Everything you need to start your own construction business: setting up the paperwork, finding the work, advertising, using contracts, dealing with lenders, estimating, scheduling, finding and keeping good employees, keeping the books, and coping with success.
If you're considering starting your own construction business, all the knowledge, tips, and blank forms you need are here.
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How to Succeed with Your Own Construction Company
by Stephan and Janelle Diller
1. Taking the Plunge - 5
Learning the Hard Way - 6
But Is It Right for You? - 10
Are You Up to the Challenge? - 13
The Next Step - 14
Choosing Your Name - 19
Registering Your Company Name - 20
An Employee Identification Number - 21
Getting a Business and Contractor's License - 22
Getting Bonds and Insurance - 24
What About a Franchise? - 26
2. Knocking on Opportunity's Door - 35
The Professional Look - 36
What Do You Have to Offer? - 39
The Next Step - 40
3. Digging Up Business - 53
Creating a Logotype - 55
Institutional vs. Promotional Advertising - 59
High Dollar Advertising - 65
Your Media Choices - 71
Qualifying Leads - 86
4. Making the Sale - 90
A Hard Lesson - 90
That Important First Impression - 91
Sell Yourself Before You Sell the Job - 93
Sell the Value of Remodeling - 99
Listen, Listen, Listen - 99
Bid Specifications, Not Ideas - 101
Don't Let Money Do All the Talking - 103
Polishing the Proposal Folder - 105
The Final Step - 107
Selling the Next job Off This One - 108
5. Dealing with Clients - 111
The Handyman - 112
The Purchasing Agent - 114
The Manipulator - 115
The Perfectionist - 116
The Deadbeat - 117
The Fall Crazies - 118
The Pre-construction Meeting - 119
The Change Order - 120
Job Completion - 121
Summing It Up - 123
6. Making It Legal - 125
The Smart Contract - 126
Complete Agreement, 137
A Contract Checklist - 137
Time and Materials Contract, 138
Collection Troubles - 140
7. Financing - 147
Money Sources - 148
Getting Paid - 152
Contractor Financing - 166
8. How Much to Charge and How to Bill It - 169
The Options - 170
Your Prices Are Based on Your Costs - 171
The Profit Question - 178
Contract vs. Time and Materials - 178
Bidding or Negotiating for Work - 181
9. Estimating with Accuracy 183
Estimating Methods - 186
The Estimating Take-Off Form - 190
Putting Your Estimate Together - 194
A Math Primer for Estimators - 198
A Sample Estimate - 202
10. Scheduling the job - 213
The Basics of Scheduling - 214
Choosing the Right System for You - 215
Staying on Schedule - 226
Scheduling Software - 226
11. Finding and Keeping Good Employees - 299
Hiring Employees - 230
Hanging On to the Good Ones - 242
Firing Employees - 244
Working with Subcontractors - 244
12. Running an Efficient Office - 247
The Equipment You Need - 248
Managing Your Time - 254
Computers or No Computers - 256
13. The Paper Shuffle - 263
The Federal Tax Forms - 265
14. Keeping the Books - 299
Breaking the System into Parts - 301
Managing Cash Flow - 316
Totaling Up for the Year - 317
15. Buying Insurance - 319
Kinds of Insurance - 320
16. Looking Ahead - 325
You're on Your Own - 327
For Further Information - 327
Index - 330
How to Succeed with Your Own Construction Company
by Stephan and Janelle Diller
Taking the Plunge
It's hard to swing a hammer on a contractor's payroll and not dream of running your own construction company some day. You know you could do it faster, better, and make better money. So why let someone else make the profits while you work for wages? Why not take the risks and get the rewards yourself?
If that's what you've been thinking, keep reading. This book can help you make the big step from wage earner to contractor - in the shortest time possible and with the best possible chance of success. We're going to explain how to take the plunge, step by step, and in the clearest language possible.
Most new contractors quit their regular construction jobs because they have good prospects for making it on their own. A strong economy and a few good leads may provide all the courage needed to step out on your own. As long as the economy stays robust, you can keep busy moving from one job to the next. You feel good about all the money going through your bank account. For a while that may seem like prosperity - until you get a notice from the Workers' Compensation Board or the IRS that you're delinquent on some payment required by law. Or your suppliers start calling to find out where their money is. Or a client threatens suit because of some work you did or didn't do. Worse yet, the bottom may drop out of the local economy - leaving you with all overhead and no income.
