Scott On Writing.NET : Going Independent

Going Independent: When Do You Bill Your Clients and What Are The Payment Terms?

Scott Mitchell — Fri, 10 Oct 2008 00:11:00 GMT

A decision all independent software developers must make early on in their career is when to bill a client and under what terms. This decision, of course, is not the developer's alone to make - it must be discussed and agreed upon by the client, as well. Similarly, a developer must decide how to charge: by hour or by project. Over the years I have received numerous e-mails from fellow developers who are contemplating striking it out on their own, and wonder what suggestions or advice I have for billing.

My general policy is as follows:

Software Development:
For software development I charge per hour. I have never taken on a client and billed per project, and likely never will. My primary concern with billing per project is that my estimation or the client's estimation may be off base, which hurts one of us. Also, when billing by the hour there is no concern about scope creep or other things tacked on by the client late in the game in an attempt to get more bang for his buck. Billing per hour is ideal for the software developer, but customers often prefer a fixed price for the project because it puts a cap on the amount it will cost. A new customer does not know what kind of work they can expect from a developer per unit time. To ameliorate this concern, I usually propose a very simple, short feature or milestone for new clients, so that they can get a good gauge of how long it takes me to complete a task, and what level of quality they can expect. I have also given price caps for customers on tight budgets, but this is more the exception than the rule.

Another reason that I propose a very short and simple first project for new clients is because I require payment in full and up-front for new customers. This sours some customers and I've certainly lost some business because of this policy. The way I see it, this requirement serves as a vetting process. It shakes out customers who may have shaky cash flow or who are going to later nickel and dime me for the work performed or, worst yet, not pay at all. Once I've had some time to work with a client and have established a good working relationship, I will relax these conditions and bill on a monthly basis (or more often, if requested). If I have not yet established a relationship and do not fully trust the client, I continue requiring payment up front and in full. When I finally end up billing on a monthly basis, my terms are Net 15 (that is, I require payment within 15 days of invoice), but I have some customers who much prefer Net 30 and once that relationship and trust is established I'm willing to agree to those terms.

I find this process of establishing trust by requiring payment up front at first, and then billing monthly with Net 15 terms to be a surefire approach to ending up with solid clients. To ensure prompt payment, some independent software developers use tactics like hosting the application on their server and not sending the code to the client until payment is received in full. Another, more questionable approach, is to put a backdoor into the application so that if the client does not pay the software developer can "break into" the application and "turn it off" until payment is received. I dislike both of these techniques as it frames the working relationship in adversarial terms.

I have waived or relaxed these requirements - payment up front for new clients, Net 15 terms, etc. - for very large or very established customers, such as regional businesses with thousands of employees, or Fortune 500 companies. These types of clients are more the exception than the rule, though, as the vast majority of my clientele are small businesses. And some companies or industries have Net 60 terms and won't make any exceptions.

Training
Like with software development, I require payment up front or on delivery of services for new clients. I will make exceptions for very large and established clients, but only sparingly. My hesitancy here in due in part to a negative experience with a local training company that was very late with payment. I ended up taking the client to small claims court, but was paid in between the time they were served and when the court date was set. (My decision to go to small claims court and the resulting process is summarized in My Small Claims Court Experience.)

While I always charge by the hour for software development, I charged for training services using a variety of models. For personal training I usually charge hourly, as it makes the most sense. In this way the customer has direct control over the costs and knows the precise charge for another hour or day's worth of training. For classroom events I usually charge a per-day rate, which depends on a number of factors, including:

Class size
Number of days of instruction
The location relative to my home - is the classroom setting five miles away, or across the country?
The material used and the topics covered - am I given the course-wear to teach or do I need to create it?

When a potential customer asks for a training quote, I use the above criteria to judge how long it will take me to create the course-wear (if needed) and to prepare for the class, how much travel time there will be (if any) and the total hours of instruction. I then multiple that number by my usual hourly rate for software development, then multiply that by a number between 1.0 and 2.0. This coefficient depends on the size of the class (the more students, the higher the number) and based on how excited I am to teach the class. If I'm teaching a two-day class to 5 smart devs who work in a fun company that's headquartered on the beach, and we're having a luau at the end of the second day, then that number will be a lot closer to 1.0 than if it's a class of 25 devs at a stuffy corporate office and I have to wear a suit each day. The figure derived from that equation, plus any travel and entertainment costs, are what I quote the client.

Writing
Unlike training and software development, it's hard to get a client to pay you by the hour for an article, tutorial, or book. Also, in my experience, it's rare to be paid by the word. Usually publishers have a pre-determined rate they pay for a written piece with a minimum word count. For print media - books and magazines - there is also a maximum word count. The pre-determined rate for magazines and websites is usually a dollar amount; for books it's a royalty rate and advance. (For a breakdown of compensation on writing a book, see The Economics of Writing a Computer Trade Book.)

Also unlike training and software development, it's virtually impossible to get a client to pay you anything up front. Book publishers offer advances, sure, but they don't start rolling in until you have completed a significant portion of the work. (This is true for computer trade authors; I'm sure Stephen King gets his advance whenever he wants.) As a result, as a write you have to be willing to get paid after the article or tutorial or book is written and published. As a result, I take a bit of a gamble if I write for a small publisher, small magazine, or small website. Having been bitten in the past, these days I rarely write for small operations unless I know the people running them and trust that I'll be compensated. But if a small publisher contacts me out of the blue and wants me to write five chapters for a book, I'll pass.

