Small Business vs. Side-Gig
While some people consider a side-gig different from a small business, there is very little difference from a financial and tax standpoint. That means that if you are working for Uber, you are effectively running your own small business driving while Uber is your marketing and scheduling. The way to look at it is that you have your own small business if you get a 1099 (same as any contractor). All the principles here apply to both side-gigs and small businesses, so keep that in mind.
Small Business vs. Hobby
There is a difference in the eyes of the IRS in a small business versus a hobby. If you can prove you have a profit motive, even if you don’t initially make money, the IRS may consider what you are doing as a business. The difference is that as a business, you get to write off expenses on your taxes (often on a Schedule C) while expenses for a hobby are not deductible. You do not have to make a profit to write off your expenses (it is common for businesses to have bad years, especially when starting), but you have to be trying to make a profit.
Let me give you an example. I enjoy boating. Owning a boat is a hobby for me. The way we look at it is that owning a boat means you have a boat-shaped hole in the water you throw money into (BOAT, of course, stands for Bring Out Another Thousand). All of those expenses do not provide a tax deduction. If, on the other hand, I decided to start offering boat trips for money (running a business), I may be able to depreciate the boat and write off expenses such as fuel. If I run a boat business, I will need to get a Captain’s License, different insurance, and keep good records of when I’m using my boat for pleasure versus business.
The bottom line is to decide if you are running a business or a hobby in advance. As they say, the best way to turn your hobby into something you hate is to make it a business. Doing what you enjoy is important, but sometimes the money is not worth it.
Following your dreams – identifying the right business.
Many people start a small business as an opportunity to follow their dreams. The great part of running your own business is that you get to run it your way and follow your vision. The downside is that there is a chance that the market may not agree with your vision, or you may not be able to execute on it. To put it bluntly, it is on you if you fail, but if you succeed, it is also on you.
When you start a small business, you put your dream out there, and then you have to give it a good run. Start with defining your dream and goals. If your goal is to own your own business, you will have to refine your dream to understand what type of business you want to run. What are your skills? What are you passionate about? What will people pay for? All too often, the best business is not the sexiest business. Start with deciding if you want to provide a service or a product.
People want to pay money for services they do not want to do on their own. We all have different services we are (or aren’t) willing to pay for. Some people pay someone to do their taxes, while others do their own with software. There are many service businesses with a wide variety of skill requirements. The key is to connect your service business to your passions, skills, and what people are willing to pay for. Not everyone will be interested in your service, but you may be successful if you can provide a unique service that matches your passions and skills.
The classic service business (with limited overhead) would be a cleaning business. You can open a cleaning business with low overhead, almost overnight, and specialize in cleaning cars, houses, power washing, or other areas. The dirtier, the better. I saw someone the other day whose entire business is picking up poop (dog, cat, horse, whatever). It is a great business. They have a small van and go from house to house picking up poop.
If, instead, you decide to make or sell a product, you need to find a corner of the market where you can be competitive. It would help if you had something that would make your product different from others. If you decide you want to open a cupcake shop, you need a way your cupcakes are different (which will drive sales). If, on the other hand, you decide to start an Etsy shop selling custom jewelry, you need to have not only a competitive product but also a plan for handling when your competition copies you (which will happen).
Some businesses combine services and products, but you need to decide your primary focus. If I go to a restaurant, I want good service, but I’m going there for the food. If you have excellent service but terrible food, I’m not returning. If the service isn’t perfect, I might still give it another shot if the food is fantastic.
Try out a few things if you have trouble deciding what business you want to start. Start small and see what works. A word of caution: Watch out for any class, seminar, or book that says they have the best business ideas. Their business is to sell you ideas, but they sell those ideas to everyone. For example, you will find a dozen courses and books about doing ‘retail arbitrage’ on eBay or Amazon. People have been successful doing retail arbitrage (buying things locally and selling them online), but it is not only a crowded market but may be against Amazon policies.
The power of a niche.
Once you have an idea of the service or product you want to provide, I challenge you to identify a niche. A niche can be thought of as what you want your corner of the market to be. One way to think about your niche is to identify your ideal client. In the poop scooping business, their ideal client may be busy professionals with dogs. Their customers are people who can afford to pay someone to pick up after their dog and do not have the time to do it themselves.
With the ideal client in mind, you can adjust your product and marketing to meet their specific needs. When people start their business, they often do not want to limit themselves to a niche. They figure that they will take any customer who will pay them. While this is somewhat true (you will take their money), having a niche will allow you to market more effectively and ensure your product serves your target audience well.
Funding your business – Debt vs. Cash
No matter what business you decide to start, your goal should be to do it with cash. That means not taking out loans or using your credit cards to start a business. Unfortunately, many small businesses fail. If you have taken out a loan for the business and it fails, you are still responsible for the loan and will be in a bad position. If, on the other hand, you spent your own cash to start the business and it fails, you have lost your own money, but you aren’t in the hole paying for the business in the future.
When you start a small business and apply for a loan, you are guaranteeing it personally. An established business may be able to apply for loans under its own name (and guarantee). Your business will need a track record, profit and loss statements, and possibly collateral to qualify. Funding your business with your credit cards is even more dangerous as you not only have to pay for them personally, but they also come with a national average of 16% interest. You can look at the Small Business Administration (https://www.sba.gov/) to see what they may have for grants to help, but try not to take out loans to start your business.
What about getting an investor to help? An investor puts in their money to buy part of your business (or business idea). The bonus is that you get their cash to invest in the business. The downside is that you have someone else who will want some control over the business and its outcomes. Depending on the investor, they might be a great mentor or might drive you crazy.