What happens then? Do you quit and go back to work for your old boss (if the job's still open)? Do you declare bankruptcy? Or do you stop and rethink where you're headed, how you got there, and what your options are?
We hope you're reading this book before you reach the point of desperation. But even if you're desperate, what you learn here should be well worth the time you invest scanning these pages.
Maybe you're just starting to explore the idea of construction on your own. If so, you're lucky. Not everyone is so far-sighted. Nearly one-third of 0 new businesses fail in their first year. Only half survive two years. The statistics don't have to be so grim. You can overcome most problems. We'll show you how. You don't have to discover all the dead end streets, blind alleys and potholes yourself. Let this book be your road map.
Learning the Hard Way
Before beginning, we'll offer some personal history so you understand our perspective. We're a husband and wife construction team. We both grew up in the construction industry. Steve's father owned his own home-building business for 45 years. Janelle's dad owned a ready-mix concrete plant and plowed his profits into real estate. We saw our fathers work long hours and come home dirty and tired. Their struggles in running businesses - even successful ones - didn't appeal to us. The money looked good enough, but we weren't sure we wanted the customer hassles or the hard work. A construction company seemed like the last thing we wanted to do.
Still, construction was what we knew best. And everyone needs a career. So we tried to make a living in the home renovation business, fixing up old houses for sale in Colorado Springs. We might have made a living at it, except that home loan rates zoomed to 18 percent and the local economy went into a tailspin before our first home was done. Fortunately, a couple of jobs dropped in our laps and we were "contractors," whether we'd planned to be or not. Even more unexpected, we liked it!
Those first jobs rolled in so easily that we thought others would quickly follow. Those first jobs came from casual acquaintances who knew we had some construction skills. Of course, as luck (or logic) would have it, the phone didn't ring again for six months. Fortunately, we had very little overhead and a second income that kept us afloat.
Our success story would be more persuasive if we could say that some serious reading and a few changes solved all our problems. Unfortunately, that wasn't what happened. We discovered ways to make a good living in the construction business. But we never found a magic formula. Maybe there isn't any. What we discovered was the hundreds of mistakes nearly any contractor can make in this business - and a few ideas and ways of doing business that seemed to work again and again.
That's what we're going to share with you - information to make your first few years a lot easier than ours were. We'll tell you how to estimate and schedule jobs, set up books and run your office, dig up business and close the sale. Of course, you have to add the real magic that makes a business succeed: hard work, construction know-how, and management skills.
The Big Picture
The construction industry is the nation's largest in terms of the number of people employed. It touches the lives of everyone, either as a consumer or as a producer. Until just the last decade or so, new construction was the glamorous part of the industry and remodeling was the ugly duckling. Home renovation and remodeling were like crumbs left on the table after all the prime jobs had been swept up.
That's not true any more. The remodeling and renovation industry is growing much faster than new construction. Experts predict that remodeling work will continue to thrive because our nation's housing stock is getting older. A home is built only once. But most will be remodeled several times before they're finally demolished. For many homes, the cumulative cost of remodeling and repairs will far exceed the original cost of construction. That makes home remodeling, renovation and repair a very promising business.
Of course new construction may seem more glamorous. You don't have so many unexpected problems. You don't have to work around a house full of people. And you don't have to deal with the eternal problem of knowing where to start and where to finally call it quits. Fortunately for the consumer, most remodelers see those as minor inconveniences in a very challenging and rapidly growing industry.
For the first few years we planned to move up to the "real" contracting business some day, putting up new buildings instead of just making them better. Gradually though, we began to realize that remodeling had major advantages. Once we stopped apologizing for being on this end of the industry, it was easy to get more respect. Most important, we found ourselves getting more business and more recognition as specialists in the construction industry.
Here's Why We Concentrate on Remodeling
1) Most remodeling and repair work is financed by savings or the settlement of an insurance claim, not proceeds from a loan. When new construction is being strangled by high loan rates, repair and remodeling work tends to keep humming. In a weak business market, many prospective new-home buyers opt to remodel instead of buy. The market ups and downs aren't nearly as dramatic or dangerous to the remodeler as they are to the contractor who does mostly new work.
In 1985, Professional Builder reported that from 1979 to 1983 residential construction dropped about 60 percent. In the same period, inflation-adjusted dollars spent on remodeling dropped less than 13 percent.
According to Qualified Remodeler, in 1978, 16.2 percent of National Association of Home Builders (NAHB) members said remodeling was an important part of their operation. By 1982, that percentage had more than doubled to 36.8 percent.