In Summary...
What's infinitely more important than the decision you make as when to you bill your clients and what terms to use, is to have very frank and clear communication before any work begins. It is imperative that you discuss with your client when you will bill and when you expect payment. They may agree, or they may want to change the terms. But what's vital is that there is a clear understanding. I've talked with many independent software developers who were too uncomfortable bringing the subject up or just assumed that the client understood and agreed with implicit payment terms, and as a result there was no communication prior to the work. This can lead to an unhappy client if his expectations of the payment terms were different than yours.

Also, if you have sent an invoice to a client and he has not paid by the time the invoice is due, do not hesitate to contact the client and politely inquire about payment. And, lastly, if a client becomes severely overdue, do not hesitate to stop working for him. You are not obligated to work for free.

An Interview with Patrick Chu from ItsYourTurn.com

Scott Mitchell — Tue, 11 Jul 2006 20:00:00 GMT

ItsYourTurn.com is a play-by-play game website that I was turned onto several years ago by a colleague. Since I joined the free site in October 4th, 2002, I've played 2,286 games (although I'm sure you'll be delighted to know I've won 58.7% of the games I've played).

ItsYourTurn.com (IYT) runs on the Microsoft web stack - ASP.NET 2.0, SQL Server 2005, IIS 6.0 - and is run, full time, by Patrick Chu, two other developers, and a part time support staff. IYT has over 2.5 million registered accounts, a database with over 470 million active records, and records around four million page views per day.

Recently I interviewed Patrick, asking an array of technological and business-related questions. Patrick provided very in-depth and thought out answers, including information on IYT's hardware and hosting configuration, the motivation and rationale behind starting this business, his thoughts on AJAX, life during the dot com bubble, and his views on the future of web development.

You can read the interview on 4Guys, at A Conversation with Patrick Chu.

Enjoy!

Issue Resolved - Don't Need my Day in (Small Claims) Court

Scott Mitchell — Tue, 26 Jul 2005 19:14:00 GMT

This is the fourth installment of my ongoing Small Claims Court Experience...

The need for going to small claims court has ended since, as of yesterday, I received payment in full from the company. While it would have been educational to have my “day in court,” I still learned a lot about the process of filing a claim, serving a defendant, and all the other fun stuff that is required when moving to small claims court. So I guess I got the best of both worlds - a bit of education and payment in full!

Hopefully the company has learned its lesson - don't keep those you owe money to in the dark. About one week after I filed the paperwork for small claims court I heard from the company for the first time since Feb./March of this year (other than me barging into their offices back in June). They called and said, essentially, “Partial payment has been sent, should be in the mail today, we'll send more later this week.” Sure enough, payment was in the mailbox that afternoon and another check later in the week. There were another two partial payments, with the last one arriving yesterday.

The whole reason there was frustration - frustration that boiled over into action - was because this company was giving me the runaround by not returning phone calls or answering emails. All it would have taken was a polite and apologetic explanation. I also had a chance to talk to other instructors who have also reported receiving partial payment (haven't followed up to check if they've been repaid in full). So things righted themselves in the end, fortunately.

Thanks for the interest/suggestions/comments from those reading my assorted blog entries on this topic, as well as a thanks to Carl Starett, a local San Diegan blogging lawyer who exchanged a few emails with me, answering assorted newbie questions.

A complete list of blog entries related to this topic can be found at My Small Claims Court Experience and through Going Independent category. Your feedback is most welcome - please leave a comment or drop me a line.

Partial Payment Received

Scott Mitchell — Sat, 02 Jul 2005 03:51:00 GMT

This is the fourth installment of my ongoing Small Claims Court Experience...

Well, I guess I wasn't being fed a load of lies when I travelled to the company on Wednesday with my small claims court papers and was told not to file, that partial payment was on its way. After some thought and comments from interested readers, both in my blog and via email / IM, I decided nuts with it and filed on Thursday (yesterday).

Lo and behold, today I got in the mail partial payment, exactly half of what is owed to me. The letter was postmarked June 30th, so I'm not certain if they really had “mailed out” the partial payments earlier in the week and they just had yet to get around to taking them to the post office, or if me showing up at the company with a short temper and papers in my hand prompted them to send me 50% in an attempt to placate me.

Any suggestions as to what to do now? As I see it I have two options:

Accept the partial payment and wait (hopefully not another six months) for the other half. The upside with this approach is that I actually get to see some of the money owed to me materialize into my bank account. That would be nice, eh? The downside, of course, is that I believe acceptance of partial payment would require me to drop my suit, no? As commenter Brian said, “ In Georgia and Florida too, I believe, if you accept a partial payment it is considered giving credit to the debtor. Giving someone credit means you have a different route to take to win your case and get paid in full. For example if someone owes you $1,000 they send a partial payment of $20 and say they will continue to pay you as they can then you cash the $20 check. You have now granted a loan to that individual and must give them whatever legal time they are entitled to repay the loan.”
Reject the partial payment. With this option I would be passing up the “bird in the hand.” I like Brian's suggestion, though: “ My advice if you do receive the check go back to their office with the check and the legal paperwork and demand either another check to make the debt paid in full or return the check and tell them you are going to court.” If they refused to pay I would then proceed to take the matter through the legal channels.

