Business Posts

Startup Basics: Federal and State Tax ID Numbers

State and federal tax ID numbers (also known as an Employer Identification Number or EIN) are like a personal social security number for your business. They let your small business pay state and federal taxes.

A federal EIN is used by the U.S. Internal Revenue Service to identify a business entity. This 9-digit number is required to pay federal taxes, hire employees, open a bank account, and apply for business licenses and permits.

An EIN is required for most businesses, including, but not limited to, those that have employees and those that operate as a corporation or partnership.

It's free to apply for an EIN, and you should do it right after you register your business. Business owners can apply for an EIN via an online form or by completing Form SS-4 and submitting it by fax or mail. Online applicants will receive an EIN immediately; applications submitted by fax or mail may take several weeks to process. The IRS recommends applying far enough in advance to ensure that the number has been issued before it is time to file a return or make a deposit.

All EIN applications must disclose the name and Taxpayer Identification Number (SSN, ITIN, or EIN) of the true principal officer, general partner, grantor, owner, or trustor. This individual, which the IRS calls the “responsible party,” controls, manages, or directs the applicant entity and the disposition of its funds and assets. (Unless the applicant is a government entity, the responsible party must be a person, not an entity.)

Generally, businesses need a new EIN when their ownership or structure has changed.

The need for a state tax ID number ties directly to whether your business must pay state taxes. Visit your state's website to identify whether you need to get a state tax ID number in order to pay state taxes. You will need your federal EIN in order to apply for the state tax ID number.

If your company regularly operates in Illinois or employs people who live there, you will need to obtain a tax ID number from the Illinois Department of Revenue. This ID number is used to pay Illinois income, sales, and use taxes, as well as the amounts withheld from employee wages for Illinois individual income tax and unemployment insurance. Illinois issues the ID number based on the information you enter on Form REG-1 (the Illinois Business Registration Application); businesses that pay specialized kinds of taxes (eg, cigarette, liquor, telecommunications) will be required to file additional schedules.

For more on these and other topics, consider registering for the NaperLaunch Academy Workshop series. In addition, business librarians, NaperLaunch coaches, and SCORE mentors are available for one-to-one mentoring sessions.

Posted: 
Monday, April 19, 2021 - 10:00

Qualifying for a Small Business Loan: The 5Cs of Credit

Besides bootstrapping, there are basically two ways to fund revenue growth in a business: take on debt or invite equity investors. In this blog post, we look at using debt to raise capital, and more specifically, what is required to qualify for a commercial loan.

All commercial lenders follow some standard underwriting principles and consider certain factors. This process is intended to build up a lender’s confidence that a business owner will repay the loan according to the loan provisions. In doing so, the lender generally considers what are known as the 5 Cs of credit.

The 5 Cs is a system used to gauge the credit worthiness of potential borrowers. Weighing these five borrower characteristics—character, capacity, capital, collateral, and conditions—is the lender’s way of estimating the chance of default and, consequently, the risk of a financial loss for the lender. Make no mistake about it, lenders want to loan money—that is how they grow their business—but they want to do it with some security. Borrowers can take steps to make their loan application more appealing to a lender by focusing on continuous improvement of their business in each of the five areas discussed below.

  1. Character (Credit)
  2. To assess a business owner’s character (or credit worthiness) lenders may check credit history and credit score. A borrower can raise a credit score with some very simple internal controls and rules—making sure that all bills are paid on time and that any credit issues in the credit report are resolved and cleaned up well in advance of making an application for a loan.

    Character involves more than just a good credit score. It also encompasses reliability, being someone who does what is promised and follows through on all commitments. Another thing an owner can do is inform the business’s banker about significant achievements in the business. This builds the business’ reputation.

  3. Capacity
  4. A lender will measure the business’ capacity to repay the loan amount by evaluating the operational cash flow of the business. Poor management of accounts receivable could have a negative impact on the ability to qualify for a loan. Capacity to repay is also impacted by the amount of debt carried by the business. A high debt ratio puts the business in a more precarious position to repay its debts.