In fact, this shift presents a problem. Most builders wouldn't touch a remodeling project when times are good. But they're more than anxious to bid remodeling jobs when work is slow. Because they don't have the unique skills that remodeling takes, they botch a couple of jobs and then get out. In the process, they leave behind one more blemish on the reputation our industry carries. Remodeling requires better management, scheduling, and public relations than new construction. Unfortunately, too many builders don't discover that until they're knee-deep in a tricky job.
2) The remodeling industry tripled in size between 1975 and 1985. By 1984, more money was being spent on remodeling and repair work than on new construction. Industry experts project total remodeling dollars to triple again by the year 2000, reaching nearly $300 billion a year. That compares with about $100 billion spent in 1989. About 40 percent of those dollars will be spent on additions or alterations. The rest will be spent on maintenance and repairs.
Asbestos removal by itself will become a big business. Remodeling magazine projects as much as $200 billion will be spent on eliminating the health risk from asbestos over the next ten years. And within the next few years, many states will probably require a radon test before houses can be sold. Detecting and correcting radon problems will become a nice sideline for many remodelers.
Predictions are that the industry will average 10 to 15 percent annual growth through the 1990s.
3) Remodeling takes less money and less risk than new home building. What you need is some equipment, credit from your suppliers and subcontractors, and cash to meet payroll until receipts catch up with expenses.
New-home builders need lots more. Many try to get started by putting up a speculative house. They find a bank to finance them, build the house, and hope that it sells. They also hope to get enough leads so building another spec house isn't necessary. Spec building is risky. Especially in suburban areas where big, publicly-held developers are active. They're masters at the fine art of getting more square feet of floor for less money.
Remodeling, by its very nature, lends itself well to a mom and pop company. You don't need a showroom or a fancy sales office. You can work out of the back of your truck. Plenty of good remodelers started this way and have chosen to stay this way.
Four-fifths of all remodeling companies have ten or fewer employees. But there are few very large remodeling companies. Most of the giants are in a single line of work, such as siding, roofing, or window replacement. Qualified Remodeler's 1988 listing of the 500 top remodeling companies in the U.S. included only five full-line remodelers in the top 25 companies. The number one company grossed over $120,000,000 doing siding and decks. Many in the top 500 were full-line remodelers with gross sales over $1,000,000 in 1987.
Some new-home builders hire subcontractors to do nearly all the work, from digging the foundation to decorating. All you need are competent subs. Construction becomes a matter of putting the many parts together like a giant jigsaw puzzle. Every house may have a different set of plans, but the parts go together the same way.
Not so with remodeling. Your first job may be enlarging porch windows and painting the exterior. Your second may be adding a sun room; your third, updating a kitchen. Unless you specialize, no two jobs are ever the same. As a result, most remodelers know a lot about most construction trades. It's hands-on skill that helps a remodeling company build a reputation in this industry. Good construction skills are essential. But as the company grows, good management skills become just as important. The remodeler who built the company with construction know-how has to master the fine art of running a construction office. That's not easy, as maybe you've already discovered.
4) Remodeling is a people business, not a product business. Turning clients into friends is one of the things that we like best about the business. If you don't like dealing with people, you might as well stop reading. Your success depends, at least in part, on how well you can get along with clients. Remember, they're trusting you with their most valuable possession, their home. Home renovation can be very stressful for home- owners. The mess, noise, and general disruption to their schedule is a nuisance for anyone. It's your responsibility to help clients survive while you build and remodel.
5) There's always room for someone who can do it better. The Better Business Bureau reported over 47,000 complaints against the home improvement industry in 1986. That was an increase of 31 percent over 1985 and accounted for 10 percent of all consumer complaints. Home improvement ranked second highest in number of problems of all the business categories
Those statistics aren't meant to scare you off. We've never had a complaint lodged against us; we've never spent a day in court or even with an arbitrator. We know lots of remodelers who can say the same thing. We also know several remodelers who got more than their share of those 47,000 complaints.
There's plenty of room for anyone who can do it better. If you do quality work, are willing to work hard to build a reputation, and can get along with people, the industry needs you!
6) Remodeling can be very profitable. We know that's true. But, we won't mislead you. It can also be very unprofitable. If you can control your overhead and if you're consistently good at estimating costs, you can make good money on almost every job. Most remodelers who leave the business haven't been able to do either.
