So ...you’re thinking about starting your own company.
You’re hearing about dot.com millionaires every day and people who came to this country with pennies in their pockets and created empires. It sounds good - make your own hours, no limit to how much you can earn, more time with your family, etc. And it is good, when it works. But there’s also a down side: At least in the beginning of a start-up, you’re doing virtually everything (advertising, getting new clients, resolving performance issues, pricing and drafting customer proposals, licensing, billing, insurance, hiring employees, negotiating with suppliers, paying taxes, cleaning the office and more) in addition to the actual productive (paying) work itself. Much of your time will be unpaid, unlike being an employee.
And there will be a lot of time, or you won’t succeed. Most self-employed people I know claim that they spend three times the hours they spent as an employee. Three times! When you are an employee, the lines are often quite clear about your exact duties and responsibilities, the hours and days you are expected to work, and the manner of compensation. In most cases, you aren’t expected to run the company or even capture new customers, just do the work correctly and on time. And, no offense, if you work for the government, you’re paid for just being there. If you’ve always been an employee, this will be a big lifestyle jump for you - you are going to be responsible for everything.
Some people are able to make the jump, others aren’t. The main reason for failure that I’ve seen is that, as an independent businessman, you have to exercise extreme discipline. You have to schedule your time to accomplish a variety of tasks on time. And usually not your time. Contrary to popular belief, independent consultants don’t schedule our life, our clients schedule it for us. So do our suppliers, advertisers, tax collectors and others. They, and not you, determine if you will have to work all night, or on holidays or at other inconvenient times. And they, not you, may require work to be done in a less than optimal time window. You’ve got to know how to comply or resist, or you’ll quickly be out of business. The fact that you may be the absolute best at what you do isn’t what’s important here: You may be the best, but it doesn’t mean that you have the ability to run a business. However, the good news is that, if you don’t have an education in accounting or graphic design, there are people available to help you (like us), and you can delegate that work to some of those experts without losing control.
Aside from the above, how do you know if you’re going to make any money working on your own? If you’ve always been an employee, you know exactly how much you’re making each pay period, how much you take home, how much paid sick and vacation leave you’re accrued and many other fringe benefits like health care, 401(k), educational assistance, group term life insurance, health savings accounts or retirement contributions, much less a gym membership, a turkey at Thanksgiving or coffee and snacks in the break room. While it has the down side of your entire work life being indentured to a single employer, it does have the element of dependability that you won’t get with your own company. The phrase “you eat what you kill” is a crude statement of the reality: You have to get business, make it profitable after paying your expenses, and keep the rest after paying the tax man. Much of your business may vary because of forces beyond your control, like seasonal changes, currency devaluation, weather here and abroad, political forces and the like. But much of your business costs can be controlled, like payroll, rent, utilities, subcontractors and suppliers. It’s a complex and constantly evolving formula. For example, you can go to a supplier out of the country, saving money in labor or materials, but the costs of warranty replacement for lower quality or defective parts and the time lost communicating across the globe may still eat up much of the savings. It may be a better choice to produce in-house but use available updated machinery or labor training which reduces the number of employees. In this regard, short-term profits may have to be measured against long term goals.
In any event, even if you simply transfer from an employee status, there is still a world of difference. Whether you want to become your own contractor, own a candy store, buy a franchise or drive for Uber, there are some basic financial changes you’ll have to get used to. Here are a few:
1. Depending on what you’re doing, you may need a basic or specific license from the jurisdiction(s) you’ll be working in. Unfortunately, this is usually a money making scheme for the local government, and you don’t get much for this piece of paper, which sometimes can be quite expensive. Even a hot dog cart license can cost hundreds of dollars a year. Unfortunately, even a cheap entry level “general business” license is really just an excuse for the government to get their foot in the door to track your business with inspectors and impose additional licenses and fees (like the personal property tax discussed below). And if a car or truck is required for your work, it may have to be licensed as a work vehicle, which can cost more. Many jurisdictions also charge a yearly “personal property tax” on what they consider to be the stuff you use to make your living, even if it’s just a desk and a computer. Moreover, if you’re going to operate your business under a name other than your own, you’ll probably have to file a “trading as” application with your local jurisdiction (for a fee, of course) and with your bank, so that you can open a checking account under that name. And, in many types of businesses (check your local codes), licensing comes with intrusive inspections always, it seems, at the most inopportune times.
2. Aside from vehicle insurance, even if you don’t own the premises where you work, you will be required to have basic insurance (fire, theft, etc.) and, if the public comes to you or you work on their premises, liability insurance. You may also have to get zoning variances if clients or customers routinely visit you at home, as opposed to offices. Signs and other identification may be prohibited or regulated at various locations and may require separate licensing and, of course, fees. You might want to keep a local attorney on speed dial for assistance.
3. Classifying yourself as a self-employed independent contractor is one thing. Having the government agree with you is quite another. (If you’ve been following the rise of Uber, you should be aware of this problem.) You may be questioned about this at some point. In order to qualify as an independent contractor, there are several criteria that must be satisfied. Depending on the jurisdiction, you must show, for example, that you work for more than one customer, schedule your own work, have your own tools and/or supplies, can turn down work, work on your own premises, and aren’t supported by only one main customer, and the like. If you are turned down, there will be negative tax implications for both you and your “employer”.
