How to bootstrap a consulting business
In my previous article, I received a question in response to “Myth #1: I need to get VC funding to make my company successful.” I was asked to explain what it really takes to get a consulting company off the ground. How much money does it take to start a consulting company? How much constitutes a “little bit of money“? This is a great question, so let’s start at the beginning.
The Beginning
Starting a consulting business is no different than starting any other software company until you get past the paperwork stages. You file with the state, open a bank account, get a domain name, and do all of the typical software startup things. In fact, on paper a software company and a consulting business are exactly the same. You’re going to need hardware, software, developers, time, and a little bit of money. There’s that phrase again. How much!
I don’t think many people realize how easy it is to start a software consulting business. I started Moon River Software with about $5,000 and a couple of credit cards which I barely used. The plan was to start out consulting while writing software products on the side. When software sales exceed consulting revenue, it’s time to switch from consulting to full-time product development. That hasn’t happened just yet, and it will not happen for quite a while, but the software sales are slowly growing. The money that I had saved up didn’t go to software, hardware, or many of the other things that you might think. It went into my pocket. So, I put $5,000 into the company and promptly started giving myself paychecks.
Does that seem strange? Of course it does. That money should have gone toward resources that the company needs. Something important. Not back into my pocket. Right? Not so fast. For a consulting business, the lifeblood of the company is the incoming business, measured by the hourly rate times the number of billable hours. Guess what? You don’t get paid until the work is done. So, just like switching jobs, you need to have some money in the bank to help you get through what I call the paycheck gap. What schedule did your old company pay on, and what schedule does your new business pay on? Some companies withhold one full paycheck, which depending on the schedule could be 2-3 weeks. If the company pays on a monthly basis (and some of them do!), you might not see a paycheck for quite a while. Even if you want to pay yourself every week, chances are that you can’t because the business hasn’t made any money yet.
The Paycheck Gap
The Paycheck Gap is the time period when you must perform a careful balancing act between cashing incoming checks, writing checks for your own payroll, and sending money to pay business credit cards or other debts. The biggest problem with a consulting business is that there is a net terms payable agreement. That means that after you bill the company you do the work for, there’s still a lag between when you’ve done the work and when you get paid. Let’s say you start a job on June 1. On June 14th, you’ve done two weeks of work and you bill them. If the net terms are 2 weeks, you might expect a check around June 30th. That means an entire month has gone by and your company has had no income until you get that check. That’s hard.
To make matters worse, net terms of 15 days are not very common. Most companies use net 30, net 45, or even net 60. That means that even after you’ve done 2 weeks of work, it could be an additional 4, 6, or even 8 weeks before you see a check. That puts you into late July or even early August! The larger the company, the longer the net terms tend to be. This means that from the time you leave your old job to start consulting, it will likely be 6-8 weeks before you see a check. I’ve done work for companies that only allow you to bill them the last 3 days of the month. I did a two day job for a company the second week of last December. In addition to not being allowed to bill them for another 3 weeks, I had to wait another 4 weeks on top of that to receive my check. Total time from work complete to receiving a check: 7 weeks.
Let me make one thing perfectly clear before we go on: Do not expect your clients to pay early. Period.
You might get paid a day or two early. If there are quarterly or yearly accounting audits going on, you might expect a more timely payment. But there is only one situation I know of in which they will pay significantly early, and that’s if you start giving them discounts for doing so. In that case, you’re offering them an incentive, and are cutting their costs. If you’re desperate for the money, offer a 1%-2% discount for paying early and 9 times out of 10, you’ll be paid quickly. Otherwise, you’re going to have to wait.
Why does a 2% make a difference? Say you’re charging them $2,000/week. A 2% discount will save them $40. And for what? Writing a check a little earlier than it needs to be written. Accountants are penny pinchers for a reason. That’s what they’re paid for. Cash on hand is great, but if they can save $40 by writing a check a week early, they’ll do it. Because over the course of a year, saving 2% each week on your invoices alone could save the company more than $2,000 total. Arthur Anderson, eat your heart out.
Back to my example of not being paid for 7 weeks. That’s almost two months before you see any money for your business! Not only is that timeline typical, but who is to say that you’re going to be paid on time? What will happen to your business (and you) if you aren’t paid on time? What happens if you aren’t paid at all? Don’t think this will never happen to you. It happens to a lot of people and it very nearly happened to me, so be on your guard.
The Paycheck Gap ends when you are receiving checks from your clients on a regular basis.
Catch Up Mode
Once you have cleared the Paycheck Gap you are on your way to being successful. What happens is that your business will turn from being forced to survive on peanuts in the short term to what I will call ‘Catch Up Mode’. This is the time during which your business must issue back paychecks to you on a regular basis, typically for work done anywhere from three to nine weeks ago. Moon River Software’s Catch up mode period was six weeks of back paychecks.
