How To Setup Your Own Software Development Company
This post was originally titled "FTE vs. Contract in this Economy", but it didn't seem to capture the essence of this entry. I wanted to write about why I think contracting is better in this down economy, but I also wanted to write about how you you might go about setting up your own company. Starting a company is relatively easy from a legal standpoint, and hopefully I can provide some resources that'll make it even easier.
First of all, I believe that contracting is better in this economy for a very simple reason:
When you're a contractor, you're prepared to be let go.
There's really nothing like being laid off. It sucks. It often shocks you and makes you depressed. The good part is you usually get a good afternoon's worth of drinking out of it, but that's about it. Severance is cool, but let's face it - you'd much rather be employed.
As a contractor, you're always looking for your next gig. You're prepared for the worst. You're more motivated to learn marketable skills. You're constantly thinking about how you can market yourself better. Writing (blogging, articles, books) is an excellent way to do this and I believe it's rare that FTE are as motivated to do these kinds of things.
Being a contractor forces you to better yourself so you're more marketable.
People's biggest fear of contracting is that they'll have a hard time finding their next gig. In my career, I've rarely had an issue with this. There's always contracts available, it's just a matter of how much you're going to get paid. Yes, I've had to suck-it-up and make $55/hour instead of $125/hour, but that was back in 2003 and $55/hour is still more than I would have made as a FTE.
The other thing that makes me believe contracting is better in this economy is I believe companies are hiring more short-term contractors than employees. I don't know if this is because they consider employees liabilities and contractors expenses, but something about it seems to make the books look better.
So you've decided to take my advice and try your hand at contracting. Should you setup your own Corporation or LLC?
Starting a Company
Yes, you should absolutely start your own company. As a Software Developer, chances are you're going to make enough to put you in the highest tax bracket. If you're a Sole Proprietor (no company), you will pay something like 35% of your income to taxes and you can be sued for everything you own by your clients.
Should you create an LLC or Corporation? I started Raible Designs in May 1998. I started out as an LLC and later converted to an S Corp. For the first few years, I made $30-$55/hour and this seemed to work pretty well. I believe this was similar to having a Sole Proprietorship (because I was the only employee), except that I was protected from lawsuits.
In 2001, I got my first high-paying gig at $90/hour and my Accountant suggested I change to an S Corp to save 10K+ on self-employment tax. I'm certainly not an expert on the different types of business entities, but this path seemed to work well for me. It was $50 to convert from an LLC to an S Corp. I'm not sure if you can go from an S Corp to an LLC. The beauty of an S Corp is the corporation typically gets taxed at 15%, so you can run a lot of things through your business and pay less taxes. Date nights can be business meetings, vacations can be Shareholders Meetings, seasons tickets can be client entertainment and you can write off your car and fuel costs.
There's lots of good resources on the web that describe the different business entity options. My favorite is A List Apart's This Web Business IV: Business Entity Options. Another good resource is How to form an LLC.
The hardest part of starting a new business is coming up with a good name. My advice is to make sure the domain name is available and pick something you like. I chose Raible Designs because I designed web sites at the time. Raible is a pretty unique name, so that's worked well having it as part of my business name. Googlability is important - don't choose a generic name that will make you difficult to find. Potential clients should be able to google your business name and find you easily.
Once you've picked a name, the business establishment part is pretty easy. In Colorado, you can File a Document with the Secretary of State. Their site also allows you to reserve a name if you're not quite ready to make the leap.
You'll also need to get a Federal Employer Identification Number (FEIN) from the IRS. The IRS has a good Starting a Business article and also allows you to Apply for an Employer Identification Number (EIN) Online.
Once you've got all the documents setup, you'll want to create a bank account for your business. I'm currently using Wells Fargo and really like how software-friendly they are. Their online banking is clean and easy to use. They also support QuickBooks for the Mac. They have Payroll Services to allow you to pay your quarterly taxes online as well as setup direct deposit, but I'm not using them.
For payroll, I use PayCycle and have nothing but good things to say about them (see update below). I have the Small Business Package at $42.99 per month. This package allows me to pay myself and employees + up to 5 sub-contractors with direct deposit. It also allows me to pay both Federal and State quarterly taxes online. Of course, if you can also get an Accountant to do this for you.