It certainly helps to do a high volume of business, but volume alone won't make you profitable. Some high volume remodelers we know aren't making much money. And we know some low volume remodeling specialists who consistently make good money. Profit margin is usually more important than volume. Be a remodeler who earns a healthy margin regardless of volume, not a remodeler who takes all the work available regardless of price.
Your reputation as an experienced remodeler should help open up some other opportunities in specialty markets. If you have any doubts, get a quote on having some asbestos removed.
7) Owning your own business is very satisfying. True, our bias is showing. We grew up in families that appreciated the flexibility, variety, and challenge self-employed people enjoy. We think running a remodeling company gives us a sense of pride that few businesses could. Looking back over the last ten years, we're proud to have survived changes in the local economy and to have grown and prospered as we accumulated experience. It feels good because we did it ourselves!
But Is It Right for You?
How do you know if. you're cut out to run your own business? There's no sure way to know without actually trying it. But answer the following questions to get at least an initial impression. The first set of questions explore your general attitude toward being self-employed. The second set of questions is more specific. It covers the kinds of personality traits needed to run a remodeling business
Neither test asks questions about your actual constructions skills. We've done it this way for three reasons. First, we assume that if you're reading this book, you have most of the construction skills needed in the remodeling business. You can either do the work, know who to hire to get the job done, or you've got an armload of books to fill in your gaps.
Second, testing your skill as a remodeler can't be done in half a page. In fact, maybe it can't he done on paper. Besides, you probably know already if you have the building skills needed to go out on your own.
Third, construction skills probably aren't as important to a remodeler as business smarts. We know several very average remodelers who have strong companies because they have good employees and they keep tight control on the business end. We also know some highly skilled craftsmen who have had trouble as remodelers because they couldn't estimate accurately or run an efficient construction office.
Here's the test. Take a minute to read the following statements. If you strongly agree with a statement, give yourself 4 points; if you generally agree, 3 points; if you disagree somewhat, 2 points; if you strongly disagree, 1 point.
1) I am very confident of my skills.
2) I would gladly hire someone like me to do a job.
3) I'm not a clock-watcher. In fact, I find it hard to forget about my work outside of working hours.
4) Hard work - not luck - builds businesses.
5) I'd rather work with a difficult, highly skilled person than an easygoing, less skilled one.
6) If I put my mind to it, I can do just about anything.
7) I like being in charge.
8) I rarely feel helpless in dealing with life's problems.
9) I'm not as motivated by making a lot of money as I am by being good at what I do and being successful in my field.
If you scored between 27 and 36, you're probably motivated enough to run your own business. But what about running a remodeling business specifically? Do you have the temperament for it? Take the next test and score it the same way.
1) I am able to delegate responsibility.
2) I try hard to tackle the parts of a task I don't like first so I can get them out of the way
3) I like the challenge of keeping on schedule with a job or task, and I'm usually able to meet the deadlines I've set.
4) I don't mind doing "cold" or follow-up calling on a prospect.
5) I'm organized in most things that I do.
6) I usually make a good impression on people and I'm able to maintain it.
7) I'm somewhat of a perfectionist and I take pride in my work.
8) I demand high quality work out of others.
If you scored between 24 and 32, you'll probably like running a remodeling company and probably can develop the business skills needed. if you scored much lower, be careful. If you still think you're perfectly suited to running your own business, at least look for a likeable partner who would ace the test.
The Good Side
If you scored high on both tests, you have a lot to look forward to. As we've already said, there are plenty of pluses to owning your own remodeling company.
Remodeling is far less volatile than new construction. Because of that, it promises to be a strong growth industry throughout the 1990s. It's cheaper to get into and stay in than new construction. Yet, if you run your company right, it can be very profitable.
Owning your own business can be satisfying as well as profitable. Your hours are more flexible than when you work for someone else. There's never an end to the variety and challenge you'll find in remodeling. And you also have a chance to deal with the public every day.
Last, but certainly not least, if you're honest and capable, the industry needs you!
The Bad Side
Of course there is one. But this is the only time we're going to mention it. There are a number of things that can be and have been very frustrating to us.
Remodeling, especially in the early years, doesn't give you a steady income. In fact, there can be plenty of times when you have no income at all! Twenty thousand may come in one month and nothing the next. If you don't know what your true expenses are, you can find yourself in one of those financial sinkholes we mentioned earlier.
