Starting a Business – Part 1

We are a small firm that seeks to help small and medium sized businesses, and we often get clients who are eager but unsure about how to get their startup off the ground. Here we hope to outline a few of the considerations a potential entrepreneur should have before starting a new business.

Let’s start with the very basics.

Is Your Business Idea Feasible?

This business is going to be your livelihood – make sure that your livelihood is something that is tenable and realistic. You need to do research on your startup idea – what good or service will you provide? To whom? Is there any demand for your idea, and is anyone else already supplying it? See what similar businesses are doing, and whether or not they’re successful.

You’ll find an hour of research on the front end of a business might save yourself months or even years of stress on the back end. It also gives you the practical benefit of being able to demonstrate your seriousness to potential investors. You’ll need to acknowledge that even if your startup is in a healthy, well-trodden industry, your margins might be thin.  Ask yourself whether you’re willing to put the time and money in, and also be realistic about what can happen if this business does not work out.

Choose a Business Name

First, make sure the name isn’t taken. A quick Google search can generally verify whether or not your startup name is already in use. Illinois also has a database of business names currently in use, and registering a name requires that it is sufficiently different from anything else currently in the database.

Second, business names, much like human names, can be judged by a simple litmus test – if you were to tell it to a 3rd grader, would they be able to 1) pronounce it and 2) use dispassionate ridicule to twist it into a parody?  Imagine putting this Business Name on a card and handing it out to investors – it does not need to be boring, but boring and utilitarian are often preferable to gimmicky and gaudy. Think about how you cringe whenever you remember the name of your first email address. Try to avoid that feeling when you’re naming your business.

Business Plan or No Business Plan

Do you need a business plan? What even goes into a business plan? Honestly, there are lots of example business plans online so if you’re curious about what goes in one, look there. Generally, a business plan is not necessary, but it’s probably a good idea to do one. The reason is that the process of going through the plan will help solidify your thinking about your future business. You will think through some of the early challenges the business will face, which will make the growing pains easier to deal with. Plus, if you’re looking for investors, you’ll need a plan. People rarely throw their money at someone without a plan (you’re not Elon Musk).

Decide how to Organize your Business

This is the next step, and it determines how you register with Illinois and the Federal Government, or if you need to register at all. A small business is most likely to organize under Sole Proprietorships, Partnerships, or LLCs. We will tackle what each of these mean in another blog.

E-Cigarette and Vape Product Regulations

Starting a business can be difficult, and anyone looking to start a business selling e-cigarettes or vape products can easily be overwhelmed. Due to recent panics over e-cigarettes, as well as attempts to curb juvenile drug use, this business has been heavily litigated and regulated, both on the Federal and State level. Here we’ll outline some of the obstacles a potential startup business might face.

Illinois Tobacco Products and its Tax

Firstly, e-cigarettes, vape products, and whatever devices, solutions, or substances affiliated with them are classified by Illinois as Tobacco Products. It does not matter if the vape flavoring has nicotine or not. If it’s designed, produced, or marketed for use as an inhalant, it is a Tobacco Product, and therefore taxable under the Tobacco Products Tax.

The Illinois Tobacco Products Tax is a tax paid by the distributors.  Distributors are usually manufacturers or wholesalers, but this can also apply to retailers (as we’ll address below). This tax rate is 15% of the wholesale price of products sold or disposed of over the course of a month. Furthermore, distributors must file a bond of at least $1,000, and after the first year of business, the bond amount must be equal to three times of the distributor’s average monthly tobacco tax liability, or $50,000, whichever is less.

Tobacco Retailer’s License

Retailers need a Tobacco Retailer’s License to sell tobacco products in Illinois – the license itself only costs $75 annually. Retailers are the ones handing the product directly to the customer. However, if a retailer happens to be manufacturing his own goods, or if he’s selling products that have not yet had the Tobacco Products Tax paid on them, then this person will have to register as both a retailer and a distributor.

The PACT Act

The PACT is a federal law that seeks to make cigarette trafficking as difficult as possible. “PACT” literally stands for “Prevent All Cigarette Trafficking.” E-Cigarettes and Vaping both apply. The Act sets stringent requirements for retailers, including double age verification on customers, extra labeling on packages, and then meticulous record-keeping that must be filed in a monthly report to the local state tobacco tax administrator. Anyone engaged in the business of selling these products across state lines will also be required to register with the ATF, the Bureau of Alcohol, Tobacco, Firearms and Explosives (yes, the Bureau’s name does not fit within its acronym), which is the organ of the Federal Government given authority to enforce the PACT Act. These are the smaller challenges.