So, any suggestions as to what route I should take? The total payment due is low enough that even if I don't see a red cent it won't impact me financially, but I would like to be paid as promised for services delivered, naturally. Plus, I'm no Vanderbilt - whereas I won't go hungry or miss a mortgage payment if this payment is never paid, I'm still going to miss it, as I've always had a strong attraction and bond to every dollar bill I've ever met.

As I see it the benefits of going through with the court case are:

Education - I've never had to go this route before and this unfortunate circumstance presents a lesson to be learned that, if floundered, won't be a big deal.
Showing this company that they can't push around the little guy - this company really needs to review how it interacts with its instructors. Did I receive one call explaining partial payment was on its way? No. And on Wednesday, when I wrote an email to the controller asking them to verify that partial payment was, indeed, on the way, did I hear back at all? No. This company's communication patterns mimic that of a black hole.
Getting paid in full (hopefully) - I know a judgement doesn't equal getting paid, but who knows if I'll ever see the other half of the payment if I accept their terms.

The major downsides of pursuing a case would be (and in this order):

Time - the courthouse is like 15-20 minutes away, one way. Lines are long. Filing the paperwork ate out about two hours of my day, two hours I could be working for clients who do pay. I've calculated at this point that the time I've spent so far pursuing this, plus the additional time that would be required in court and whatnot, would end up costing me more dollar-wise than the other half of their payment.
Not seeing a dime - if I accept the partial payment I'm half way to getting what's owed to me. If I reject it, who knows how this whole mess will turn out? I might end up not seeing a penny.

Due basically to the time costs I'm leaning toward just taking the half they sent and waiting for the rest. I'd really like to stand up against this company, but at the rate this is going I don't know if it makes economic sense. Any insight, comments, suggestions, etc. most appreciated. Thanks!

Screw It, I Filed the Claim

Scott Mitchell — Thu, 30 Jun 2005 23:39:00 GMT

This is the fourth installment of my ongoing Small Claims Court Experience...

In yesterday's blog entry I mentioned that I went to the company's office and was told, upon informing them that I was heading to the courthouse to file a small claims court case, that a partial payment had been sent earlier in the week. I felt I was being lied to, but didn't know what else to do than just wait it out and see if payment did arrive by the end of the week. After reading the comments in yesterday's blog post and a few private emails, I decided that I had a better chance winning the lottery then getting payment (or a truthful statement) from this company, so today I went and filed the paperwork. The courtdate is in early August, assuming everything goes to plan (i.e., the don't file for a later date, they are properly served, etc., etc.).

<rant>
When filing the paperwork the employee who was assisting me did a quick search on the company and noted that the company's address as recorded by the secretary of state was different than the address I had put down as the place to have the defendent served. This piqued my interest so after leaving the courthouse I stopped at this other address and found yet another office for this corporation. A bit more of an exhaustive search on this company revealed that they also have offices in San Jose and Scottsdale... but they can't freakin' pay their instructors the small sums they promised them for the services the instructors have already performed. Gah.
</rant>

Ok, enough ranting on about this. In fact, you probably won't see another entry on this small claims court hubbub for a while, until the actual court date draws nearer. I don't mean for this series of entries to turn into a whine-fest, but rather to serve as a source of information for other independent consultants who arrive in a position similar to the one I find myself in. As aforementioned, the best way to avoid such a headache is to not let yourself get in this position in the first place. See the first blog entry for more suggestions on this matter.

A Faint Glimmer of Hope

Scott Mitchell — Wed, 29 Jun 2005 21:50:00 GMT

This is the third installment of my ongoing Small Claims Court Experience...

In my last blog entry on this topic I mentioned how, a week ago, I was about to head out and officially file the necessary paperwork when, walking out the door, I got a call from a fellow trainer's father who was a lawyer and gathering information to take this company to superior court. Additionally, I managed to get ahold of some email addresses of past instructors, and sent out an email blast asking if any of them were in my position. Sadly, I have since received news that an additional six instructors have done work three to nine months ago and have yet to be paid a dime or given an ounce of explanation other than the standard run-around.

Having wrapped up a project yesterday, today I had a free hour to actually head down to the city's offices and formally file the claim. Thanks to suggestions in earlier blog entry comments and IMs/emails, I decided it wouldn't hurt to stop by this company's office with the paperwork in hand and give them one last chance to pay up before I filled the paperwork.

Unfortunately upon arriving the owner of the company, and the person I've been dealing with since the account became delinquent, wasn't in the office. Instead, another lady helped me. She explained that they had recently received a large check that was long overdue and had sent out partial payments to the instructors that they owed. She said the checks were mailed out yesterday so I should be receiving them any day now, and that the other half would be coming soon after. I huffed and puffed a little, letting her know how unprofessional her company was behaving and so on.

In the end, I didn't file the paperwork. I decided, instead, to wait til the end of the week to see if, miraculously, a partial payment does arrive. I think I may be being a bit to naive, taking this company's word at face value. After all, as this person was explaining the situation to me it felt like I was listening to a pitch to buy some excellent real estate in Florida as an investment that will pay for itself ten times over. I mean, if they had gotten this big check and were going to pay me, even a partial payment, wouldn't they email or call me to update me on the status?

The new and final deadline, then, is Friday - no check by then, and I'm heading in to file the paperwork on Tuesday the 5th. I hope there is a partial payment in the mail... I don't want to go to court, I just want what's owed me to be paid. Even if there is payment working its way through the mail system as I type this, though, this company needs to learn how to better communicate with those it owes money. Not returning phone calls or answering emails, not providing those you are indebted to with any information as to the status of forthcoming payment, even if it's partial, is not acceptable.