In the decade we've been in business for ourselves, we've seen our Workers' Compensation costs go from 9 percent of every dollar paid to over 30 percent. Our liability premiums have gone up over 500 percent. Add to that the paperwork required by federal, state and local government and it can get pretty discouraging. We get really tired of being tied to a desk when we should be on the job site.
Anyone who's self-employed will tell you about their long work days and weekend work. The extra hours are especially discouraging when they're the result of an estimate that was too low. You planned to hire a crew to do the work but ran over budget. So you're doing the work yourself.
Even if you're making great money on a job, you're probably the first one on the job in the morning and the last to leave. Every day. Every week. On every job.
The part we like best - the people part - can also give us the most headaches. You'll find yourself dealing with an interesting variety of people, some of whom are a bubble off plumb. Even if you can spot them ahead of time - and there are usually some warning shots fired - you may not always be able to turn down the work, especially in the beginning.
Maybe most difficult of all, when you first set up shop, you're the bookkeeper, estimator, carpenter, personnel manager, salesman, and diplomat. And you have to be good at all of them. Some people like the various hats, some hate it.
Don't despair, though. This book is going to explain how to avoid the most common problems.
Are You Up to the Challenge?
How do you take advantage of the pros without being burned out by the cons? It's not an easy question to answer. But let us offer four suggestions from some professionals who have been in the business a long time.
1) Keep an upbeat attitude by trying to look at the larger picture. Try not to sink down in the day-to-day grind. Remember that you're building a business. Good ones don't happen overnight. If you can make it past the first two years, you've done better than 50 percent of the people who try.
2) Educate yourself. Take advantage of seminars, trade books, and even local college business courses. The more you can learn about what you're doing, the better off you, your business, and your clients will be. None of it will be wasted, even if you should decide down the road that running your own company isn't for you.
3) Plan, plan, plan. Industry experts stress the importance of a game plan. Where do you want your company to be in a year? In five years? 1-How can you get from here to there? It also helps you keep that larger picture in sight.
4) Don't take work home with you. We know this must sound like strange advice. But we believe it's important. If your office is in your home, it's hard to resist working on an estimate at night or getting your shop ready for the next day. Tell yourself that after 6 o'clock, your day is done. Do something that will energize you for the next work day. You shouldn't have to eat, sleep, and dream construction.
The Next Step
The next step is to actually set up your business. The first choice is the form of business ownership. There are three alternatives:
1) Sole proprietorship
Each has its own legal and tax distinctions. The following will give you a general idea of which legal form is best for you. Every state has slightly different requirements. Before you make the final decisions, talk with an attorney and an accountant.
A sole proprietorship is a business owned by one person. As the owner, or proprietor, all of the company income and expenses appear on Schedule C of your federal tax return. Company profit is your income and you pay tax on it every year. You're legally responsible for all company debts. As owner, you assume all liability not only for your actions, but also the actions of your employees.
In the past, the 'actions of your employees" has usually meant what happens while your employees were working. If your foreman drops his hammer and gouges the floor, you're responsible for repairing it. If a careless toss of his lit cigarette burns down the house, you're liable. if he has an accident driving from one job site to another, you again are responsible.
Recently, though, that interpretation has been broadened. In 1987, an Oregon contractor was held liable to a third person who was raped by an employee. The employee had been under a lot of stress and had been taking illegal drugs. During his working hours he became "disoriented," forced his way into a house, and raped a woman. The court held the contractor responsible because he should have been able to see that the employee wasn't stable and was a danger to others.
This chilling example should tell you two things. One, your liability for employee actions is very broad. It's more than most of us might consider even logical. And two, until the courts interpret the law differently, you must be very careful about who works on your jobs and what instructions they are given.
There are four main advantages to running a sole proprietorship.
1) You have total control of all business decisions.
2) All of the profit goes directly into your pocket.
3) Setting up a sole proprietorship is quick and simple.
4) Business losses are completely deductible.
The disadvantages are these:
1) You're legally responsible for all company debts.
2) You're liable for all company acts and omissions including those of your employees.
3) If your business income is high, you'll pay more tax than if the income was kept in a corporation.
A partnership is a business owned and operated by two or more people. The partnership is formed by an agreement negotiated between the partners. There may be a large number of partners - 50 or more, or as few as two. Each partner owns a percentage of the business. It doesn't have to be an equal percentage, although it can be. One may own 50 percent, one 30 percent, and one 20. Profits and losses are usually divided based on the same percentage as ownership.
