Monday, February 14, 2011

Startup Stage: Buying Stuff and Independent Contractors

Part 3 in a series in Startup Stages

So you think the purchasing of products and services from is straight forward?  While generally true of the former, the hiring of services, particularly that favorite of all startups, the independent contractor, can expose the startup to significant liability.  Let's take a look at the issues surrounding third party purchases by the startup.

Purchasing by the Business of Products and Services from Third Parties
Once a business entity exists, the founders need to shift the purchasing of supplies, equipment, and services from their personal accounts to the business, in order to take advantage of the limited liability benefit.  Keep in mind that goods and services paid for by the founders (i.e. via personal credit card) do not automatically belong to the business.  They must be transferred in.  The easiest way to do this is via some form of expense reimbursement policy.

Still assuming no employees at this stage, three additional compliance issues must be met:
  • Ensuring that independent contractors (if any) are not de-facto employees under Federal or state work rules.  Just because your service provider is willing to be an independent contractor, does not necessarily make it so.  The government has a say in this.  (For more details, see my post.)
  • For tax purposes, properly classifying inventory, depreciable assets, and expense items
  • Obtaining a state resale certificate in order to avoid paying sales tax on items purchased for resale
In terms of risk management, overhead necessarily increases and involves:
  • Executing independent contractor agreements with contractors
  • Filing/issuance of IRS 1099-MISC and California EDD DE-542 forms or your state's equivalent (if independent contractors)
  • Setting up a business checking account
  • Creating accounting controls with respect to purchasing, expense reimbursement, and payables to reduce the risk of fraud and monitor cash burn
  • Establishing purchasing terms & conditions
  • Obtaining personal property and casualty insurance (if there is a high value to inventory or capital assets)
  • Protecting intellectual property (see last post)
For the hiring of services, a well written independent contractor agreement is key. At a minimum, it should (a) define contractor status, (b) assign to the business any intellectual property the contractor creates, (c) spell out contractor responsibility for withholding taxes and insurance, and (d) define the financial terms of the relationship.

Personal property insurance may not make sense unless the startup has expensive capital assets or a high value of inventory (both of which the startup should ideally avoid by outsourcing or building to order).The same goes for establishing purchasing terms and conditions (“T’s and C’s”), although unlike insurance, this costs almost nothing to set up. Having your own set of purchasing T’s and C’s will ensure that you are not inadvertently agreeing to the vendor’s T’s and C’s.

Next post:  The BIG Risk Trigger:  Hiring.

Related posts in this series:
The "Nitty Gritty" of Startup Formation
Intellectual Property Creation and Startups

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