Having a good Accountant and Financial Advisor (for your retirement plan) will likely be an essential part of your business.. LinkedIn's Service Providers is a good way to find recommended professionals in your area. For example, click here to search for Accountants and then click the change location link in the top right corner to specify your zip code.
Finally, you'll need insurance. The Hartford has a good Small Business package that costs around $500/year. It's liability limits have worked for all of my clients and I'm covered if my laptop ever gets stolen. For Health Insurance, I recommend using eHealthInsurance.com to find a good provider for you. I don't get sick or hurt much, so I typically get a disaster prevention plan with a $5K deductible. For dental insurance, brush your teeth. Vision insurance typically sucks, so I wouldn't buy it. Yes, our health care system in the US needs work and I believe if everyone had a small business, it might get more affordable a lot quicker.
Over the next few days, I'll post some additional advice I've received on retirement plans, deducting a home office, drawing up contracts and how to come up with a good rate. If you're an Independent Software Developer and have any additional advice, I'd love to hear it.
Update: I take back what I said about PayCycle. After having a couple of insufficient funds when re-activating my account in January (they were pulling from the wrong account), they've changed my direct deposit lead-time to 5 days for the next 6 months. This means I forget to create checks on time since their reminder gets sent 2 days before. Time to try Wells Fargo.
Update October 2009: I never left PayCycle and I continue to use them to this day. I'm a satisfied customer, but do believe it still takes too long to make changes to your electronic services setup.
Posted by Scott Olson on February 10, 2009 at 03:03 PM MST #
Posted by Loc on February 10, 2009 at 03:06 PM MST #
> Just curious: did you start your professional career as a FTE and then moved to contracting, or just went straight to it?
I started as a FTE with MCI Systemhouse and became a contractor 6 months later thanks to a good friend.
Here's a couple of posts that are somewhat related:
Posted by Matt Raible on February 10, 2009 at 03:12 PM MST #
Great post, thanks. I've been thinking a lot about this lately...
When you said "$55/hour is still more than I would have made as a FTE", would that have included taxes/insurance/etc? $114K/year minus taxes/insurance/etc brings the take home pay down a bit. I've always thought, perhaps mistakenly, that the take home pay for FTE v. contracting is close to a wash because of the taxes/ins/401k/hardware/etc. Plus there's the time a contractor has to put in to take care of the business that FTEs do not, and since it's all about the billable hours, that's not a small consideration.
I would think there's a large difference in buying disaster insurance for one person versus regular medical for a whole family (spouse plus kids). And I would have to see if I could get by without vision and dental for my family (kids need checkups and cleanings), so that'd be a consideration.
Generally I've seen that the big benefit of contracting is overtime pay, the gaps between contracts, and the ability to use the tax shelters of a corp. The downsides are that you're immediate expendable, you have to manage the business and paperwork, equity stakes are hard to come by, folks are hesitant to put you on long term core to the business things, and you can't really 'go native' with the team.
I do agree that being a contractor makes you more marketable for contracting positions, but I think there's a difference between FTE and contract positions. I've always gone the FTE route with smaller companies because I like being personally vested in the group and I like to be at the core of something as it grows over a period of time. I've never done a big company IT shop kind of gig, maybe that's a difference. I also like equity in the company because I find it to be a great motivator. Plus it seems to me that a group of rockstar people (including testing, design, IA, business, etc), can come up with some great things beyond me slinging code for cash. And really, I like being able to have a significant say in things (process, technology, product ideas, etc) and being part of 'big picture' decisions.
Maybe I'm just uncomfortable with the idea that coding isn't anything more than a skill that one gets paid for - no passion for the product, no personal investment, no kool-aid...just a cash transaction...
Anyway, I'm just thinking out loud - thanks for the article, it's good food for thought.
Posted by Chris on February 10, 2009 at 03:50 PM MST #
Good advice. I'd say for anyone testing the waters to form an LLC first. In Colorado it costs a few dollars and 30 minutes of time to incorporate as an LLC and get a tax id number using the links above, online. LLCs work exactly like sole-proprietorships from a tax basis (declared as schedule C on your tax return) but with some legal protection.
My accountant said that once you make over 40K per year consulting it's worth the extra paperwork and complexity of going to an S-Corp. Personally I prefer to have an accountant prepare and file all the tax forms and paperwork so I don't have to worry about messing something up - I know more than one person who has made some expensive tax mistakes in the past. Better in my opinion to pay a good accountant a few hundred extra bucks a year to get it right. Most banks allow you to pay people via electronic transfers for a nominal fee if you have subcontractors and don't want to send them paper checks.
