How to Start a Consulting Business
Over the last year or so, one of the largest gaming/hospitality companies in the world (whose name rhymes with schmem-gee-em) has offered early retirement packages to scores of its executives in an effort to increase profitability. We’ve met with a number of these incredibly talented professionals who are wondering “what’s next?”
Starting a consulting business can be daunting, not because of the steps required to actually set up the business, but the notion of sacrificing the predictability and security associated with a steady paycheck and benefit package can be too much to stomach.
Having worked a “real” job for someone else and endured all the nonsense that can accompany the perceived security of having an employer, and having worked since 2008 to build my own livelihood, I’m a huge proponent of striking out on your own. Therefore, brace yourself for as persuasive an argument as I can muster for casting aside your doubts and worries, taking control of your future, and starting your own consulting business.
But first, a parable of sorts. A friend of mine has known me since college. We’ll call him Tony because why not pick an Italian name as long as I’m making one up? I used to work trade shows for his company all through undergrad, through law school, and while I earned my MBA. When I started my marketing company, his company became a client. He’s one of the few people still in my life who knew me when. Currently, and for as long as I’ve known him, he’s been one of the top executives in his company and makes a very healthy salary. Like, VERY. Like Gina-is-never-picking-up-the-check-for-lunch-again-ever healthy. As you might expect, he has the nice watch, the fancy car, the beautiful sprawling home, and all the other standard indicators of wealth.
One day over our quarterly lunch, we were reminiscing about the early days of our friendship and he remarked how far I’d come. Being a bit of a pessimist he said, “aren’t you worried that one day it will all collapse? That you’ll fail?” No, I didn’t punch him in the throat; these are the types of conversations we have and why we’re friends.
I thought for a moment, because, as a business owner, the specter of failure always hovers nearby. Then, it occurred to me. “Tony, at any given moment, I have more than 100 active clients. You have one.”
If a client goes away, I don’t panic. If he were to be laid off, losing his one client, how would he replace that income to maintain his lifestyle?
I tell that story to everyone who is considering starting their own gig but can’t get comfortable with the unpredictability. I believe that having your own business can be more secure, more steady, and more predictable than being an employee. And I say that not to try to land you as a client, but because I have seen the devastation that results from an unexpected layoff and I count my lucky stars that I’ve managed to build a life without that possibility.
Enough with the preachiness. How do you start a consulting business?
First, let’s discuss whether to form an entity. In past articles, we’ve discussed the liability protection you enjoy when you operate a business through an entity like an LLC or corporation. I won’t belabor that because you can read about it here. Depending on the type of work you’re doing, liability protection might not be that important. After all, you can often obtain similar protection with a good insurance policy. So why go to the trouble and expense of forming an entity? Let’s discuss two other reasons:
You certainly can just print business cards and, after having obtained the proper business licenses, start operating as a consultant. Your clients will ask you for a signed W9 form, and then issue you a 1099-MISC form at the end of the year showing the money you were paid so the client can consider it a business expense and you can claim it as income on your taxes. When you operate without an entity, you’re operating as a sole proprietor and your business income will be taxed accordingly, per your tax bracket.
If you have an entity, you can elect to be taxed as, say, a subchapter S corporation. This enables (requires) you to pay yourself a salary, which payments are subject to all the same deductions as the W2 you’re used to. Only the distributions or dividends you take above and beyond the salary are subject to tax at the higher rate. As always, consult your CPA about the tax savings you might be able to enjoy by forming an entity that’s taxed as something other than the default.
When clients are considering hiring a consultant, your having an entity lends an air of professionalism and sophistication. That’s more of a marketing play for you. However, with misclassification of workers becoming a hot topic for states and the IRS, a client takes a big risk hiring a sole proprietor as a consultant because the state or the IRS might deem that consultant an employee and force the client to pay back payroll taxes, workers compensation insurance, and penalties for having failed to properly classify the worker as an employee in the first place. In many jurisdictions, the presumption that a worker is an employee can be overcome if that worker (1) has his/her own business license, and (2) is free to provide services to more than one company. Yes, an independent contractor or consulting agreement helps, but I’ve personally seen the state of Nevada disregard what’s written in a contract where the worker should have been legally classified as an employee. If it walks like a duck and talks like a duck…
We are seeing more and more of our clients become aware of and sensitive to the misclassification issue, because it presents so many risks and costs. If you, a consultant with your own license, can help reduce your clients’ worries, you become a much more attractive option.
How would I find clients?
We have had a number of clients who were laid off immediately turn around and consult for their former employers. Provided you check all the boxes to be properly classified as an independent contractor, this can be very attractive for the former employer insofar as they don’t have to pay workers’ comp insurance, payroll taxes, and can offload liability onto you. That’s where your entity and insurance policies become important. It’s also helpful if the services you were providing as an employee were seasonal or were needed only sporadically. They can hire you as needed, rather than paying you a salary to twiddle your thumbs.