Meh.

Update on My Small Claims Court Experience

Scott Mitchell — Thu, 23 Jun 2005 05:08:00 GMT

Last week I wrote a blog entry about a client that has yet to pay for work I completed half a year ago. Rather than just take my lumps and move on, as I have done in the past, I decided this time to take the matter to small claims court this time because:

The company that is not paying appears to be quite good and not paying a lot of people for some time now,
The people I have interacted with run me in circles, unanswered emails/voicemails, excuses galore, and rarely, if ever, what sounds like a sincere apologetic, “We're sorry, but we're having cash flow issues“ or something of that nature.
I'm interested in exploring the process, although hopefully I'll never need to do this again.

That blog entry last week generated some great ideas, tips, and suggestions from those who left comments. In fact, to answer a number of questions raised by those comments, I started a separate page here on my blog, My Small Claims Court Experience. That page serves as a master index to blog entries focusing on this small claims court experience as well as providing a short history of what led up to this decision. Additionally, I am filing these blog entries in the Going Independent category.

When I was teaching my class back in January of this year I saw and said hi to another instructor who was also teaching classes at the facility that day. I had recognized him from the courts not far from my home where I play basketball a couple times a week. Anyway, I ran back into him on the courts in late May and asked him if he had ever been paid for his services - not surprisingly, he hadn't. We talked a bit and it turns out his father is a lawyer and is in the early stages of taking this issue to superior court. Long story short, I gave him my phone number and asked to have his dad give me a ring.

On Tuesday of this week I had my completed small claims court papers in hand and was ready to make one, or maybe two, stops. I was first going to show up at the non-paying client's site with the papers in hand and a message along the lines of, “I'm off to file this, why don't you save yourself the hassle and cut me a check.” If they chose to continue their current course of action my next plan was to, naturally continue on over to the courthouse and file the paperwork.

However, as I was literally heading out the door the phone rang and it was the father of my basketball colleague. We talked, he basically gave me his status on the matter. In essenance, he's still in an exploratory stage, so he's not 100% certain if this thing will move forward to court or not, but he wanted to hear my story and discuss matters. In any event, I decided rather than rushing to small claims court I'd instead wait to see how this matter unfolds. (Don't know how long I'm going to wait on this... probably not too long, but I don't want to chose one option - small claims court - and not be able to take advantage of a better option that might open up further down the road.)

In any event, I was searching through old emails I received from the company using Google Desktop Search, and stumbled across one that had been sent to my Junk Suspects. It was a sort of “I'm leaving the company to pursue other interests, wish you all the best” from a person I had interacted with early on in my experience with this company. What was interesting was that rather than use Bcc, this person sent this email to about a dozen folks directly through the Cc line. Aha!, I thought, this must be a list of past insturctors!

So I quickly whipped up an email, Bccing it to this list of people, explaining my situation and asking anyone who had been an instructor and had not been paid to reply and let me know. Sent that out late Tuesday night and, as of tonight (Wednesday), I've heard back from four people who are in the exact same boat - taught one or more classes, haven't been paid, some from back as far as late 2004.

This company makes me ill. While they may have “cash flow” issues I think their manner of operation is immoral and repugnant. They clearly have hired several instructors and not paid them, and then hired several more, likely not planning on paying. This company just gives me negative vibes. I did a search on their corporation name with the California Secretary of State and found that over the last decade there have been three corporations formed by the same person with very similar names - like Acme Training, Ackme Training, and Acme Technology Group - over the past decade, a new one every few years. I imagine that what happens is a corporation is started up, it's run trying to make a profit, obviously, but ends up running up a lot of debt - such as promising to pay for instructor services renderd - and then, if things don't work out, they fold up shop just to create a new, similarly named corporation. (This guess as to their business practices may be heavily influenced by the bitterness of not getting paid and having to deal with these folks, of course.) Anyway, it's disgusting how they can do this to independent trainers and just stick 'em with no payment for their services. Of the instructors I've heard back from all have opted to just take the loss and move on.

Anyway, so that's where I'm at now, just thought I'd keep y'all updated. Thanks for reading...

When a Client Won't Pay...

Scott Mitchell — Sat, 18 Jun 2005 23:18:00 GMT

Over the years I have worked on a number of consulting projects and had to put up with a “rotten apple” client on more than one occassion - one that might take an eternity to pay, or might bicker over the agreed upon price after they have received the services rendered and are staring at the invoice, or - worst of all - those that simply don't pay. Thanks to some excellent long-term clients, I am in the position now where I can be very conservative when accepting new jobs. Essentially, when working with a new client for the first time I will not do a lick of work that is not pre-paid. After I have worked with the client long enough to develop and build some trust, and after I have been paid a couple of times, on-time and without nickel and diming, I'll do work on a Net 15 or Net 30 basis. That has been my policy on consulting jobs for a couple of years now.

However, I have not seemed to learn my lesson in this matter with regards to my training services. Occassionally a technology training company will request my services to teach a class on their behalf. I've done this maybe a half-dozen times over the past few years. Anywho, it's never yet been a problem until recently when a local company failed to pay me for a three-day class I taught. It has now been over half a year since the services were rendered and I've yet to see a dime. I've gotten nothing but the run-around when trying to communicate with the company - being sent to voicemail, not getting returned emails or phone calls, being given a cacophony of excuses as to why I've yet to be paid.