If you have a family or are a more frequent health-care user, an HSA is a really good option. (High-deductible policy combined with a tax-free savings account). Premiums are quite low for the insurance and you can pay for anything from glasses to doctor's appointments to vitamins and toothpaste on a tax-free basis. The dentist will usually charge you less if you pay up-front. I ran all kinds of numbers and I can't find a single scenario where an HSA costs more than a standard PPO plan, especially if you're a heavy health-care user.
Posted by Cameron Pope on February 10, 2009 at 03:56 PM MST #
Posted by Chris on February 10, 2009 at 06:08 PM MST #
I have been told that an LLC does not help you for liability if you are the sole employee (since there's no one else to blame but you if something "goes bad"). I assume you've run all this by lawyers, etc. Is that something that clients typically sign off on in the contract itself? (limitation of liability and that sort of thing)
Thanks for the great post. I do agree with your observation about the attitude of many FTE's.
Posted by Peter on February 10, 2009 at 06:58 PM MST #
Thanks for the great post, Matt. As a long-time contractor -- through both this recession and the last one -- I definitely think this is the way to go if you have confidence in your skills. I'm especially looking forward to your thoughts on deducting a home office. I've been working from a dedicated "home office" room for a while now, but haven't gotten around to figuring out how to deduct it.
As far as health insurance goes, I'm using an HSA-compatible plan from Anthem (the BCBS here in Colorado) for about $150/mo. I think the net outcome of FTE benefits vs. self-employed individual health insurance probably varies depending on your age and health situation.
Posted by David Simmons on February 10, 2009 at 08:02 PM MST #
Posted by Mark Johnson on February 10, 2009 at 08:37 PM MST #
Posted by Damian on February 10, 2009 at 10:41 PM MST #
Damien, unfortunately you are wrong. Piercing the "corporate veil" is certainly possible, but it is expensive and very improbable. If you are working under the confines of an LLC or corporation, you are acting under that entity. To pierce that veil, you typically need to prove fraudulent activities or that you used the corporation as a fraudulent device to do a criminal act. This is not easy and there is significant case law that supports the difficulty piercing a corporation. Errors and omissions would be a difficult reason to pierce a corporate entity.
Posted by Jeff Genender on February 10, 2009 at 11:45 PM MST #
Thank you for your the post.
After reading your post, I now believe that I can do it. Lately, I've been reading about incorporating vs solo proprietor.
The economy is really bad and finding a job that doesn't pay for what amount peanuts is difficult.
I've been contracting for few years now and I'm hesitating between starting a software company or a consulting company. It looks like it's easier to start as a consulting company.
I believe in my skills but is a good network essential before starting your own company?
Posted by Eric Richardson on February 11, 2009 at 06:23 AM MST #
Earlier last year I did my first work as a contractor for about 6 months. I was actually a W2 employee of a consulting company so I definitely got the shaft in terms of rate ($55/hr) and benefits (none). I'm sure they were charging more than twice that rate to the company. Anyways, while the $55/hr was more than I made during my previous fulltime job (even after paying COBRA) I really just didn't like it. I don't like not knowing where my next paycheck is coming from, and I also didn't like taking a day off and I felt I could also never get sick since I wouldn't get paid.
Plus the fact that I have two kids and a stay-at-home wife I just feel I needed a little more security even if I have to give up a higher pay.
Posted by Ben C on February 11, 2009 at 07:41 AM MST #
Posted by Damian on February 11, 2009 at 07:55 AM MST #
Posted by Damian on February 11, 2009 at 07:59 AM MST #
Posted by Navier on February 11, 2009 at 06:06 PM MST #
Great write-up, Matt. I really like:
"When you're a contractor, you're prepared to be let go."
Four months ago, I left a salary job that I had been at for 10 years to go solo. It's been quite a mindshift ... I take every hour that I am working for someone as a contractor very seriously and it has made me sharper and more focused on the task at hand ... but at the same time I feel being a business owner gives me a wider view of business AND technology.
I take comfort that you recommend creating an S-Corp, because that's what I did!