If you have specific industry experience, make sure you get letters of reference from your former colleagues and approach other companies in the industry that might benefit from your expertise. This assumes, of course, that you haven’t signed a noncompete that would prohibit such conduct.
Though less intuitive, also consider how your specific set of skills might translate to other industries. If you managed and grew spas in hotels, why not approach health club chains to help them elevate their member experience? If you were the office manager or COO for a large CPA firm, I’d bet the challenges your employer faced were similar to those of other service firms.
Lastly, while it seems wise to market directly to your end client, I’ve found that approach to be less successful than marketing to others who have the same end clients. For example, when I started my practice, I spent one morning every week for two years in a room FULL of business owners. I assumed each one of those businesses would eventually become a client. Not so, I learned. I did better when I built relationships with others who also worked with my end clients – CPAs, commercial insurance brokers, bankers, and financial advisors.
Get creative with this, too. I often meet with lawyers who want to hang out a shingle but don’t know where to find clients. If you’re a divorce lawyer, don’t just network with other attorneys, but get to know hairstylists and manicurists. Often, they’re the first ones to know when things are about to go south in a relationship. Funeral home operators and real estate agents should know probate attorneys because they often receive the first call when someone dies and there’s a house to sell. Personal trainers should know mental health professionals – what better drug than endorphins? Thinking somewhat creatively can open new lines of business for you and provide a steadier flow of clients.
What about contracts?
Just as having an entity lends an air of professionalism and inspires confidence in your abilities, so does having your own contract to present to a client. Sure, some clients are large enough they’ll insist that you sign their agreement, but for smaller clients, it’s important to have something to present.
Probably the most important part of the contract, even more important than your fee, is your scope of services. In my experience, that’s the biggest challenge we face as service providers and the one that leads to the most turmoil between the provider and the client. When you sell a widget, you know your work is done when you deliver X number of widgets for Y price. Without something tangible to sell, service providers have to be clear about what they’re selling and when the client will receive it.
Your scope of services sets and manages expectations – both yours and your client’s. Use objective measurements wherever possible. Make sure to avoid industry lingo so everyone is on the same page. If you are designing a website, make sure you are clear about milestones – what you’ll have completed and by when. If you are an advertising agency, be sure your contract outlines what decisions you can make about ad placements and use of the client’s budget and which ones need client approval. If you’re providing IT services, how “on-call” are you going to be? Will the client be charged for calls on nights and weekends? You get the drift.
Next, the fee is a crucial part of the contract. Not only is the total fee important but also how it’s paid. To bolster the security and predictability we talked about earlier, I encourage our consultant clients to get as much of the fee up front as possible. Maybe the fee is paid as milestones are completed. Maybe it’s 50% upon signing of the agreement and 50% upon completion. Maybe it’s a monthly retainer that’s due on or before the first of the month in advance of services rendered.
What about termination? Contracts should always have clearly marked exits. In other words, how does either party get out of the contract if it isn’t working? Do you have to provide notice? How far in advance? If you have work in process and the contract is terminated before you’re paid for it, are you entitled to payment anyway?
What happens after the contract ends? Many clients will request a noncompete or nonsolicitation agreement to prevent you from working for a competitor. Watch for these. Most clients are really just trying to keep you from redirecting their clients to a competitor using the information you learned while working for them. Understandable. Be sure the language accomplishes that and doesn’t prevent you from continuing to earn a living at all after the relationship ends.
Who owns the work I provide? The longer you’re in business, the more likely you are to have developed plans or templates you can repurpose from client to client. You’ll want to make sure you can use those plans, but that your client doesn’t thereafter own them. Sometimes the plans you start the relationship with are referred to in consulting agreements as “pre-existing intellectual property”. Other times, the client will want you to design something for them, and, probably rightfully, they’ll expect the contract to dictate they own those designs. It’s important to be clear about this topic, to prevent disputes and expensive litigation down the road.
As you can see from the above, which covers only a portion of an example agreement, consulting agreements can be relatively simple or incredibly complicated, depending on the services being rendered. Every one is different, so be sure your contract says what you want it to say and that you don’t agree to anything you don’t understand.
How do I get paid?
Easy. You just pay your business expenses from your business account and, with any that’s left over, you can cut yourself a check. If you are taxed as a sub-S corporation, you’ll have to address some other things, but it’s certainly not as if your money is trapped in your entity’s checking account.
What about health insurance?
This is a biggie, but easily addressed. Many chambers of commerce offer members small business group health insurance and some, though the rules at this very moment are a bit murky, offer those plans to sole proprietors. Yes, health insurance is costly and it’s far easier for a large company to offer that benefit to a group of employees than it is for a small business to do the same, economies of scale being what they are. However, don’t let this discourage you from exploring the possibility of owning your own business. Where there’s a will, there’s a way.
TL;DR If you’re thinking of starting a consulting business, don’t be afraid because it might be the most amazing thing you do; just be smart about it.