Category: Entrepreneurship

FICA Tax Holiday Will Allow More Businesses To Succeed

Category : Entrepreneurship
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Note: This is the second in a series of posts about policy changes that make starting a business easier.  The first post on heath care is here.

According to the US Department of Labor, there are a little over 1 million new businesses created in the US each year.   The popular misconception is that 90% fail within five years.  Although real data only show that at least 25% fail within the first year and at least 44% fail within the first three, that percentage is still very high.  Looking at real numbers, over 250,000 firms go out of business within one year.

Businesses fail for many reasons.  The market may change or a competitor could enter the market.  It could be a bad business idea.  The founder might decide to do something else or not have the time or make the necessary committment.  The business may have poor access to credit or funding.  Margins could be too small or the owner cannot make enough to live comfortably. 

Most startups are taxed by FICA (Social Security and Medicade) at a 15% rate on any net profit they earn.  FICA taxes cost small businesses and startups over 15% of net profits, as business owners have to pay both the employer and employee sides of the contribution.  Unlike the progressive income tax, FICA taxes start at $400 of income and end at a little over $100,000, making FICA a very regressive tax.

The 15% FICA contribution is a huge obstacle for new businesses.  For example, take a person who starts a dry cleaning business that makes $30,000 in net profits in year 1.  The founder has to make enough money to reinvest in the business and pay themselves a salary in order for them to stay in business.   The founder owes around $4,500 in FICA taxes.  Instead of taking home $30,000, less income taxes, the owner takes home $25,500.  For many people, $4,500 can be the difference between keeping the business open for year 2 or closing the business.  The same thing can happen to tech startups, too.  Many small businesses and startups need that little extra push to get them over the hump in the first three years.

I propose a FICA tax holiday for new businesses.  Here’s how it would work:

For the first two years, new businesses do not have to pay FICA taxes.  Instead, their FICA tax liability is “banked” and becomes due in year three, assuming the business is still around.  If the business fails, the founder would not have to pay FICA, but if the business succeeded, the founder would have to pay the FICA taxes from years 1 and 2.  Going forward, the business would pay their taxes normally.  

This plan is very similar to what many professionals like lawyers, accountants and others do with startups that they work with.  For example, its common (at least in Madison) for lawyers to agree to withhold bills for a year or two, or until the company is profitable or raises money.  It allows the startup to worry about business operations and not drown under expenses during the startup period.  If the business becomes profitable, the lawyers get their fees in full, plus more fees in the future.  

FICA taxes would work the same way.  Imagine if instead of 25% of businesses failing in year 1, only 24% failed.  Considering Americans start over 1 million new businesses per year, a 1% drop in the failure rate would lead to 10,000 new businesses making it into year 2.  These businesses would continue to generate profits and create jobs, thereby strengthening the economy.  If more business succeed, the FICA taxes that the government could collect in year three would be greater than the current solution.

I think a plan like this is politically feasible, as it helps both tech startups and small businesses alike, especially with the need to for stimulus during the current recession.  I think it could have broad support from both sides of the aisle nationally, but it may be too big for Congress to act nationally.  It would be interesting if a state would offer a plan like this that offered rebates on FICA taxes for businesses located in the state.  It would be another incentive to get business to stay or move to the state that would not cost much.  I am hopeful that government will think about incentives like this plan to help entrepreneurs of all types succeed.

Healthcare is a Roadblock to Startups

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Note: This is the first in a series of posts about policy changes that make starting a business easier

It was the winter of 2005, and I was sophomore at the University of Wisconsin.  My business, ExchangeHut, was humming along smoothly and I decided that I wanted to focus on building ExchangeHut sites at additional college  campuses.  I figured the best way to do it was to drop some of my classes and become a part time student.  I had it all worked out, until it was time to tell my parents.  Since ExchangeHut was going well, they did not have a problem with me taking fewer classes, but they were very worried about my health insurance.

Most students are covered under their parents’ health plans, as long as they are classified as full time students.  Since I was going to take fewer than the magic 12 credits that spring semester, I was going to be dropped from coverage.  My parents’ biggest objection to me taking fewer classes to work on the business was that I would not have health insurance.  They were worried that something might happen to me and I would be saddled with a huge debt from having to pay medical bills.

I did some research and found out that I since I was a student, I could use University Health services for most of my routine care.  I still needed some form of insurance to protect me in case I got hit by a car, got cancer or fell of my bike.  After a few weeks, I settled on a plan with a $5,000 deductible from WPS.  Since I am young, healthy and willing to have a high deductible, my plan only cost about $40 per month.  Most other student founders of startups that I talked to either went without insurance or paid much higher rates for more comprehensive plans.  Luckily, I did not get sick and have never had to file a claim, but if something were to have happened, it may have crippled my ability to continue to run ExchangeHut effectively.

Health insurance is always a high priority when I talk with other young founders of startups.  Many students that I talked to were reluctant to go below 12 credits because they would lose their health insurance.  Some were not willing to try to start a company because they knew that they needed to maintain full course loads and that they would not have time to be both a student and a business owner.   Other recent grads took jobs rather than start a business partly because of health care worries. Easier, more affordable access to decent health care would make it easier for people (not just students) to make the jump to starting their own companies.  More startups lead to more successful companies, more jobs and more tax revenue.

So, how do we fix this problem?  There are many solutions, ranging from lifting the full time student requirement to national health care.