Each partner is also personally responsible for the company's debts. Liability is not proportionate to each partner's percentage of ownership. Sadly, this means that if the business goes under and your partners are broke, you may have to pay any debts the company still owes, even if your share of the business was very small.
Usually, each partner contributes something to the business in the form of money, skills, or property. It's up to the partners to decide what each partner has to contribute and what each partner receives in return.
Note this very carefully about partnerships. Unless the partnership agreement says otherwise, each partner can act as an agent for the business. Any partner may hire, fire, borrow money, sign contracts, or make any business decision. All of the other partners are bound by these actions, whether they were aware of them or not.
As a result, if you choose to set up a partnership, it's extremely important that your partnership agreement cover all rights and obligations of each partner. Usually you'll want to have an attorney draw up an agreement that covers all the issues. Even partnerships among good friends and relatives can end in acrimony and lawsuits when the agreement omits some important point. We've seen it happen and it isn't pretty. Sometimes it's harder - both financially and emotionally - to break up a partnership than it is to end a marriage. The more you plan ahead, the smaller your risk if things fall apart.
Partnerships work well for some people. But they aren't ideal for a construction business. You have all of the disadvantages of a sole proprietorship and few of the advantages of a corporation. Consider very carefully whether your prospective partners will be bringing into the company enough to make the risk worthwhile. At the very least, try to find someone who can provide something you don't have, like money, contacts, carpentry experience or sales skills.
Again, the advantages:
1) The sum is usually greater than its parts. With one or more partners, you should have plenty of capital and expertise.
2) If you lack startup capital or management skills, bringing in partners may be the quickest and easiest way to get the business going.
3) Except for the contract between the partners, it's a very simple form of ownership.
And the disadvantages:
1) All partners are liable for all company debts.
2) Business losses may be deducted only to the extent of your investment.
3) You're legally responsible for the actions of your employees.
4) You're responsible for the business decisions of the other partners whether you know about them or not.
5) A partnership is dissolved after a partner's death and must be reorganized.
6) If your business income is high, you'll pay more in taxes than if you operate as a corporation. The partnership files only an 'information" return showing income and expenses. Whatever profit is earned is divided among the partners and each pays tax on those earnings.
A corporation is legally separate from the people who own and operate it. It's like a third invisible person. It can bid, make contracts, receive loans, and will pay taxes on its earnings. It goes on living even when shareholders sell their stock or managers leave the company or die. A partnership, on the other hand, is dissolved on the death of a partner. A corporation makes it easy to continue business from year to year. Although it's a very minor benefit, in some states it's also possible to pass on a construction license within a corporation.
Most corporations raise money by selling shares or stock. If you decide to incorporate, be sure to authorize far more shares than you ever expect to issue. From that point on you can sell any of the shares that have been issued.
You may own all of the shares, in which case you control the business. However, if you want to raise additional money for your company, you may sell shares to others. In doing so, you're also selling part of your control. As long as you keep over 50 percent, though, you have the votes to control the company. Of course, most investors want some voice in how their company is run. Raising money will be easier if you're willing to share control.
If you incorporate, you become an employee of the corporation. Both your salary and the fringe benefits you receive will be expenses to the corporation - part of the cost of doing business. The corporation doesn't have to pay taxes on that money. But, of course, you do. The corporation pays income tax on the profits it makes every year, even if that money is used to buy equipment or vehicles or to carry inventory or accounts receivable. If part of that profit is distributed to stockholders, it's taxed twice, once as profit to the corporation and once as income to stockholders. That's one major disadvantage of incorporating.
Most companies choose to incorporate for two reasons. First, corporations are taxed differently and usually at a lower rate than individuals. As of this writing, corporations pay federal tax of only 15 percent on the first $50,000 of net income (profits). If you took that same $50,000 as additional personal income, your federal tax rate would probably be 28 percent. Keeping profits in the corporation lowers the tax so you can accumulate the money needed to run your company. Of course, that money isn't in your pocket yet. If and when the money does reach your pocket, you'll still have to pay the tax.
There's another reason why so many companies incorporate. Unlike sole proprietorships and partnerships, your personal liability is probably limited to what you've invested in the company. Both the tax advantages and limited liability need more explanation. First, taxes.
There are two kinds of corporations. Although there are a few characteristics that distinguish the one from the other, for all practical purposes, the choice is usually based on tax considerations. The two types of corporations are type C corporations and type S corporations.
