out of 3 became profitable, while the other 2 were dragging business down. I ended up closing those 2 stores up and losing over $150k in rent and labor costs. Not to mention all the legal costs of getting out of the long leases.
Another important detail is control over the space. When you invest into a physical location, you are at the mercy of the landlord to keep renewing your lease at an acceptable rate, or renewing it at all. However when things done remotely, you can relocate to a larger or cheaper space and have almost no affect on your business.
Doing things remotely, and investing into a brand and marketing, could be the flexibility and advantage that could make your business successful.
Here what SBA says about it:
A sole proprietorship is easy to form and gives you complete control of your business. You're automatically considered to be a sole proprietorship if you do business activities but don't register as any other kind of business.
Sole proprietorships do not produce a separate business entity. This means your business assets and liabilities are not separate from your personal assets and liabilities. You can be held personally liable for the debts and obligations of the business. Sole proprietors are still able to get a trade name. It can also be hard to raise money because you can't sell stock, and banks are hesitant to lend to sole proprietorships.
Sole proprietorships can be a good choice for low-risk businesses and owners who want to test their business idea before forming a more formal business.
Comments: when you start accepting any kind of money for services or products, you automatically become a sole proprietor. It’s a good idea to make sure your revenue get’s to a steady place where you are sure about the direction and future of the business. However, most of the time you will not be able to rent a retail space without forming a company.
Limited liability company (LLC)
An LLC lets you take advantage of the benefits of both the corporation and partnership business structures.
LLCs protect you from personal liability in most instances, your personal assets — like your vehicle, house, and savings accounts — won't be at risk in case your LLC faces bankruptcy or lawsuits.
Being an LLC protects your personal assets and separates them from business assets.
Profits and losses can get passed through to your personal income without facing corporate taxes. However, members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security.
LLCs can have a limited life in many states. When a member joins or leaves an LLC, some states may require the LLC to be dissolved and re-formed with new membership — unless there's already an agreement in place within the LLC for buying, selling, and transferring ownership.
LLCs can be a good choice for medium- or higher-risk businesses, owners with significant personal assets they want to be protected, and owners who want to pay a lower tax rate than they would with a corporation.
Comments: Be careful opening single member LLC’s, since it has almost no protections, consider opening a C Corp instead, it might be little more expensive, but it will have higher protection against business liabilities. Some states also have high publication requirements for LLC, means you will have to publish a Public Release about the formation of your LLC in a local newspaper.
A corporation, sometimes called a C corp, is a legal entity that's separate from its owners. Corporations can make a profit, be taxed, and can be held legally liable.
Corporations offer the strongest protection to its owners from personal liability, but the cost to form a corporation is higher than other structures. Corporations also require more extensive record-keeping, operational processes, and reporting.
Unlike sole proprietors, partnerships, and LLCs, corporations pay income tax on their profits. In some cases, corporate profits are taxed twice — first, when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns.
Corporations have a completely independent life separate from its shareholders. If a shareholder leaves the company or sells his or her shares, the C corp can continue doing business relatively undisturbed.
Corporations have an advantage when it comes to raising capital because they can raise funds through the sale of stock, which can also be a benefit in attracting employees.
Corporations can be a good choice for medium- or higher-risk businesses, businesses that need to raise money, and businesses that plan to "go public" or eventually be sold.
Comments: for any person who seriously considers opening a business and focus on it full time, you should consider C Corp or S Corp. If you consider raising money in the future, C Corp is your choice. Angel Investors, potential future partners or VC’s mostly will not invest into S Corp.
An S corporation, sometimes called an S corp, is a special type of corporation that's designed to avoid the double taxation drawback of regular C corps. S corps allow profits, and some losses, to be passed through directly to owners' personal income without ever being subject to corporate tax rates.
Not all states tax S corps equally, but most recognize them the same way the federal government does and taxes the shareholders accordingly. Some states tax S corps on profits above a specified limit and other states don't recognize the S corp election at all, simply treating the business as a C corp.
S corps must file with the IRS to get S corp status, a different process from registering with their state. There are special limits on S corps. S corps can't have more than 100 shareholders, and all shareholders must be U.S. citizens. You'll still have to follow strict filing and operational processes of a C corp.
S corps also have an independent life, just like C corps. If a shareholder leaves the company or sells his or her shares, the S corp can continue doing business relatively undisturbed.
Comments: All corporations are filed as C Corp first, and then it can be applied to get S Corp status with the IRS. You have 1 year to apply for a S Chapter, however exceptions are often made allowing C Corps to get S Chapter even after 1 year of operating.
Choose S Corp only if you are not planning to onboard more partners or investors in the future, for example a family business is a good case to have S Corp. S Corps are better for when you consider selling your business in the future, however there are ways to minimize the tax difference between selling S Corp and C Corp.
There are many more business structures, Partnerships, Non-profit orgs, B Corp, Close Corp etc. But the overwhelming majority of the first time and small business owners will use one of the above for their business.
Most businesses are registered online with the help of an incorporator. One of the companies i’ve used in the past is incorporate.com, you can form a company in any state within a few days and with a dedicated account manager at your disposal, it can be a good place to start for anyone with little prior experience.
Congratulations, you have now learned about business types, structures and models to get started on your own BizBaby.