What that means, in reality, is that you will need to use some of your own money to start your business. Service businesses tend to have lower start-up costs. Product-based businesses may require you to get creative and start with small batches and limited rollouts to make it work. You will not only need money to run the business but also to pay your home bills as things get up to speed. Make sure you have the financial and personal capacity to take on the challenge.
Minimum Viable Product (MVP) – Step Don’t Leap.
With your dream business in mind, the next step is to create a “Minimum Viable Product (MVP).” The intent is to get just enough of a product (or service) set to open your business. In the pooper scooper business, it may literally be just a scoop and some bags. If you are starting a custom jewelry business, it may just be some samples (which you may already have). The point is to get something out there that you can sell. Selling your product will bring in income and allow you to get feedback from real customers.
The challenge is that when you start a business, you can spend way too much time trying to get things ‘perfect’. When I started my business (Childfree Wealth, https://childfreewealth.com), I spent way too much time figuring out how to get my website perfect. In the end, I just had to put it out there and let people react. It is still not perfect, and I have a list of things I want to change, but it is good enough to bring in clients.
The MVP concept is becoming popular in most businesses. Look online for stories about how supposedly high-tech apps launched with a bunch of smoke and mirrors. It has become common to use people to fill in for tasks that the app is supposed to do. Amazon Mechanical Turk (https://www.mturk.com/ ) was designed to provide a workforce to do tasks just like this.
Your goal should be to start your business as soon as possible and take it step by step, not make a giant leap. If possible, start your business in your spare time while still working your full-time gig. Get it up and running and bring in a reasonable income before quitting your job. If you must leave your full-time gig to start the business, make sure you have an emergency fund of 6-12 months of expenses to bridge the gap.
Most businesses start as either a sole-proprietorship or Limited Liability Company (LLC). To the IRS, sole-proprietorships and LLCs are often treated the same. If you decide to start driving for Uber tonight, you have effectively opened a sole-proprietorship. You are the business. An LLC allows you to have more than one person own the company, or you can have what is called a single-member LLC (just you). The bonus of an LLC is that there may be some liability protection if formed and managed appropriately. The IRS sees most LLCs as ‘disregarded entities,’ which is a technical way of saying they see an LLC as you (and it is reported on your personal taxes). If you have an investor, you may need to look at something like an S-Corp.
Depending on your state, you may be able to file for a DBA (Doing Business As) designation for a sole-proprietorship or even form an LLC through your Secretary of State or other similar agency. You can also pay for a lawyer or legal service to help you. If you need to form an S-corp or something fancier than an LLC, you will want to work with an attorney.
Partnerships are tricky. If you are starting a business with someone else, realize from the beginning that partnerships make everything more complicated. Make sure you have a well-developed partnership agreement that discusses who owns what and who makes what decisions. Watch out for the 5 D’s that hurt most partnerships: Disinterest, Divorce, Drugs, Disability, and Death. As a Childfree Individual, we have to watch out for a 6th D: Diapers. Have a plan for each of the Ds if you will be in a partnership.
Licenses and Insurance
While reviewing your Secretary of State’s website to form your business, check to see what licenses (and zoning) might be required for the business. Even a home-based business may need local zoning approval and a business license, but this varies greatly state by state (and even town by town). Your state Small Business Association may also be able to help. You might want to check with any local trade organizations for your business area (such as the local Farm Bureau). Make sure you have the appropriate license before you start.
In addition to licensure, you need to make sure you have appropriate insurance coverage. For example, if you use your car for business (including gig work like Uber), you may need different coverage or a rider that covers you for commercial use. Don’t skimp on insurance. You may also need a business insurance policy, errors and omissions (E&O), and other insurance depending on what you are selling. Additionally, depending on the service or product, you may need to be bonded (put up money to ensure you do what you say).
Business Financial Planning
With your business idea, MVP, licenses, and insurance in hand, it is time to start running it. I recommend that everyone starting a business reads “Profit First” by Mike Michalowicz. The concepts are simple, but the focus is on creating a system where you know what you are spending, what your profit is, and if you are going in the right direction. You don’t need advanced accounting, but you need a business banking account (or multiple if you follow profit first). Keep all of your business expenses and income separate from your personal account.
Taxes are a part of running a small business. Not only do you have to worry about income taxes, but you may also have to collect and remit sales and use taxes. Check with your city and state for local sales taxes you may have to charge. If you are selling online, check out the rules on a tax ‘nexus’ which is a fancy way of saying you have to collect sales taxes even if you aren’t in the state.
For income taxes, you are responsible for making estimated tax payments. You may hear these called quarterlies, even though it isn’t precisely on the quarter for the IRS: https://www.irs.gov/businesses/small-businesses-self-employed/estimated-taxes Each state has its own rules on estimated taxes. I’ve had quite a few people get into some tax trouble with their side-gigs. If you get a 1099, you are responsible for making estimated tax payments. If you don’t, you may not only have a large tax bill due, but you may also have to pay penalties and interest.
Giving it a go
Not everyone is made out for entrepreneurship. I enjoy running my own business and have had at least a side business for most of my life. People who are serial entrepreneurs come up with new business ideas every day. The challenge is seeing your vision through, especially when times get tough. Look for mentors and know when to ask for help.
If you want help with small business financial planning, we offer a no-cost 60-minute introductory meeting that you can schedule at https://calendly.com/coachdrjay/childfree. You can learn more about how we can help you with your life and financial plan at https://childfreewealth.com and you can take our course on Starting a Small Business.