The Mechanics of Consulting
Since going independent in February, A few people have asked me about starting an independent consulting practice. This post shares some of my experiences. In order to keep it to a manageable length, I have omitted stuff like developing and maintaining relationships with clients, writing statements of work, running the actual projects, as well as the banal necessities of invoicing and collection.
If you happen to be thinking of doing something like this, please keep in mind that your milage will certainly vary. A cursory internet search about starting a company turns up lots of strong opinions – many of them written by people who seem to be selling something. I’m not an attorney, I’m not a CPA, and I do not specialize in setting up small businesses. This post describes my experiences and should be taken with a grain of salt.
With that, here are some of the mechanics:
I registered an LLC with the secretary of state of Massachusetts. This involves filling out a straightforward web form and costs $500. There is a $500 annual fee to keep the company active, and a $500 fee if you want to make changes to the filing (like updating an address or a name) in the middle of the year. I paid an attorney to fill out the form for me, but in hindsight it’s simple enough to do for yourself.
My understanding is that I didn’t have to register an LLC. I could also have simply started “doing business as,” myself. I registered both because I thought it was cool to own a “real” company, and also to provide a legal framework to keep my personal and my business finances separate. Despite the words “limited liability,” an LLC does not actually provide much in the way of legal protection for my assets. That sort of protection comes from consistent, audit-ready financial practices, and insurance.
The form requires a brick and mortar street address as the official location of the business. Everything else can run through a post office box, but the state wants to know where the business actually operates. Since the filing is a public document, some people might be leery of using their home address. When I started my business, I rented a mail slot from WorkBar, my local co-working facility. That let me use their address rather than my own.
You aren’t allowed to have the same name as another registered company. Attorneys can do the search for you, but google and the secretary of state’s website provide a solid first pass. Because my brand is just “me,” I used my name in the filing. There are many reasons that a person might name their company based on what they do, rather than on who they are. Based on my experience and that of several friends, either path can work.
Legal contracts always use the formal name as registered with the state. In conversation, I may refer to my business as “Dwan Consulting,” or similar variants – but on the contract it’s always “Dwan, LLC.”
Once the corporate registration has been accepted, you can apply for a corporate tax ID from the US government. This is another self-explanatory web form.
You will receive a PDF with your company’s tax ID, which you can use to fill out the W-9 form that all your customers will want.
With the tax ID in hand, I set up a pair of business bank accounts. I use the checking account for the vast majority of my transactions, and the other one to hold money for taxes. A good rule of thumb on taxes is to set aside half of your gross income. This is almost certainly overkill. Over time you will accumulate data that allows a more accurate number.
In addition to the bank accounts, I use an American Express card for my business expenses. The one I use has an annual fee and comes with benefits that in my opinion make it worth the money. The benefits that I like the most are passes for in-flight internet (I used one in writing this post!), access to airport priority lounges (snacks, comfy chairs, good wifi, and ample power outlets), upgraded memberships in car rental and airline upgrade programs, and so on. There are tons of non-billable expenses associated with business travel, so this works for me. As mentioned above, your milage will vary.
Since I set up the tax ID number with the IRS, my company can have its very own credit history. This will come in handy if I ever decide that I need a business loan.
Some of your customers will insist that you carry insurance. Whether they do or not, it’s a really good idea to sign up for a policy. I was surprised at how little it cost for me to have remarkable amount of coverage.
There are two primary kinds of policy that are of interest to the independent consultant. I have both, and it costs me about $100/month:
- General Liability: This is insurance in the event that I directly cause damage or losses to my customers. For example, if I spill coffee into their precious server and destroy their data, that’s general liability.
- Errors and Omissions or Professional Liability: This is insurance in the event that I do not directly cause the damage, but my advice and service are bad enough that when the accident happens – it’s obviously my fault. If I wrote the design that specified that the office coffee pot should be located directly above the precious server, that would fall under “errors and omissions.”
Boilerplate Legal Agreements
I had the good fortune to work with a lot of different contracts and agreements during my time at Bioteam. Because of that, I was confident enough to distill several example documents into templates for Nondisclosure, Proposal, and Consulting agreements. If you don’t have that background, this is a place where I would suggest hiring an attorney to be sure that you understand the terms and conditions under which you intend to do business. This is particularly true if you intend to write software or generate intellectual property.
I use Quickbooks Online. It’s about $50/month, which comes with bank account integration and time tracking. I like the time tracking feature a lot, since I can create invoices that show, day to day, when I was on the clock. I make a practice of recording my time in the system every day. Time tracking software like Harvest is also quite good in this regard. There are other features of Quickbooks that I haven’t needed yet, like payroll and direct deposit.
Taxes are a big deal when you’re out on your own. You are responsible for both the employer and the employee portion of social security and medicare tax. You are also responsible to file quarterly pre-payments. Even though it’s not technically required in your first year of operation, it’s a good idea.
As mentioned above, a good rule of thumb when starting out is that you should set aside 50% of all the money that you get paid. That will feel really uncomfortably high, but it’s way better to over than to under estimate. Over time, you will get a feel for your actual effective tax rate.
I pay an accountant to do my taxes at the end of the year. We usually sit down and go through quickbooks together so that he’s confident that he understands my system, and then he does the rest.
It’s worth noting that a single member LLC like mine is something that the IRS refers to as a “disregarded entity.” The government, doesn’t care if I move my money around between my own pockets. This means that even though it’s a big deal to me when I pay myself, it doesn’t matter at tax time whether I moved money from my business checking to my personal accounts. It’s all the same filing.
Expenses and Deductions
There are lots of good references out there about what you can and cannot deduct as business expenses. I tend to err on the low side, only using the business accounts where it’s really unambiguous that the only reason I’m spending the money is to support my business. I know people who are more aggressive on that front. It seems to work out okay for them.
And that’s it! Even though there are plenty of moving parts, it’s really not all that complex to set up and run a sole proprietorship.
I’m interested in whether this post was interesting or useful to you. Please leave comments or shoot me an email.