When a client doesn't pay I am aware of three available options:

Do nothing - just chalk up the experience, write off the loss on your expense sheet, and never do business with that client again. This is the easiest approach as it requires no action on your part, counts as income off the top at the end of the year, and can help teach a valuable lesson moving forward. However, you don't get paid, so that's a bummer.
Sell the debt to a collection company - I've never done this but have talked to consultants who have gone this route. Essentially you sell what is owed to you to another company for pennies on the dollar and let them hassle the client for their money. This approach takes a bit more work than doing nothing, but not too much more, and you do get something. Problem is, you get much less than was owed, although I assume you can take the difference off your income sheet at the end of the year.
Get a judgement against the client - that means take them to court and sue them for the money owed. This can, of course, be expensive and time consuming and might not yield any results, especially if the client can't pay because they simply don't have the cash. This route can be especially a hassle if they money owed exceeds the limits allowed for small claims court (hence necessitating hiring a lawyer) or if the client resides in another state or city.

In the past I have, without fail, always taken option #1. However, I have decided that with this latest client I am going to pursue option #3 for two reasons: first, and most importantly, this client seems very unethical. They claim that they have yet to pay me because of cash flow reasons, yet they've continued to operate their business for six months since payment was due. Furthermore, I have talked with a number of other instructors they have hired during various times (both before and after me) saying that they, too, have yet to be paid. This behavior makes me sick to my stomach. Second, and more trivially, I am curious about the whole small claims court process. I've never been to any sort of court matter before, so it will be interesting to observe and record the process and results.

Has anyone taken the small cliams court route before for a non-paying client? Any advice/recommendations/tips? Is it worth it or am I just wasting my time and energies chasing a few measely bucks that I likely won't see in the end anyhow? Thanks!

Going Independent Yahoo! Group

Scott Mitchell — Wed, 08 Sep 2004 22:23:00 GMT

James Avery - who recently made the switch from working full time to working for himself - has started a Yahoo! Group for those who are independents or are thinking about going independent. The Group is called Going Independent, and already has over 65 members.

Right now the Group is serving as mostly a coffee house-type list, with people introducing themselves. The real power of this Group, in my opinion, will come once the Group has gotten large enough and people start utilizing it as a resource for advice and answers to common questions.

Going Independent: Some Thoughts from James Avery

Scott Mitchell — Sun, 15 Aug 2004 16:43:00 GMT

Back in April of this year I started a Going Independent series of blog posts, inspired in part by Johnathan Goodyear's articles on this topic. Anywho, it's been a while since I've updated that series, and I plan on doing so eventually, but in the mean time James Avery has started a similar series of posts on going independent on his blog. His most recent entry - Going Independent - Making the Decision - is definitely worth reading. I particularly enjoyed reading about James's epiphany on when to make the leap from being employed to being self-employed:

So starting my own company and working as an independent consultant while working on writing and software in my spare time seemed like the perfect solution, but the question was when to do it. This is when the fear started to kick in, no longer was I a single guy with no responsibilities, I am newly married with house and car payments, I needed to make sure that I had a semi-reliable income. For the last year or so I have been putting off this idea of going independent, writing it off to needing more experience or wanted to wait for the perfect time. Then I was out at the MVP Summit earlier this year and I was talking to a number of different developers and we were discussing going independent, I mentioned to Jonathan Goodyear that I was thinking of going independent and he said something like "What are you waiting for?"

I started working for myself back when I was still an undergrad at college, but I had a similar tough decision to make myself upon graduation. I had been offered a great job from Microsoft, an oppotunity to work with the Hotmail team in Microsoft's office in Silicon Valley, and needed to decide between pursuing that oppotunity or continuing to work for myself. I opted for the latter, figuring that I had to roll the dice and try my luck at working for myself. In the worst case, I reasoned, I could always go begging back to Microsoft if working for myself turned out to be a bust. (Of course this decision was infinitely easier than James's, seeing as I was single, had just graduated college, wasn't saddled with a mortgage, etc.)

In the end, I made the right decision for me. Striking out on my own forced me to grow in ways that working for a company wouldn't have afforded. Had I chosen to work for Microsoft, my life's script would have been a bit more spelled out - I would have moved to San Jose, I would have had help from Microsoft in finding a place to live, I would have gotten to know and socialize with coworkers, and so on. When I decided to work on my own, I packed up the car and drove out West, not knowing where I was going to settle, how I would meet folks, or what, precisely, I would be doing. It made for a bit more of an adventure and introduced challenges that would have likely otherwise not presented themselves.

Oh well, enough of this emotional ramble, check out James's blog entry, it's worth the read...

Going Independent - Taxes

Scott Mitchell — Tue, 27 Apr 2004 18:27:00 GMT

This is the third part of an ongoing series on going independent. The aim of these blog entries is not to convince one to stike out on their own, nor is it to encourage one to stay employed. It's merely some food for thought for those considering the transition... Part 1 talked about the pros and cons of being employed vs. being self-employed. Part 2 looked at some of the first steps that one needs to take to go independent. This part will examine tax issues surrounding self-employment.

Here's a riddle: what is the one question you could ask someone to determine if they were self-employed or not (short of asking them directly)?