Don't know why I didn't go solo sooner :)
Posted by Rob Lambert on February 12, 2009 at 12:21 AM MST #
Posted by Dahui on February 12, 2009 at 02:39 AM MST #
Date nights can be business meetings
Isn't this what the IRS calls tax fraud?
Your comments about health and dental insurance are spot on... if you are a single guy with no preexisting conditions.
Sure I brush and floss, but due to a preexisting condition, I was slapped with a unforeseen $10000 dental bill.
A family, especially and older couple with kids and a preexisting condition can see high deductible plan coverage at $1200+ / month.
The only good news there is that some states allow small businesses to buy into group insurance rates. And if both parents work, one can work for a large company with good insurances.
Posted by Sigh on February 12, 2009 at 06:30 AM MST #
Very good post Matt!!
I am looking more into setting up a company my self and your post is a big help. Looking forward for more posts on this.
Posted by Sreeram Koneru on February 12, 2009 at 08:59 AM MST #
Good post Matt. I'd like to caution anyone considering a jump from FTE to contracting, if you are in the US your first consideration should be health care costs (unfortunately). If you are single & healthy contracting can be much more lucrative. If you have family that depends on you for health care, or have pre-existing conditions, you may want to think twice. I had no problem picking up insurance when I was single, and actually paid less than when I was a FTE. But with a family things can be quite different, and for some pre-existing conditions many insurers won't provide coverage at any cost! The perfect situation for contracting is if you are either healthy with no dependents, or can get insurance through a spouse.
Timely discussion on the s-corp too. I've been considering converting my llc to an s-corp.
Agree completely that as a contractor you're more motivated and always looking to improve your skillset. All in all I love being solo, but it's certainly not for everyone.
Posted by Tim Reardon on February 12, 2009 at 09:57 AM MST #
I'd also recommend another author, Rob Walling, who also writes regularly on these topics: SoftwareByRob.com, also available on feedburner.
Posted by Mark on February 12, 2009 at 11:51 AM MST #
Posted by Raible Designs on February 13, 2009 at 11:18 AM MST #
I have been a contractor for almost two years now. I agree with Matt that "When you're a contractor, you're prepared to be let go."
I am a W2 contractor however. I struggle with finding real benefits to forming an LLC, or other corp. entity. I find that the pay difference between W2 and 1099 contracts barely cover the difference in who pays the taxes. In addition, you need to have extra liability and errors and omissions insurance. Also, in my state, you have to pay sales tax on contracting services.
Unless you are running a lot of "stuff" through your company, what is the benefit? Also, is it possible to contribute to a HSA plan pre-tax when you are a corporation?
There seem to be a lot of you who have taken the extra leap. I would appreciate your thoughts....
Posted by Josh on February 14, 2009 at 07:04 AM MST #
Posted by Gary on February 16, 2009 at 03:59 PM MST #
I work out of Maryland and have contracted to corps in several other states. Since my business (an S Corp) does its business in MD, that income was declared as MD income. There was nothing else to do aside from faxing them the usual tax form (I forget the number of it but they'll ask you for it by name - it's really easy).
I'm a FTE now which has helped a lot because our 2 kids are small and we do some caretaking of my mother, but I do miss being independent. It does require a lot of time in management, marketing, networking, research, etc. that being a FTE will relieve you of. Wish I had started when I was younger!
Being an S-Corp is good peace of mind, but the S-Corp paperwork can get rather tiresome - monthly deposits to Fed and State, quarterly and annual reporting, and in MD they keep trying to raise the annual cost to corporations. I always did my own payroll management and reporting just so I understood what was going on. You can use Excel for this - it takes some setting up though, but I had a client with a quick Excel need that I was able to help him with, and he was really impressed since he's an accountant and is supposed to know Excel. ;)
Our health insurance for my family of 4 was running about $500+/month - not bad, and comparable or better coverage to what I am used to as an FTE. I'm not sure, but I think pre-existing conditions make things difficult for you regardless of what plan you have. That's my biggest fear now and try to stay healthy and eat well so we don't fall into that hole.
Last comment - don't do any work without a contract. This may sound obvious but at some point you may agree to do a rush job, or get too friendly with the client, and accept a verbal agreement. Unless you know your client very well, this can bite you when they don't pay! Also, as a little guy, a bigger firm will sometimes just decide not to pay you. It helps to keep a carrot on a string in front of them, if you can.
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