Many people will be tempted to start paying off any business credit cards they have accumulated balances on, just to prove that their business has no debt. Take my advice. Don’t. Give yourself a paycheck and try to catch up on your back paychecks. Not paying yourself first is seriously demotivating. It seems like everyone is getting paid except you. Forget about the fact that you’re going to be paying interest on some purchases. Forget about the fact that your balance sheet could be closer to zero liabilities. Your salary is a big liability, and receiving paychecks is a huge morale booster. You start seeing the profits of your labor, and the fact that your efforts are actually paying off. Pay yourself first is typically a strategy used for retirement savings, but it works extremely well when growing your business. If you are constantly paying everyone else first, there will be very little or nothing left for you.
During this time period for Moon River Software, I had more than enough money in my bank account to pay the credit card bills for the equipment I was buying, but instead let the bills linger while the cash sat in my account and instead went to my payroll. Why? Well, my business credit card gave me a 0% interest rate on all purchases for one year, starting in October. Guess what? I had no incentive to pay them off early. Instead, the money went to me in the form of paying off the money I loaned the company to get off the ground and in terms of my payroll. In fact, I just paid off a $10,000 balance that I’ve accumulated over the last year because in October, interest would have started to accumulate. Had they offered me a discount to pay it off early, I would have.
At this point, if you’re running your consulting business properly, then you’re making a profit every week, and will slowly catch up with your payroll. In the case of MRS, every two weeks that went by I caught up by another week or so. Once you’ve caught up and are writing checks for payroll every Friday for work completed the week before, you will start logging a legitimate profit. Now you can put money away for those times when you will not be working, be it because you have taken a vacation, or are between clients.
Just to be clear, the billing cycle between you and your business is different than the billing cycle between your clients and your business.
Profit
It should go without saying that being profitable is a bare minimum requirement for running your business. If you’re not profitable, you’re going to go out of business, plain and simple. At the end of every quarter, you read about companies who log tens of millions of dollars in losses every quarter. The first quarter of this year, GM posted a $323 million dollar loss. That’s a lot of money, by any standard. How do they keep going you ask? How could they possibly stay in business while losing $323 million in a single quarter. That doesn’t even count the previous five quarters where they also logged losses of more than $1.3 billion the year before. Yes. Billion with a ‘B’.
Let’s switch gears and talk about the profit stage of a company. I think here is where a lot of people get confused about the long term goals of a company. As soon as a company is profitable, the owners start thinking about all kinds of things that they can do. Buy more equipment, hire more people, get a bigger office space, increase corporate benefits, buy gadgets and gizmos for employees as rewards, etc. These people have lost sight of the true goal of the company, and there is really only one.
Your primary goal is to stay in business.
Now repeat those words with me. “My primary goal is to stay in business”. The single best way of ensuring this is setting up a rainy day fund. Financial planners the world over recommend that individuals should have no less than a 3 month safety net. This is money in the bank for you to pay your bills, your mortgage, car payment, meet your monthly expenses, live a little bit, and still be able to make ends meet for at least three months with no income. You need to do this for your business. And not just for the founders. For every employee in the company, founder or not.
Rainy Day Fund
Moon River Software recently crossed the six month Rainy Day Fund threshold. Right now, in the business bank account I have enough money to cover all corporate expenses, including the office lease, payroll, internet access, colocation server costs, phone bills, and several thousand dollars in additional ‘surprise’ expenses for six months with zero additional income. The business has zero debt beyond this months’ credit card bill and upcoming payroll expenses. It’s been said that running your own business is one of the most stressful things in the world. With this Rainy Day Fund behind me, running my business is one of the least stressful things in my life. I know that I can screw up all kinds of things and still be in business. Here’s why.
Let’s go back to the example of GM and figure out how they’re still in business. Their loss of $323 million in the first quarter of 2006 was on revenues of $52.2 billion dollars. Let’s assume they did the same thing that I did, and could theoretically operate for 6 months with no income. That would mean they had over $100 billion in the bank. Losing $323 million is a mere 0.3% of that. For arguments sake, lets triple that loss and say they instead averaged a $1 billion loss every quarter for the next X years.
With a $100 billion Rainy Day Fund, even losing $1 billion every quarter, they would still be in business for the next 25 years. Yes, that’s correct. 25 years! Isn’t that impressive? Between you, me and the engine block, GM doesn’t have that kind of money to spare. They’re in pretty poor shape. I think that untrained monkeys could do better by flinging poo against a ‘Corporate Strategies’ mat on the wall, but that’s why I work for myself instead of GM.