  1. National Health care – If we had national health care, we would not have to worry about health insurance, but might have to worry about quality of care and other issues.
  2. “Small Business” or “Entrepreneur” Insurance Pools – Allow entrepreneurs to buy into pools that act as buyers, similar to large corporations.
  3. State government funded “Entrepreneur” policies – State governments could allow entrepreneurs to buy state health care policies.
  4. Allow young entrepreneurs to stay on parents health care longer – Allow insurance companies to either allow young people to stay on longer for free, or give young people (and their parents) to charge more.

I personally think that options 2 and 3 are the most promising.  I would think that insurance companies would want young startup owners as customers, as they are less likely to get sick than older people.  I think that insurance companies that offered an “Entrepreneur Plan” would not only make money, but they would also be able to tout their support of business and entrepreneurship.  I think it would be a good way to get customers, too.  They could even sell the introductory policy as a loss leader to get potentially successful people into the company early.  Then, when businesses succeed, entrepreneurs might continue to use the insurance company for their growing insurance needs.  I am working with a few business owners in Madison to try to organize a form of this, but it has been harder than I expected.

I think states would also be wise to create entrepreneur policies as incentives for startups to move to or stay in states.  Wisconsin, along with many other states, have already created incentives for startups and investing, but as far as I know, no state has done anything like this with health care.  Since many startups, especially tech startups, are mobile and can be run from anywhere, incentives like affordable health care would be effective ways to attract and keep startups.  I would also like to see policies like these opened up to young people who are working in non-profits.

These changes would help people who are thinking of starting businesses, but are scared off by health care expenses.  They would also help entrepreneurs who do not have health insurance, are paying for inadequate coverage or paying too much for good coverage.  Health care is only a small part of the solution, but it is an important one.  Do you agree that health care is a problem?  What solutions would you propose?

College is the Best Time to Start a Business

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I was talking with a friend who is in the UW Business School about a discussion in one of his classes about the best time to start a business.  Most of the class believed that the best time to start a business was 5-10 years after college.  They argued that it would be best to start a company after working a job for a few years, building up savings and learning about how the business world works.  Its my feeling that this is the conventional wisdom.  I think both the students and conventional wisdom are dead wrong. 

College is the best time start a company.  In college, you have very few, or no, responsibilities.  You most likely are not married and do not have kids.  You probably do not have a mortgage or a car payment each month.  You are not tied down in a job or a specific city and can live on comparatively small amounts of money.  You have freedom and lots of free time and are surrounded by other smart, like minded students.  These smart students are the perfect place to find partners.  Your only responsibilities are to pay your tuition (which can be tough), go to a few classes and get passing grades (and have fun).  If your company fails, you have plenty of time to either start another or get a job.

Universities also provide many resources to student business owners that graduates would have a much harder time accessing.  For example, I entered ExchangeHut into the Burrill Business Plan Competition during my sophomore year.  This competition was a free way to learn how to write a business plan, present to a panel of judges and make connections in the local startup community.  I also met my lawyer during the competition and made connections in the press that I would not other wise have been able to make if I was not a student.  Not only are there student papers that love to write about student startups, but traditional media love a story about student entrepreneurs, whereas it can be much harder to get press if you are older.  Students also are able to use University Health to cut down the costs of health care and have access to library research materials, free wireless internet and much more.

Additonally, lack of market knowledge can actually help startups.  College students may be more likely to try new, innovative ideas that others would dismiss out of hand.  They have no history to protect and may be more willing to take risks that others might not.

After graduation, most grads look for a job and start to earn a salary.  After a few years of making decent money at a job, they have probably upgraded their lifestyle, making it harder to live on a smaller salary.  Many college grads are married or are in serious relationships 5-10 years after graduation.  Some have kids and many own houses.  It is much harder to quit a decent job and take the big risk of starting your own company when you are used to a paycheck every two weeks.  Its even harder if you have a spouse or kids.  The time commitment required to be run a successful startup can take a toll on family life.  Its also harder to find potential partners, as many people in your network will also be settled in their jobs.  You might dismiss ideas because “in your experience, you know companies don’t work like that.”

Some may say that students cannot start companies while they are in college because they have to pay their way thought school.  I would argue that many students can do better starting a company than working 15 hours a week as a bartender.  Even if they fail, they will have something interesting to talk about during job interviews.  Companies are looking for smart people who have skills and starting a businesses teaches you these very skills.

While it may be more comfortable to start a company with a financial cushion under you, I believe that the benefits of starting early outweigh the benefits of waiting.  College is the best time to start a company: it provides you with access to smart people, university resources, discounted health care and easier press coverage, all during a period when you have limited responsibility and hours of free time.  If you are in college and thinking of starting a business, go for it!  What’s the worst that could happen?  At least you’ll be avoiding the Business School Way of Life!

Crowdspring is Fantastic

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I had read about the power of crowd surfing over the last few years, but had never gotten a chance to actually try it out.  My partner from ExchangeHut, Corey Capasso, introduced me to CrowdSpring, a cool new startup that is crowd surfing for graphic design.  Its a simple idea, but it works amazingly well.  Here’s how it works:

You go to crowdspring and fill out a form with what your project’s needs.  Then, you post how much you are willing to pay for the winning design.  After you submit your project, the entire CrowdSpring community is able to work on your project.  You are guaranteed at least 25 entries, or your money back.  The project lasts for a week and you can watch the designs roll in, comment on them and ask for revisions.  After a week, you choose the winning design and get the files from the designer.  Crowdspring takes care of the legal documents to make sure that you own the design that was created for you.

I recently used it for a project of mine and it worked perfectly.  Here is an example of an entry on crowdspring.  I would suggest checking crowdspring out for any of your graphic design needs in the future.  Crowdspring is cheap, easy and provides quality work.