Thursday, March 8, 2012

Money Matters for the New Consultant (contributed by Gary K. Evans)

Gary K. Evans ( spent 17 years as an independent consultant and trainer in object-oriented development and Agile processes. He is now working for a major financial institution in Enterprise Agile Process Enablement.

First, Hire an Accountant

If you're a professional, I assume that you're very good at your chosen field. Because your area of expertise probably doesn't include accounting and tax regulations, you should hire a fellow professional—an accountant—to take care of this. Make sure to shop around and find one with at least some self-employed clientele. Like technologists and any other professional, accountants differ in their skills and specialties. My accountant makes more per hour than I do, and he's worth every penny. Each year, he has saved me money that would have otherwise slipped through my fingers.

Some consultants prefer to do their own taxes, so they buy Intuit QuickBooks or an equivalent tool to help them track their income and expenses. I certainly would not criticize this. I use QuickBooks myself. Whether or not you enlist the services of a professional accountant, you must keep meticulous track of your financial life. QuickBooks does this, and will generate invoices for your clients, flag receivables that are past their payment date, and so forth. If you try to do this with Excel, you are more adventurous than I. Spring for the $200 or so to buy a proper tool like QuickBooks. It's a deductible business expense, and you will be very glad you did. So will your accountant, if you have to give him or her a categorized General Ledger file so you can get the proper deductions and depreciations.

Rates: Don't Be a Cheap Date

Setting rates is neither a science nor a crapshoot. You can peruse some of the many books on this topic to learn exactly how to do this, whether you do fixed fee, daily rate, or hourly rates. Here, I'll comment only on the pitfalls I've encountered.

You don't work every day. W-2 employees get up in the morning, go to work and come home in the evening. Every day. An independent contractor gets up every morning, but what happens after that is somewhat random. In a good economy, expect to be unemployed about a quarter of each year. You do want to have some kind of life, don't you? Another way to think of this is that you work three weeks and have no engagement the fourth week of each month. Factor this down time into your price setting. And, in a bad economy, prepare for up to six months without work. In my worst year, I worked only four months out of twelve. It was tough, but my past discipline in setting aside savings got us through.

Should you match the going rate? Finding the going rate for, say, C++ development in Washington D.C. or anywhere else is easy. The Internet is the most accessible source of such information, and recruiting companies often publish salary surveys organized by skill and geographical region. Starting out, be aware of what clients are paying both salaried employees and contractors. Independent contractors must cover business expenses that employees don't have, so they’re expected to request hourly-equivalent rates from 40 percent to 100 percent higher than do W-2 employees—but you do have to be good enough to justify these higher rates.

I've found considering your value to be a tremendous factor in determining your consulting rates. Value is often equated with price, and I'm not the first person to note that when I increased my rates, I got more and better work because my perceived value increased. If you have extensive experience and real expertise, you can command higher rates.

Lowering your rate to get work. This is a disaster, both now and for the future. Small clients all want to get top-quality work for $25-$35 per hour. If you're willing to go that low just to work, I urge you to get a W-2 job that pays the same rate.

Paying your own expenses from your daily or hourly pay. I did this once—for four weeks. Never again. Now I bill for my services and invoice separately for my expenses, perhaps up to an agreed-upon maximum amount. I don't even negotiate on any other arrangement. Unless you're bidding on a fixed-fee project, reputable companies who work with independents expect to pay services and expenses separately. However, this is just my policy, and Karl has approached this issue rather differently than I. He has often quoted fixed rates for short on-site training engagements that included a portion to cover reasonable hotel, travel and meals. His clients like this because it simplifies processing the invoices, since no receipts are required. And it gives Karl the flexibility to sleep in a tent or stay in a luxury hotel, depending on his choice.

Non-billable time. I was stunned when I discovered how much time I spent doing invoices and expense reports, cold calling and warm calling, organizing files and contact lists, learning new technology, and developing new material—and I couldn't bill anyone for the time! Estimates vary, but an independent 1099 should plan to spend twenty to thirty percent of his working week in non-billable time.

The 2X/3X rule. Independent consulting is costly because you have to cover all your own expenses. That means you must consider yourself as an employer, and price yourself with the mind-set of an employer selling your services to a client at a rate that ensures a respectable profit margin. To this end, I offer up the 2X/3X rule, another piece of wisdom I received from a successful consultant. First, identify the amount you'd be paid as a salaried employee at a corporation doing what you do as a consultant. Doubling this number will provide you a break-even target as a consultant. But if you triple your salary figure, you'll be able to reinvest in your business and grow it. When I first started out and determined the doubled figure, I almost choked. But after just a couple of years, I learned how right he was.

There are roughly 2,000 working hours in a year, so a before-tax employee salary of $100,000 equates to $50 per hour. A consultant doing the same work as an employee earning $100K should be asking for $100 to $200 per hour. Why? The consultant will probably work for a few weeks or months, and short-term engagements carry a higher hourly rate. The independent consultant has no employment security and must pay his or her own overhead: life and disability insurance, retirement funding, business liability insurance, computer equipment, maintenance and repairs, office supplies, telephones, fax, …. That is why the 2X guideline only brings you to the breakeven point.

Don't Burn Cash on an Office

I was amused by a colleague who decided he should go into independent consulting and immediately spent $5,000 on a laptop, fax machine, new PC, answering machine, preprinted business forms with his color logo and a bucket of really marginal items. And he didn't yet have a single client, or even the prospect of one.

Build an office as you need one. I bought an answering machine first so I'd be able to return calls. When my first client called to say he had selected me and was faxing me a contract, I asked him to delay sending it until after lunch. Then I ran out and bought my first fax machine and hooked it up. I received the contract, signed it and faxed back the signature page. That machine lasted seven years, but it had to pay its own way first.

Sole Proprietorship vs. Incorporation

This is an important issue. Incorporating gives you some legal and financial protection, but it costs (extra accounting and filing fees, among other expenses). Some people incorporate right away (presumably an S-Corp designation, not a C-Corp like Fortune 100 companies). Others wait to incorporate until they have an established business and want to shelter their income. Part of the issue is image (corporations have a cachet of stability), and part is cultural (some companies won't hire a sole proprietor, and work only with corporations).

Another option is to setup a Limited Liability Company or LLC. This is a business structure that is simpler and less expensive than an S-Corp, still allows money to flow directly to the LLC organizers, and presents a more business-like image than being a sole proprietor..

I was a sole proprietor under the DBA (Doing Business As) designation for more than six years before I incorporated as an S-Corp. I now have a second business for software product development and it is an LLC. The structure you choose is a business and legal decision, and you should listen to your accountant and legal advisers here for guidance on the structure that is best for you and your goals.

(If you found this article helpful, please consider making a donation to the Norm Kerth Benefit Fund to help a consultant who has been disabled since 1999 with a traumatic brain injury from a car accident. You can read Norm's story or donate here. Thanks!)

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