4. Taxes are a huge difference. They’re now your responsibility. It’ll make you appreciate your old payroll department. As a self- employed independent contractor, instead of getting that W-2 from your employer, you’ll receive a 1099-MISC from everyone that paid you more than $600 for the year. There will have been absolutely no withholding from any of your payments, but you’ll be responsible for paying the full federal, state and any county income taxes, depending on your state. Before you decide to take the plunge, basic calculations are in order. Let’s do a simple example: You make $100,000 gross this year. Since you will obviously owe more than $1000 in taxes, the IRS requires you to pay “estimated taxes” each quarter and not wait until the end of the year to file an annual return, like you did when you were an employee. (Your employer did, however, have to file quarterly estimated taxes.) You’ll be assigned an “EI” number by the IRS for this purpose. How do you estimate the quarterly estimated taxes? First, figure out your income. That should be easy enough. Then, deduct your expenses from that income, not quite as easy. That would include any cost of generating business (maybe you owe a franchise fee or note payments if you purchased an ongoing business), your fixed (rent or vehicle payments, as well as insurance and licenses, for example) and variable (power, water, supplies, materials) costs that vary with the amount and type of business. [It’s beyond this simple explanation to become your accountant, but be aware that an accountant could educate you about important things like depreciation, home office deductions and auto expense deductions that could reduce your ultimate tax liability on the “Schedule C” of your tax return, which is used to calculate your net profit.] You’re not done yet, though. You’re responsible for 15.3% SECA tax on 92.35 percent of the net income, and possibly other federal and/or state contributions. Starting in 2014, if you don’t have the minimal essential health care coverage required under the Affordable Care Act, you must pay the greater of $95 or 1% of your income.
5. And don’t forget that all of this depends on the legal business form you choose. The above applies if you’re acting as a “sole proprietor,” but if you choose to incorporate your business as a limited liability corporation (“LLC”), Subchapter S or even a full (“C”) corporation, you may have “double taxation,” paying corporate tax, then a second tax when you receive distributions as an employee or owner. But it may be advisable for liability insulation or to protect your personal assets, if your business or personal situation demands it.
Enough? All of this isn’t meant to discourage anyone from going into their own business. But you should do it with your eyes wide open, or you can really get into trouble. The second most common cause of business failure is what we call “undercapitalization,” which means that you just don’t have sufficient money to get your business off the ground. It always takes much more than you think, both up front and for the first two years of operation. Again, speak to an accountant about this for complete advice, as the old adage “when starting a business, be prepared to live for two years without a paycheck” is still valid advice.
Look, lots of capable people start their own businesses every day. But many stop every day, too. To be successful (not necessarily millionaires, but making it on their own), they should at a minimum have (1) a dedicated clientele (either from their old employment, perhaps purchased from an already existing business, even a franchise) or maybe a a strong local following that’ll at least provide an immediate income stream; (2) sufficient funds, either from personal savings, investors or loans to cover expenses for at least a year or so; (3) a real written business plan with a five-year pro-forma financial statement (essential for getting a business loan), advertising plan and goals, and (4) knowledge of or assistance with managing money (billing, receipts, payments, quotes, contracts and the forms and systems for using them), making legal decisions and marketing. (5) A brilliant, unique idea is wonderful, but it’s about as likely as getting hit by lightning twice, so don’t wait for it. And what’s brilliant to you may not be brilliant to someone else or even useful for most people - watch “Shark Tank” on TV for some good pointers. Moreover, if you’ve got no track record, do a market survey, test your assumptions. News Flash: Most wealthy people aren’t that intelligent (right place, right time syndrome) and most bright people never become rich. These two traits don’t automatically go hand in hand. Most businesses are quite mundane, but can be handsomely rewarding (I’m thinking of a client who became a millionaire providing those thin wire hangers that cleaners hang your laundered shirts on.) (6) And learn, then never stop learning. I meet lots of Millennials who think that becoming an entrepreneur means you never have to learn (or even work) once you create a startup business. To the contrary, it means you have to do even more. There’s always someone coming up fast behind your business model (or some business just ahead that may steal your idea), some new invention that may make your product or service obsolete, some fork in the road that you have to see coming (like weather, currency exchange, government regulation or supply chain disruption) and you won’t see it until it’s too late if you rest on your laurels. And think about it in the reverse: Would you be comfortable going to a doctor who hasn’t read a medical journal since graduation?
Finally (7), the appropriate personality. As we discussed at the beginning of this article, this may be a big change from being an employee or student to becoming an entrepreneur. You never get to have a bad day. No one wants to buy something from someone who is disinterested or distracted. And no one wants to work for a boss that doesn’t listen or is a jerk. You must always be excited about your business and be able to convey this excitement to your clients and workers. If this isn’t you, find someone who is. Equally important is that you must train your people to do exactly the same thing and continually monitor them to make sure they do. You don’t want to lose business because of them. All of this while having the perseverance and discipline to run the business at the same time. I never said that this would be easy or fun. But if you pull it off, it’s extremely rewarding!