In a C corporation, the corporation pays taxes on its profits. When the corporation distributes some of those profits to shareholders in the form of dividends, shareholders pay a second tax on the distribution. That's why most small corporations don't pay dividends. It's double taxation. It saves tax to pay a larger salary (a deductible business expense to the corporation) and no dividends.
An S corporation blends the advantages of a partnership with the advantages of a corporation. You still have the legal protection from personal liability. But all income and losses are passed through to the stockholders who then have to pay the tax, even if they didn't actually receive any money. Stockholders pay tax on their share of profits at their regular tax rate. That's the same rate as would apply if the company were run as a proprietorship or partnership. In effect, you escape the double taxation problem that you would have in a C corporation.
A corporation can sue and be sued. If it's set up and run correctly, the corporate shell protects shareholders from liability. To have this advantage, though, it's very important that you separate personal finances from corporate finances. If you don't, a court may decide that you and your corporation are one and the same, exposing you to personal liability for corporate debts.
Which Corporate Form is Right for You?
Unless you expect to make a lot of money or have more than the S corporation's current legal limit of 50 shareholders, we recommend an S corporation over a C corporation. Most small, and certainly most new, corporations are not profitable enough to make it worth their while to choose a C over an S. The tax advantage of being an S over a C is less than it used to be with the most recent tax changes. Have both your attorney and your accountant make a recommendation. The IRS allows one switch from C to S or the reverse. After that, you need IRS approval to change again I. With good advice, you can choose the one right for you and stick with it from the beginning.
The Final Word
Incorporation doesn't make you a better remodeler. It won't make your company any more profitable. In fact, we would suggest putting off the decision to incorporate until you've been doing business for a few years. There's no hurry. Your banker will insist on getting your personal guarantee on loans whether you're incorporated or not. So you'll probably be personally liable for most corporate debt anyway.
|Sole Proprietorship||Partnership||S Corporation||C Corporation|
|Financial liability limited to your investment?||No||No||Yes||Yes|
|Business losses may be deducted? Only to extent of investment||All||All||All||All|
|Where does startup money come from?||You||You and partner||Shareholders||Shareholders|
|Easy to form?||Yes||Yes||No||No|
|Ease of succession?||Hard||Hard||Easy||Easy|
|Can license be passed on?||No||No||In some locations||In some locations|
|Who is legally responsible for decisions made?||You||You||Corporation||Corporation|
|Who is legally responsible for employees' actions?||You||You||Corporation||Corporation|
|Tax status?||Pay as individual||Pay as individual||Pay as individual||Pay as corp. & individual|
Forms of ownership
There's another reason to delay incorporation. It's expensive, usually a thousand dollars or more. Better to spend your money on what will bring in more money than on legal formalities. Wait a few years until business is good and getting better. Then spend some money to form your corporation.
Figure 1-1 compares the three forms of ownership. Use it to compare the advantages and disadvantages of each form.
Choosing Your Name
No matter what form of business you choose to set up, there are some things a new remodeling company has to do. The first is probably choosing your company name. Does that sound easy? Choosing a name can be surprisingly hard. Consider the following.
1) You want a name that isn't already being used.
2) You want a name that identifies the kind of work you do.
3) You want a distinctive name that people remember.
4) Ideally, you want a name that has all three of the above.
Still think it's easy? Try this exercise. Look in your local Yellow Pages under home improvement and read through the listings. Now close the book and try to remember as many company names as you can. Do any stand out? If any have, try and figure out why. If none do, maybe you can better understand how difficult it is.
For most remodelers, the easiest solution is also the most common. How many company names included the name of the owner: John Doe Remodeling? A name like this satisfies the first two elements listed above, but doesn't do much for three and four. How many were Miller Kitchens? Or White Construction? The first is so specific a homeowner might wonder if you do baths or additions. The latter is so general you wonder if, they do a little of everything - and none of it well. Nevertheless, you're probably better off being too general rather than too specific, especially if you're like most remodelers and you do all kinds of remodeling and some new construction. Certainly for your new construction work, a name that has remodeling in it wouldn't be a good choice.
Good names are hard to find. One of the few we know of is used by a highly successful competitor in our area. His last name is Klass and he goes by Klass-ique Remodeling. It's a clever play on his name that's worked well for him. For some reason, the same contractor uses the name "The Remodeler." We don't know the history of that, but suspect that more than once he's regretted the clumsiness of using two company names. His combined name neatly fits criteria 1, 2,3, and 4: A unique name that identifies the scope of work and is easy to remember.