    Other factors that could impact capacity include revenue history and revenue growth. Without a lengthy track record of recording sales and increasing those sales figures over time, the capacity to repay is less certain.

  5. Capital
  6. Capital is the amount of money that has been invested in the business that becomes operating funds. It is a measure of two things: the amount of money invested by the owner and how money is available to keep the business functioning. Lenders prefer to extend credit to borrowers who have invested their own money into the business, as this demonstrates proof of the borrower’s commitment to the business.

    Borrowers with a large capital contribution in the business will find it easier to get loan approval because they present a lower risk of default. This works the same way as mortgage lending. Just as when buying a home, a borrower who has placed a down payment of 20% of the value of the asset can get better rates and terms for the loan, the business owner who has invested cash in the business is more likely to receive favorable terms.

    Without making a personal cash investment in the business, an owner will find that getting loan approvals will be very challenging, if not impossible.

  7. Collateral
  8. Collateral is usually an asset owned by the borrower that the lender will accept as security for the loan. Any real property, large equipment, or other assets can be used as collateral depending on the purpose of the loan. If the borrower defaults on the loan, the lender can seize the asset that was used as collateral.

    Service businesses often have very few assets of this type. A related approach is “factoring” a business’ accounts receivable, which may be a viable option in some situations. Some service contracts may not be fulfilled for several months, delaying receipt of the cash payments from clients. For a fee that is some factor of the total receivables, an accounts receivables lender can take over collection of the receivables and provide cash to the business immediately. Of course, such costs should be taken into consideration when prices for services are negotiated.

  9. Conditions
  10. The lender will consider various factors related to the borrower’s current situation and the specific conditions related to the loan application, including the purpose of the loan. Lenders will assess the need for the loan; obviously, raising funds to grow the business or to purchase a specific asset that will help the business grow will be more appealing to a lender than a loan to help bail out the business from losses, especially those stemming from poor decisions or lack of preparation for catastrophic events.

    Other conditions might be related to the extent of the owner’s experience or how long the business has been in operation, its profitability and productivity. A lender also must consider the amount of the loan, the interest rate, and expected payment amounts, each of which will have an impact on the business.

    To summarize, a business owner should consider how well the business’s history, financial standing, and operational success will appeal to the lender in each of the 5Cs before the need arises to take out a loan to fund growth. Being mindful of these commercial loan requirements can be a motivation in the way the business is managed. In fact, operating the business with the 5Cs in mind may be an excellent guide even for a business owner who has no intention of seeking a commercial loan.

For more information about or assistance with these and similar subjects we recommend one of three options:

  1. Register to attend the NaperLaunch Academy Workshop Series.
  2. Arrange to meet with a NaperLaunch coach.
  3. Arrange to meet with a business librarian.
Posted: 
Monday, April 12, 2021 - 10:15

Customer Lifetime Value and Startup Growth

When it comes to assessing the effectiveness of your business’ marketing efforts, not all metrics are equally valuable. For startups, one metric that is particularly useful in measuring marketing effectiveness is customer lifetime value.

Customer lifetime value (CLV) indicates the average total revenue a business can reasonably expect a single customer to generate over the course of the business relationship. The longer a customer continues to purchase from a company, the greater their lifetime value becomes.

Understanding CLV can help a business answer these critical questions:

  • How much can we profitably spend on marketing and sales for customer acquisition?
  • How much should we spend on customer service to retain an existing customer?
  • Who are our most valuable customers and how can we better target this demographic for future sales?

Not all customers are equally valuable. For most businesses, specific types of customers can be identified as the most profitable. Assessing CLV allows the business owner to dedicate more resources toward the acquisition and retention of high-value customers–thereby increasing profits overall.

Without measuring CLV, a business might spend too much to acquire customers whose lifetime value simply isn’t worth the cost. By identifying the most valuable group of customers, the business can focus on providing customer service tailored to their needs to ensure they stick around long-term.