The answer: Do you think taxes are too high? If you get a ho-hum answer, chances are the person is employed. If the person begins foaming at the mouth and goes on a 20 minute diatribe on taxes, you can bet the person is self-employed. Here's another possible question to ask: How much did you pay in taxes last year? If they don't recall, I'd bet dollars to donuts that they're employed.

Typically employed individuals don't have such a resentment toward taxes because their tax bill is collected for them by their employer before they receive their paycheck. As an employee, your employer withholds a certain percentage of your paycheck each pay period. Once a quarter, your employer sends a big check to the Federal and State governments. At the end of the year, when you fill out your taxes, your amount due is your tax burden less what you have already paid in. Some people naively get excited when they get a "refund" on their taxes - this just means you paid in more than you had to, in essence giving the government an interest-free loan.

When you work for yourself, you are your employer, so you are the one who sends the quarterly checks into the government. For those first making the switch from the employed world to the self-employed world, this process can be a bit of an eye opener. Four times a year you have to sit down and write both the Federal and State government a check. Make sure you have a good estimate of your income and make these payments accurately. If you overestimate, you're giving an interest-free loan to the government. If you underestimate, you have to pay a percentage based on the underestimation. (That is, if you underestimated by, say, $10,000, you might owe the government $10,250 - a $250 penalty for underpaying them during the year).

Additionally, there is employement tax. As an employee you pay income tax and social security / medicare. Your employer pays employment tax. (This is why companies like to hire contractors. As contractors they are not employees, so they don't have to pay them benefits or pay employment tax.) When you work for yourself you must pay self-employment tax. See http://www.irs.gov/businesses/small/article/0,,id=98846,00.html for more info. To quote:

Who Must Pay Self-Employment Tax
You must pay SE tax and file Schedule SE (Form 1040) if either of the following applies.

Your net earnings from self-employment (excluding church employee income ) were $400 or more.

You had church employee income of $108.28 or more.

The big difference in taxes between employed individuals and self-employed individuals, in my opinion, is a psychological one. As an employer, the tax withholdings are nicely taken from your paycheck automatically. It's not like you get paid $x and then have to write a check to Uncle Sam for $x/3. But being self-employed, you have to. Five times a year. (Once every quarter, and once by April 15 if you've not paid enough.) If you're at all like me, it will raise the blood a bit, because you will realize how much you are paying into the system, while others - your employed friends - don't seem to grasp it because their taxes are discretely taken out of their bimonthly paychecks, so they don't see it add up like you do. Furthermore, they aren't burdened by self-employment tax. Furthermore, their company provides health insurance and a retirement plan - those responsibilities are on your butt when you're independent.

The point is, as an employee you kind of live in an "ignorant, but bliss" world. As an independent, you see where every dollar goes - $x to Uncle Sam; $y to health/dental insurance; $z to retirement plan; etc. This is nice in that it breeds efficacy and fiscal awareness, but can be a bit disturbing when transitioning from employed status to independent status. It's like the Matrix - once you take the independent pill, you can't go back. Even if you do return to the employed world, you'll have a better understanding of how much things cost.

Going Independent - First Steps

Scott Mitchell — Wed, 14 Apr 2004 14:55:00 GMT

On Monday I started a series of blog entries called Going Indpendent, where I plan on looking at the legal, accounting, and - most importantly - the psychological issues one must contemplate when trying to decide whether or not to go independent. In today's blog entry I'd like to look at the first steps one must take when going independent - setting up a business. This talk may be U.S.-focused, as it looks at business models available here in the states.

Before diving into the options one has for setting up a business, I'd like to start with two quotes from colleagues that do a great job of highlighting the pros and cons of being employed. First, a strong case for being employed:

I personally enjoy being a corp employee. Great benefits! Decent pay. Great hours—no required O/T and paid time-and-a-half O/T. Low stress because deadlines are mostly internal and flexible. Paid training, travel, and expenses. Paid vacation. Paid sick time and even personal time. Work from home if need/want to on occasion. Get to work with and lead team(s). Paid to play with new technologies. Paid high-speed internet. Paid cell phone. Pension plan. Matching 50% to 60% 401(k) plan. Great people to work with. Job security/regular income. More or less guaranteed increases.

The above quote illustrates many of the benefits of being employed - a regular paycheck, vacation time, a steady cash flow, etc. But these advantages of employment are oftentimes employer-specific, as another colleague relates:

Unfortunately I am an employee and none of those things apply to me apart from regular pay cheque (so far, been shaky in the past). I still have to worry about cashflow (I have been pretty much 3/4 sales for 18 months now to prevent us going under), do get benefits but not greatest (2.5% into my pension and ... healthcare) but compare that to what others doing similar job get (even at same company)..., all of my vacations have been interrupted by either someone calling to notify me of some redundancies or a problem only I can fix (not always the case but noone seems to have brains, energy or confidence to sort things out on their own).

Not surprisingly, satisfaction at work has a lot to do with one's work environment. The point being, if you are miserable at work, the answer is not necessarily to go independent - it might be to just find another employer.

Types of Businesses
In the U.S. there are different models one can use when starting a business. These different models have different legal, accounting, and tax implications. The most common business models used for self-employed individuals are:

Sole proprietorship
Limited Liability Company (LLC)
Partnership
S Corporation
C Corporation

What business model to choose depends on a number of factors, such as tax implications, liability issues, whether or not you plan on hiring other employees, how many individuals you want to let claim an ownership in the business, etc. Over the next few sections we'll briefly look at each of these business models and discuss some of the pros and cons. Before continuing on, please remember that I am not a lawyer nor an accountant. My comments stem only from my research on the matter, and discussions with my lawyer and accountant. Be certain to discuss these matters and your options with a lawyer and accountant you trust before pursuing any of these business options.