If you live in a small town, choosing a unique name for your business probably isn't very important. Most people are going to be calling Tom Smith, not Best Remodeling. In fact, they may be confused if you do choose a name that doesn't directly identify you. In an urban area, your company name may he far more important. And while a name alone can't sell a job, if it sticks in the consumer's mind, it may get you in the door to bid a project.
Of course, even the worst name won't sink your company. But it can be a handicap. One tendency we've noticed is that remodelers often end up using their own name one way or another, even if they've chosen a completely neutral name for their company. If Tom Smith has a good reputation, potential clients will probably hear and remember his name and not Best Construction. Best Construction may be a nuisance for Tom Smith because it confuses potential clients.
The solution? Choose one name and use it. Put it on your stationery, vehicles, business cards, caps, all your advertising. If you know who your company is, the public will have an easier time knowing too.
One last note. Don't worry about choosing a name that will be listed first in the Yellow Pages. As we'll discuss in the next chapter, a Yellow Pages listing is more a courtesy to your clients who already know you. Very few remodelers get much work from the Yellow Pages; certainly not enough to merit an awkward name.
Registering Your Company Name
Once you've selected a name, your next step is to claim it officially as yours. Now's the time you'll probably run across the letters DBA. DBA is short for doing business as and refers to your business name. Only sole proprietorships and partnerships are identified this way. Corporations are chartered by each state and don't need a DBA.
If your company is a proprietorship and the name is Best Remodeling, for legal purposes you're Tom Smith, DBA Best Remodeling.
The DBA information informs the public of the person (or persons) responsible for the business. Not all states or counties require you to register your DBA. If you live in one that does, registering a DBA usually requires only payment of a fee and completing a simple form. Usually you'll have to run a small ad in the local paper giving notice to the public of the name you're using. Check with your county clerk and with your state's Secretary of State office.
You can't use a name that's being used by another business. Likewise, once you have registered your name, no one else in your area of registration may legally use that name. If you find the name you've chosen is already registered by someone else, don't give it up immediately. Check with the business that registered the name. If they're no longer using the name, they'll probably be very willing to release it.
Corporate names have to be unique too. The Secretary of State or Department of Corporations in your state probably keeps a register of names currently in use. They probably have a phone number where you can check the availability of a name and have that name reserved while your corporation is being formed.
An Employee Identification Number
Once you have a name, you'll need an Employer Identification Number (EIN), sometimes called a Taxpayer's ID number. An EIN is required if you have employees. If you don't have employees, you may use your Social Security number. However, if you plan to ever hire anyone, you might as well file for one right away. It saves the hassle and confusion of changing over later.
How to Succeed with Your Own Construction Business
by Stephan & Janelle Diller
If you're working as a builder but dream of running your own construction company, this is the book for you. The authors, a husband-and-wife construction team, specialize in remodeling, but the information they share is just as valuable to spec builders and subcontractors.
The authors begin by taking you step-by-step through the process of setting up a new company. You'll learn about several ways to structure your company, and the benefits and disadvantages of each of them. You'll also learn how to make a good impression on clients, how to work with architects, inspectors, and bankers, and where to look for more help when you need it.
Clear, easy-to-follow chapters cover:
There are tips on:
hiring and training employees
organizing your office
managing your time
keeping your books
buying insurance protection
staying out of trouble with tax collectors
Whether you've already started your own business, or are considering doing so, this book will give you the basic information you'll need to make the right decisions and get off on the right foot to a successful and rewarding career in the construction industry.
THE AUTHORS: Stephen Diller is a fourth generation builder. His great-grandfather was the barn raiser in his community, and his grandfather and father carried on the building tradition, specializing in custom homes. After several years working on another builder's payroll, Steve, assisted by his wife Janelle, started his own construction company. Specializing in the rapidly-expanding home-improvement market, they built a successful business based primarily on referrals and repeat work.
Janelle Diller also came from a family involved in the construction industry. She maintains an active role in the office end of the business, and also teaches at the community college.
Although the two grew up with construction, when it came to starting their own business, they quickly discovered that knowing how to swing a hammer and how to run a business profitably were two very different skills. What they needed was a book like this one: one that would explain estimating, scheduling, setting up books, dealing with the IRS, marketing, and salesmanship. After learning these skills the hard way-through trial and error, the authors decided to share their knowledge with other contractors starting their own business. The information they have provided fills the gap between construction skills and business skills. The authors' purpose is to relieve other would-be construction company owners of the pain of learning the hard way.