Depending on the data used, CLV can be historic or predictive. Historic CLV is the sum of all profits from a customer’s past purchases. This number is based on existing customer data from a specific time period. Considered a more complete method of assessing CLV, predictive CLV uses transaction history and behavioral patterns to determine the current value of a customer and to forecast how customer value will evolve with time. As more data are collected to include in this calculation, the value will become increasingly accurate.

There are several different ways to determine CLV. The most basic is to calculate the revenue earned from a customer minus the initial cost of acquiring them, as shown in Formula 1. The revenue from a customer is the average amount of revenue generated annually multiplied times the expected number of years of the life of that customer relationship. Customer acquisition cost (CAC) is the total cost of sales and marketing efforts, including associated property and equipment, needed to convince a customer to buy a product or service (see Formula 2). This basic formula arrives at lifetime value in its simplest definition – lifetime revenue minus costs.

Formula 1. Basic Customer Lifetime Value Calculation

CLV = (Annual revenue per customer * Customer relationship in years) – CAC


Formula 2. Customer Acquisition Cost

CAC = Total sales and marketing expenditures / Number of new customers


For example, if a company generates an average of $3,000 in annual revenue per customer with an average customer lifetime of 10 years and an average CAC of $3,000 per customer, then the CLV calculation might look like this:

CLV = ($3,000 * 10) - $5,000 = $25,000


Looking at CLV through this lens makes it easier to justify the sales and marketing budgets required to land new customers in the first place. Notice that the cost of acquisition is actually higher than the revenue generated in the first year, but when lifetime value is considered, the acquisition cost is much smaller.

The simple approach works best if a customer’s annual profit contribution remains somewhat consistent. For example, if a business runs on a subscription-based model with only one or two tiers, then each of its customers can be expected to provide a relatively stable source of revenue.

On the other hand, if a company’s annual sales per customer are not relatively flat, a more in-depth CLV equation is needed. This traditional version of the formula takes rate of discount into consideration to account for future customer retention discounts or other price adjustments. It also provides a more detailed understanding of how CLV can change over the years.

The traditional CLV calculation shown in Formula 3 is more complex and should only be used for precise valuation. It breaks down the individual costs and profits of each year. Calculating it requires the following pieces of information: average gross margin (in dollars) per customer lifespan, customer retention rate, and rate of discount.

Formula 3. Traditional Customer Lifetime Value Calculation

CLV = Gross margin * (Retention rate / [1+ Rate of discount – Retention rate])


To determine a customer’s dollar value of gross margin, calculate the basic CLV using Formula 1 and then multiply the result by the gross margin rate. Taking the final result from the first example above and assuming a gross margin rate of 30%, the gross margin in dollars per customer lifespan would be 25,000 * .30, or $7,500.

This traditional method of calculation allows for fluctuations in customer revenue over time, and each year is adjusted by a rate of discount to account for inflation, price incentives or special offers. (A rate of 10% is commonly used by subscription companies.) Retention rate is the percentage of customers who continue to be customers by making a purchase in successive periods.

Continuing with this example, assume customer retention rate is 88% and the rate of discount is 10%. Our calculation would look this:

CLV = 7,500 * (0.88 / [1 + 0.10 – 0.88]) = $30,000


Regardless of which equation is used, one of the most valuable applications of CLV is using it to frame a better understanding of the business’ CAC. The CAC-to-CLV ratio reveals a lot about the health of a startup’s business model. Many startups and small businesses struggle to grow because CAC is higher than the profit contributions of a customer’s single transaction. It may in fact be higher than the estimated CLV. A high CAC-to-CLV ratio may even lead to a startup’s early demise.

After calculating CLV, the business can focus on optimizing this ratio, by targeting specific target customer segments which offer the best CAC to CLV ratio. This will ensure that the business continues to grow profitably.

For more on these and other topics, consider registering for the NaperLaunch Academy Workshop series. In addition, business librarians, NaperLaunch coaches, and SCORE mentors are available for one-to-one mentoring sessions.

Posted: 
Tuesday, April 6, 2021 - 09:45