Sole Proprietorship
The first (and simplest) type of business model is known as a sole proprietorship. This is a business owned by one person - yourself. The benefits of a sole proprietorship is in its accounting and legal simplicity. You don't need to fill out any forms or pay any special dues for a sole proprietorship (as you do with, say, a corporation or LLC). Your business income is reported on the 1040 Schedule C. There are a couple downsides to sole proprietorships:

You are liable for the business! That is, say you need to buy $50,000 worth of equipment. You place an order and agree to pay on a schedule where you pay, say, $5,000 a month for 11 months. Now, imagine that the business fails after three months, and you close down shop after paying only $15,000 of the agreed upon $55,000. Well, guess what? You still owe $40,000, and the company you owe it to can come after your personal assets (like your car, home, etc.) to recoup their loss. Another, perhaps more applicable example: you decide to go independent as an independent consultant. In your first job you create an intranet application for a company that let's them manage their Web site structure. Due to a bug, when the client attempts to delete a single file, it deletes their entire Web site contents, which they hadn't backed up. If they decide to sue you for lost content/time/etc., your butt and your assets are on the line.
Taxes are high. As a self-employed person, you'll need to pay self-employment tax on your net Schedule C income. This tax (called employment tax) is paid by your employer when you're working for someone else. When you work for yourself, you must pay it! Bummer, eh? (This is true for all business models, by the way. The comment is not specific to sole-proprietorships, but rather working for yourself!)

Limited Liability Company (LLC)
A Limited Liability Company (LLC) can be owned by a single individual, multiple partners, or even corporations - in either case, these owners are referred to as managers. The benefit of an LLC is that the managers have limited liability in the company. Returning to our earlier example, if your business was an LLC and you were sued by a client for code that deleted their entire Web site, only the business and its assets would be up for grabs - your personal assets, separate from the business, could not be touched. From my understanding, LLCs vary on a state-by-state basis. States differ on who can be members, what types of businesses can form LLCs, and so forth. The cost and paperwork for establishing an LLC differs from state to state. For individually owned LLCs, income is reported via the 1040 Form, Schedule C.

Partnership
A partnership is a business owned by two or more individuals. The parties involved in the partnership all contribute to the business and are expected to share in the profits or losses. The IRS does not treat partnerships as a taxable entity; rather, each partner must file his or her share of the profit or loss on their own tax return. Form 1065 is used to report income or loss from a partnership.

Things get a bit more complex if you are married and your spouse works with/for you. If your spouse work with you in your business, they are a partner. If your spouse is an employee, working for you, then the business can remain a sole-proprietorship, but you'll need to pay social-security, medicare, and other such taxes for your spouse. If you run a business jointly with your spouse, be sure to get all the tax and legal issues straightened out with an attorney and accountant.

S and C Corporations
A corporation is a separate entity that is formed to run a business. The ownership of a corporation is divided into a number of shares. A corporation is owned by shareholders. An S corporation is a special type of corporation in place for small businesses. It can have at most 75 shareholders, and does not require as much bookkeeping or paper filing as a C corporation. There are also shareholder restrictions with an S corporation, such as: shareholders must be U.S. citizens; partnerships or corporations cannot own shares; there can only be one class of stock; and others. A C Corporation is a corporation without the limitations placed upon an S-corp.

The benefit of a coporation is that it is, legally, a separate entity from its owners. That means the corporation assumes its own liability. A corporation is taxed as a separate entity as well. When you do work for a client, the client pays the corporation. You make yourself an employee of the corporation, and receive an annual salary. Since you are an employee of the corporation, the corporation must pay social-security, Medicate, and employement tax on your salary, just as any large company does for its employees.

Corporations are useful in a number of situations, such as:

Hiring employees
Having several individuals own a share of the company (such as family members, investors, etc.)

Corporations also have some useful tax advantages. For example, a corporation could setup a 401(k) retirement plan for its employee(s), where it matches employee contributions.

The downside of corporations is that the paperwork and fees to setup a corporation are much higher than establishing an LLC, sole-proprietorship, or partnership. In addition to the paperwork for setting up a corporation, additional quarterly and/or annual paperwork is needed as well.

Wrapping Up...
When deciding whether or not to go independent, it is important to have an understanding of the legal issues you will need to address, one of which includes forming the suitable business model, be it a sole-proprietorship, an LLC, a partnership, or a corporation (likely an S-corp). Before making any decisions, take the time to research your options - there is plenty of information online at IRS.gov and your state's Secretary of State Web site. Once you have "done your homework," be sure to sit down with an accountant and lawyer that you trust, and discuss the legal and tax implications for the various choices you have. Also realize that forming an LLC or corporation requires paperwork and filing fees, so expect to pay between several hundred and several thousand dollars to accomplish this, depending on the state you live in and your lawyer/accountant's rates.

In my next Going Independent entry I'll turn from the legal issues to the accounting issues, examining how self-employed individuals are taxed. It's different enough from the way employed individuals are taxed, enough so that a discussion on the psychological issues is warranted. Until then!

Going Independent - Is it for You?

