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When she opened her law practice in southeastern Massachusetts, Maria O'Connell-Unda faced a financial challenge common to most new soloists -- the ability to create a cash reserve.
No revenues were coming in during those first few months, yet she had overhead costs associated with establishing and running a new law firm, including rent, computer supplies and office-furniture purchases, marketing costs and utilities. "It was tough to save money" during the transition to becoming a self-employed attorney, says Ms. Unda.
Fortunately, Ms. Unda had an ample cash cushion and was able to ride out the transition period. Letters and formal announcements mailed to clients she'd worked with as a salaried lawyer paid off. She landed work in various general law areas, including corporate and family law, real estate and estate planning. She even scored a plum assignment to serve as executive director for a local health foundation. Eventually, her strong client relationships helped her to rebuild her bank account and the firm to achieve profitability.
The First Months
Experts say new entrepreneurs need a cash stockpile equal to about six months' worth of expenses to handle the risks of payments arriving unevenly -- or not at all -- during the start-up period. Building a business takes time, and it's critical to have a cash surplus because personal emergencies "like replacing a furnace or hot-water heater" can quickly drain reserves, says Tony Olson, a certified public accountant in Keene, N.H.
Tom Carroll, a fee-only financial planner for Alpine Financial Group in Cincinnati, agrees. He recommends keeping debt to a minimum during the start-up phase. The exception might be to secure a home-equity credit line "while you're still working [for someone else]" and can qualify for it, he says.
Ms. Unda quickly learned to do a daily cash-flow analysis since checks arrived so sporadically. At the outset, she eliminated all unnecessary expenses to preserve funds for where they were most needed, such as to acquire software to monitor client obligations. Mr. Olson endorses that practice, saying that reviewing cash flow daily -- which is easier now with new software programs -- is "an absolute necessity from Day One."
Other ways to preserve capital include sharing equipment where possible and "not buying a brand-new car or ordering the most lavish stationery before you have an image," says Mr. Carroll. Even though start-ups may hit their monthly operating target numbers, they still "need a big pot to support lean periods" and avoid financial losses, he says.
"It's terrifying, but critical to know what your cash flow is -- especially before any major expenditure, like buying office furniture," he says.
Thinking Like an Owner
When George Brewer started his solo advertising business in the early 1990s, the biggest hurdle he faced was learning to monitor his expenses -- and quickly. Out of work in 1991 -- at age 51 with 30 years in advertising -- and tired of the politics of large ad agencies, Mr. Brewer started freelancing for agency, corporate and former moonlighting clients.
Without a business plan, he had to immediately start thinking like an owner instead of an employee. A lot of his initial expenses were one-time costs associated with the start-up period. These included insurance, legal fees, document-preparation charges, office equipment, phone lines, fax machines and printing for marketing materials. He also had to make enough to cover his monthly fixed costs and essential periodic upgrades to his computer systems. Taking advantage of the latest technologies, he was able to perform a lot of repeat computer-generated ad work.
While Mr. Brewer survived without a business plan, experts recommend preparing one as soon as possible. To provide an adequate cushion, the plan should include a "fudge factor of 25% above what you expect to spend," says Mr. Carroll. "Flexibility is necessary until you establish a [revenue-producing] pattern."
Within a few years of going solo, Ms. Unda was earning more than she did as a salaried employee, with revenues exceeding six figures. Like most lawyers, however, she feels that her biggest financial risk is liability.
For lawyers and other professionals, the "biggest exposure is malpractice, and most states don't protect you," says Mr. Olson. One way to protect yourself is to buy industry-specific error-and-omission insurance and umbrella insurance, says Mr. Carroll. This helps professionals to avoid the financial and legal risks -- such as lawsuits -- associated with providing services. He points out that one costly lawsuit could wipe out a small business, even those set up as corporations, since "the corporate veil is very thin."
Mr. Brewer has limited his operation's downside risk by generating revenues from more than 10 sources. He earns income from a major regional spa designer, a local furniture dealer and by freelancing for various ad agencies.
One risk Mr. Brewer takes is using a pay-as-you-go strategy for family medical expenses, because he feels medical insurance is too costly.
Lacking adequate health insurance can be a financial time bomb. Under COBRA rules, employees can keep their prior employer's health insurance coverage for 18 months by paying the premiums themselves. After that, you can buy group medical insurance through a professional organization, by joining a local chamber of commerce or through other groups.
"You don't want to buy 'Cadillac' coverage," Mr. Carroll says. A policy "with a large deductible may be the most cost effective solution."
Other Financial Risks
Solo professionals are responsible for their own federal, state, Social Security and other taxes, so determine your tax requirements. Decide whether your business will be a sole proprietorship, corporation or other vehicle and work with a tax professional to plan and schedule timely estimated payments.
Internal Revenue Service penalties on underpayments can be costly, running 10% to 11% annually on underpayments, says Mr. Olson. Of course, by not fulfilling your tax obligations "you'll reduce your overhead -- because you'll be in jail," Mr. Carroll jokes.
Another risk is not taking advantage of retirement vehicles, so look into retirement-plan options. Many solo professionals are so busy trying to make their new firms succeed that they neglect planning and saving for retirement. Besides taking care of your own financial future, a retirement plan can help your business recruit key employees later on.
The specific plan you need depends on the stage of your business, says Mr. Olson. He sometimes recommends that small-business owners set up higher-cost qualified plans, such as profit sharing, because, unlike Individual Retirement Accounts (IRAs), the assets are protected from creditors in nearly all states.
Other retirement plans for small businesses include 401(k) plans, simplified employee pension plans (SEP) and Simple (Savings Incentive Match Plans for Employees) IRAs. All employees who qualify can participate in Simple IRAs and there are no complicated monitoring requirements. They typically offer employers greater savings at less cost than 401(k) and other retirement plans.
Are the risks of working for yourself worth it? Many who survived their early years as solo professionals say yes.
Mr. Brewer says he "loves his work" and has made more money during the past 10 years than he would have by working fulltime for an ad agency or design studio. He compares the financial aspects of self-employment to a table that "now has four legs, but sometimes it can have only three -- and it can teeter" due to the cyclical nature of the advertising business.
"The old adage is that we're the first ones to know a downturn is coming, but the last ones to know it's over," he says.
Ms. Unda never expected to go into practice for herself, but made the move in 1996 after five years with an established law firm and with a maternity leave coming. Becoming self-employed has given her the independence and control she desired and the freedom to juggle her schedule to meet family needs. Although she wrestles with managing growth, she describes herself as "the happiest I've ever been practicing law."
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