Following the previous story, May and Zoe set up a partnership to create a baby clothing brand, and each invested $10,000 for their startup fund. Now they share the lessons they learned while bookkeeping their startup funds and preparing for lending applications.
STEP 1: Separate Startup Assets & Expenses
It took us some time to differentiate startup costs as two types: startup assets & startup expenses.
- Startup assets are the resources we need to use in our business operations over a long term period. E.g. equipment, office furniture, and machinery.
- Startup expenses are operation costs that occur in the early stages. E.g. expenses regarding business registration, simple website development, and marketing.
Bookkeeping and tax matters became simpler when we separated our assets from our expenses. Assets are valuable resources that are expected to generate revenue for the business, and are not deductible against income. For example, money spent on inventory is not deductible as an expense. Only when the inventory is sold, therefore becoming cost of goods sold or cost of sales, does it become tax-deductible.
On the other hand, expenses are deductible against income, which means we can simply subtract all our expenses from our income during the tax year, to reduce taxable income.
STEP 2: Obtain the Startup Fund
How did you cover the startup cost? Did you apply for business loans right away?
No one will lend us money unless they see someone pays for our products. As well, we didn’t want to receive a business loan and have a debt burden before gaining any traction in the market.
We forecasted our sales and expense costs for the first 6 months, and decided to each contribute $10,000 to start the business. Once when we started making sales revenue, we will apply for loans to expand our business.
Have you researched about business loans yet? What should someone keep in mind before choosing a loan?
Again, it’s very hard for small businesses to get lending without sales revenue. Once we prove our growth potential, there are different types of loan programs available. The government as well as Non-Profits offer great lending programs for small businesses. Banks and financial institutions have great programs too, but they usually charge a higher interest rate. Key questions to note:
- How much money do we need?
- What will the money be used for?
- How long will it take you to pay it back?
In general, lenders mainly care about whether the borrower can repay the loans or not. Government lenders also consider whether their lending will boost the local economy. That is, if our business is successful, we will be required to pay taxes, which drives revenue for the government.
As a business, we have to project a reasonable growth of sales in order to check our ability to repay loans. Since we are partners, we are both personally liable for the debt. It’s an risk we have to take, so we have to be very careful.
STEP 3: Set a Plan to Pay Yourselves
When do you plan to give yourselves salaries?
In the partnership business, partners are not considered to be business employees, but rather self-employed. Instead of receiving salaries, we draw the profits out of our business. We’d like to take regular cash drawings from our business when it generates enough revenue to cover operating costs. We aim to reach our target revenue and get paid in the next year.
We learned a few things about drawing income:
- Drawings are basically our form of income. Income tax will be applied on drawings at the end of the year.
- Business expenses such as travel, rent, maintenance fee can be deducted from the taxable personal income.
- It’s important to check if there’s enough money leftover to cover any upcoming bills after drawings have been taken.
How did you plan to split the profit?
That’s something we discussed in the Partnership Agreement. Usually the distribution of profit will equal each partner’s contribution to the business, but depending on our ongoing contribution to the company, this is something to discuss and negotiate over time.