The larger challenge is a nationwide moratorium on shipping tobacco products. Under the PACT Act, the United States Postal Service is forbidden from shipping these products. FedEx, UPS, and DHL also refuse to ship any tobacco products.  Extremely small businesses might manage with personal deliveries, and larger businesses might be able to turn to third-party alternatives. But this leaves a lot of people in the middle who have no way to transport their products.

There is one silver lining on this thundercloud – the PACT Act is concerned with interstate commerce. Small businesses that operate only in Illinois do not need to register with the ATF. But the lack of shipping avenues still stands.

More to Come

As of April 23rd, 2021, Senator Dick Durbin proposed a new federal law that seeks to increase taxes on vape products. This is the “Tobacco Tax Equity Act of 2021,” and its goal is to stamp down on vaping and e-cigarettes by giving them the same tax burden as traditional tobacco products. As of writing this blog, this motion is too early in the legislative process to release any details to the public.

Overall, anyone looking to sell e-cigarettes or vape products has a host of taxes and legal considerations facing them. And it’s very possible these challenges will multiply. If you have any questions, or are looking to start a vape business, please let us know. We’d be happy to help.

Dissolution and Winding Up a Business

Since the beginning of the pandemic, one of the main questions I get from struggling business owners is how to dissolve a business or declare bankruptcy. There is a litany of reasons to close your business. The most common problem right now is that company owners get so in debt to their landlords and vendors that, even if business suddenly turned around, they won’t be able to dig themselves out of debt. When faced with that situation, sometimes the only answer is to wrap up the business.

Dissolution vs. Bankruptcy

If you’ve decided to close your business, you might wonder if declaring bankruptcy is a good option for you. For most owners, bankruptcy for the business usually means bankruptcy for them personally. This occurs because most business owners have personally guaranteed the debts of their company. Therefore, if they declare bankruptcy in their business, the debts would simply pass to them personally. Then they would need to either pay the debts themselves or declare personal bankruptcy to avoid the liability. For many owners that is not a good option.

By dissolving the company, an owner still maintains the power to negotiate the debts owed. In many cases, the creditor is willing to negotiate to settle the claim. For example, a landlord will usually agree to settle an outstanding balance if it means terminating the lease. They get some money and, hopefully, a new renter that can actually afford to pay.

I don’t want to give the impression that all creditors negotiate. The fact is that some creditors have been unwilling to work with debtors during the pandemic, and because most of the protections put in place don’t apply to businesses, creditors are not as incentivized to negotiate. For example, there is no moratorium on evictions for commercial spaces.

Dissolution Triggers

How do you start a dissolution? Pursuant to 805 ILCS 180/35-1, dissolution can be commenced in one of five ways: (1) upon an occurrence of an event specified in the operating agreement, (2) upon the consent of all members, (3) if there are no members for 180 days, (4) by judicial decree, or (5) if the company has been administratively dissolved.

The most common of the above circumstances is based on consent of all members. Basically, everyone agrees that it’s time to close the business.

What if the owners can’t agree? One member may petition the court to dissolve the company. In that case, the company will be dissolved under the fourth item listed above.

What Happens in a Dissolution?

When you dissolve a company or LLC, you must satisfy all debts to creditors before distributing anything to the owners of the company. Pursuant to 805 ILCS 180/35-10, only after everything is satisfied can the rest be divided among the owners of the company.

That seems fairly straightforward, but in practice this can get a bit messy. For example, what if an owner is also a creditor? If an owner loaned the business money, which happens all the time, that owner may be eligible to receive payment for its loan before a distribution can be made to the owners. This can cause quite a bit of in-fighting among members of a company.

 What Can Go Wrong in a Dissolution?

The easy answer is that a lot can go wrong. Obviously, the larger the company and more complex the structure, the more trouble is caused. Generally, if the owners pocket money or assets without observing formalities, they will be liable to other owners and creditors. The dissolution cannot turn into a free-for-all.

In the event formalities are not followed, creditors will likely be able to pierce the corporate veil, which means target owners individually. Therefore, if you don’t follow the rules, you run the risk of being held personally liable for the debts of the company, essentially defeating the purpose of the limited liability company.