Scott Mitchell — Mon, 12 Apr 2004 17:28:00 GMT

After talking with a couple of colleagues who are contemplating making the switch from working with a company as an employee, to trekking out down the self-employment path, I thought that I might be able to share some advice on the transition. Making the switch can be a daunting process. There are legal issues - what type of business do I form? A limited liability? A partnership? An S-corp? There are accounting issues - how do I file my taxes? Do I need to make quarterly tax payments? What will my tax burden look like? How much more do I need to earn per month being self-employed to enjoy the same life style as I enjoy as an employee? Most importantly, there are psychological and personality issues - are you self-motivated? What is your perception of money: as something that is meant to be saved; something that is meant to be invested; or something that there never seems to be enough of? All of these issues take center stage when beginning the journey of self-employment, and all should be weighed carefully before making the switch.

This blog entry - and the ones that will follow - are aimed at those who are contemplating going independent, and are seeking advice or anecdotes from those who have already made this transition. Today's blog entry looks at the pros and cons of employment vs. self-employment. It focuses more on the psychological and personality issues rather than the legal or accounting issues. Future entries will examine drudging through the legal goo necessarily, and tax implications associated with self-employment.

Let me preface this series of blog entries with the following disclaimer: I am not a lawyer, nor an accountant. In case you glazed over that last sentence, let me repeat it: I am not a lawyer, nor an accountant. My comments on legal and accounting issues should not be taken as gospel, but as a somewhat informed opinion. I have been self-employed since completing my undergraduate degree back in 2000, and have gone through the legal and accounting issues associated with becoming self-employed. So my opinions on these matters are educated ones forged from experience, but they are not backed up by years of study, certifications, or practice. I do, however, think I'll be able to accurately address many of the psychological and personality issues, which, naturally, will be most valuable to those with a similar disposition as myself.

Everyone's experiences differ, so I hope to stimulate discussion among others who are self-employed. With any luck, others will feel compelled to share their stories, mistakes, and successes in going independent...

The Benefits of Being Employed
Before deciding whether or not to go independent, it's vital that you understand what you'll be leaving. Being employed has many benefits that are nowhere to be found when working for yourself. Typical benefits of employment include things such as:

Consistency - a steady paycheck, regular working hours
Flexibility - paid vacation / sick time
Employer-Paid Fiscal Benefits - Health/dental insurance, regular raises / bonuses, a retirement plan with (perhaps) employer matching

When you are self-employed, you are your employer. This means setting up a retirement plan is your responsibility. Contributing to it is your responsibility. When you take time off - for vacation, personal matters, or illness - you're NOT getting paid. That steady paycheck is as steady as your availability, marketing, and work ethic. Regular working hours? Ha! You work when your client wants you to.

Due to this, self-employment is not for everyone. It is not for those who need a steady source of income, such as someone living paycheck to paycheck with a family to support. Self-employement is not for those who have trouble motivating themselves to work. Some people need the consistency of a 9 to 5 job; some folks need a manager giving them action items and tasks to complete. There's nothing wrong with this type of person, but chances are someone with this personality will have a hard time making it on their own. Working for yourself requires discipline and much more hard work than working for someone else.

The Benefits of Self-Employment
While being employed has a number of benefits, it also can carry with it a number of disadvantages. These disadvantages are based largely on your work environment. If you're one of the lucky ones and work in a fun, friendly, metally challenging atmosphere, on a project you find interesting, then why oh why are you thinking about going independent? If, however, you are one of the millions who find themselves dreading waking up the next day, as it only means another hour-long commute through traffic to an office building you've dreamed about destroying, then self-employment looks better each day.

Working for yourself carries with it a lot of freedom. You are your own boss. You can wake up whenever you please. Your morning commute is likely to your home-based office. If you want to take off the afternoon, no one is stopping you. You can spend an hour writing a blog entry on going independent. Of course, with that freedom comes responsibility. When you take that hour to write a blog entry, you're not getting paid. If you roll out of bed "whenever," you'll likely find yourself not motivated to start the day working.

For some people, working for yourself can have a strong effect on their own sense of self-worth. That is, there are some folks who, if they work for a company that goes bankrupt, they simply find another job and don't interalize the company's demise. If, however, they were to work for themselves, and didn't succeed, they'd take the failure as a comment on their own personal worth and capabilities. People who tie their business success to their personal worth should steer clear of starting their own business, as the vast majority of businesses fail. Those who are really successful at business typically fail more than they succeed. (Donald Trump, for example, has gone bankrupt before. Billionaire Paul Allen, co-founder of Microsoft, has had many investments since his departure from Microsoft that have not panned out. Steve Jobs has had many successes - and many failures - at Apple, being fired from his own company at one point in time.)

The point is, even in a successful business, there will always be setbacks. If you do trek out on your own, it is important to take these setbacks in context. Do not let the setback discourage you from continuing, or deminish your sense of self-worth. Rather, when those setbacks to happen, step back, observe, learn, and move forward.

Moving Forward
I plan on writing future entries about this topic. I'd like to follow this entry with one on the legal issues surrounding starting your own business. Namely, what options exist for forming a business, and what tax/legal implications they involve. In the meantime, for more information let me recommend Johnathan Goodyear's articles on going independent. In Part 1 Johnathan looks at how to determine if you have the will and personality to be an independent consultant; in Part 2, Johnathan examines techniques for marketing yourself to attract future business.