The point I’m trying to make is that once you get a 6 month Rainy Day Fund under your belt, you’re in good shape. Now is the time that you should start looking to expand your business, hire more employees, buy more equipment, and do all those other things with your money. While large corporations measure success on a quarterly basis, I would recommend measuring it every other week. Every day or every week is too often, and once per month is probably not often enough. Here’s why every week is too short.
If I bought a new laptop this week because my old one died on me, it would set me back about $3,000. By spreading out this expense over multiple weeks, my profit margin will be much lower for those weeks, but longer term, the profit is still there. If I were measuring my corporate progress on a weekly basis, adding $3,000 worth of expenses in a single week could kill my profitability curve. Depending on how much my consulting income is, it could put me into the red that week. Measuring every other week tends to smooth out the wrinkles in the curve. When you start hitting millions of dollars in revenue every year, that’s when you can measure every month or every quarter. Until then, stick to every other week.
Summary
No matter what niche market you’re trying to serve with your consulting business, you don’t need a lot of money to get started. All you need is enough income to get you through the next six weeks or so, and the willpower to not melt down into a steaming pile of mental ward biomatter. If you make your situation clear to your first couple clients that you need a reasonably fast turnaround on the first couple of invoices, most of them will be willing to help out a little bit. Push for 10 or 15 day net terms. If you negotiate well, this won’t be a problem.
The hardest part about the process is having the willpower to make the leap into being self employed. After that, it’s really not that hard.
Special thanks to Rob Walling for reviewing drafts of this article.
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Very interesting. I’m currently running my own company though we’re more product focused than consultancy (www.freecrm.com). However I was always intruiged by consulting as I’ve worked with many.
My main question regarding this was how do you start? Do you mail out every single entity you’ve ever worked with announcing your new consultancy stint? Do you pick random companies and promote your services to them? Or do the clients come to you (via google etc.)?
Well, how you start is very different depending on what type of relationship you had with past managers, what circles of people you ran in, and friends of friends. I’ll be talking more about that in an upcoming article on how to find clients. There are a lot of different ways to get clients. Too many in fact to list here in a comment.
“There are a lot of different ways to get clients. Too many in fact to list here in a comment.”
That’s what I’ve been wondering about too… Otherwise, great reading keep up the good work!
Can I know what’s the right age for starting a consulting business ?
Good write 🙂
There’s no ‘right age’, but the perception of being somewhat seasoned is important. Companies hate shelling out high hourly rates to people who look like they’re fresh out of college. Perception is a big part of consulting, and first impressions are very important.
If you look rather young, it is equated to less experience, less reliability, and you will be paid less because of it, assuming you’re hired for the job at all. Degrees are important, as are certifications.
But it’s possible to be 60 and not have the maturity level to run a consulting business. It’s also possible to be 25 and be very successful because of your personality. A lot of the repeat business and referrals depends on how well you interact with you clients in addition to how well you perform the job, thus your personality can factor into what the right age is.
From what I can tell, there seems to be an invisible floor of about 25-30 years old to get into the consulting business and be credible. If you’re in a highly specialized, bleeding edge niche, you can certainly be on the younger side and still have credibility in the eyes of your clients.
Hi Mike, Thank you for this article. I really appreciate your willingness to share your experience which is invaluable for someone like me who wants to start a consulting business. I wonder if you could give some advice for my situation.
I have been working in IT for the past 13 years: 4 years in data communication (system/firmware protocol stuff), 4 years in telephony and telecom, and 5 years in auto. In the past 7 years, I have been doing J2EE & Web development and prior to that, mostly C/C++ on unix. I have been working as semi-independent contractor (tech lead, architect, tech manager) since 1998 (corp2corp through middleman).
I thought I knew a lot of things (maybe except Microsoft) but I don’t know which of them will lead to paying customers. To set up the business, I need to create a web site with some expertise info. My common sense tells me that I should list all things I have done to increase the chance someone will find one of my skills to be interesting, but my MBA education tells me I should be focused as a small business.
What’s your thoughts on this?
Also how is consulting business different from a staffing company if the extra work you can’t handle youself is subcontracted to other people? wouldn’t a staffing company be more profitable and scalable?
Thanks for your advices.
You’re welcome. Glad to hear that it helps in some way.
To answer your question about the website, I would definitely choose a niche market and go with it. I’m often amazed at just how many niches there are out there and how well they can be exploited by people with the right know-how and the gumption to do it.
That said, it’s not always easy to identify a niche if it’s right in front of you because you’ve been working with it for so long, you have a tendency to believe that the market is saturated with people with that skillset, or that it’s not in enough demand to be able to support yourself.
You should think back to the customers you have worked with, and why they hired you at all. Is there a pattern of any kind? Do they have other employees there who can do what you do? If not, then you’ve probably found your niche. The fact that you know Unix more than Windows leads me to believe that you need to look in the Unix world, which tends to be larger customers.
Smaller customers who use Linux use it because it’s free and they see it as better to pay employees to learn stuff than to pay for licensing that makes it easier to hire people. It’s a bit of a catch 22. You spend the money one way or another. In your case, your Unix skills probably put you in more on a mid-level to enterprise business. In a Unix world, that’s probably a harder shell to crack without an ‘in’ of some kind.
One way to create this ‘in’ on your own is to focus on a very narrow niche. Use Google AdWords to drive some of your traffic and pay for your leads. I know another consulting company that pays $5 per click but they use highly focused text in their ads and their click through rate is low, but the conversion rate is high and it is worth it for them to do it.
A consulting business is probably different from a staffing company in very subtle ways, and all of them are likely to be based on connotations. Thus at a root level, there’s not much difference at all.
On the surface, the implications of a staffing company are for unskilled or manual labor although I suspect that there are staffing companies out there who are geared directly at keeping high tech people on staff to outsource to software startup companies.
I’m not clear on one thing though. If you aren’t sure of the difference between a staffing company and a consulting company, how can you make the claim that a staffing company is likely to be more profitable and scalable than a consulting company? Until you nail down concrete definitions for a staffing company and how it is different than a consulting company, it is difficult to discuss why one or the other is more profitable and scalable.
Hi Mike, thank you for the insightful response.
I agree unix/linux skills can be a harder sell than Windows skills for the reasons you mentioned. It’s hard to find small projects using unix or even Java. And bigger companies tend to only work with known vendors not individuals. That’s actually the reason I have been semi-independent. Unless you know some decision maker, it is difficult to get on their vendor list. That’s probably what you meant by “in”.
Regarding the niche, I suppose it should be an industry rather than a specific skill set. The issue with industry niche is that the projects I worked on dealt with a narrow band within industry spectrum, i.e. the domain knowledge was often limited to the specific problems to be solved. It is not very transferable to other areas or companies and could limit the markability of the experience. However, if the niche is based on a skill set, it would seem hard to differentiate – there are a lot developers who have the kind of skill set.
I apologize that I didn’t state what I meant by “staffing company”. They are the IT recruiting companies. They are on the vendor list of the customers. Every time, the customer has a need for an employee/contractor, they help fill the position by finding the resource on the market and taking their cut (>30% of the rate for contractor). It seems the barrier to entry is the client list (or to get on client’s vendor list). After that, you are in business. You can scale up if you are able to get on more client’s list. In contrast, for a small IT consulting company, you subcontract the extra work you can’t do, but I doubt you can take 30% cut. And to scale up, you will have to land enough work for youself and for subcontractors. Otherwise, it would be in the self-employed mode, not much different from what I am doing now – full time project plus some side projects.
Choosing an industry is probably better than choosing a specific problem set that you solve. People in an industry talk to one another and if you’re in good with one person, they might recommend you to someone. Better yet, you can ask them if they know people. If you’re doing good work and are always helpful in whatever way you can be, then your clients are more likely to pass your name on if you ask them.
That last piece is important. You HAVE to ask. Only a very small percentage will do it on their own if you don’t ask. That trips up a lot of people from the engineering side of the world because they’re not used to schmoozing and asking for business leads.
IT recruiting companies are different than a consulting company because IT recruiting companies are not much more than glorified placement agencies. They don’t have a vested interest in the people they place beyond a contract that states their clients can’t hire them out from under them and cut the recruiting company out of the loop.
A consulting company, on the other hand, is full of “consultants” who work for the consulting company. They have a job to worry about. At my company, the consultants are full time hires, where at a recruiting company, they are merely contractors who don’t have a job after the current one is over with.
If my company can’t find work for one of my consultants, then I still have to pay them a salary, while a recruiting company wouldn’t have to. They’d say “Well, the job is over. You’re on your own again unless something comes up.” That’s why they get paid more and are paid on an hourly basis.
My employees are paid salary. Sure, they make less money than a consultant, but the pay is stable, or at least relatively so, and they don’t need to worry about whether they can put food on the table. Extra money is banked for slow times and used for new equipment, software, hardware, employee training, and toys.
You’re right about scalability and profitability of a traditional IT recruiting company. The straight consulting model I use is a lot less scalable, but my long term goal is not to become a recruiting company. It’s to do what I enjoy, which is software development.
Hi Mike, Thank you for this article. I really appreciate your willingness to share your experience which is invaluable for someone like me who wants to start a consulting business. I wonder if you could give some advice for my situation.
I have been working in Bank for the past 13 years: 8 years in retail credit, 4 years in risk management and controls, and 1 year in financial product development. In the past 7 years, I have been doing private money lending service on my private business.
I thought I knew a lot of things but I don’t know which of them will lead to paying customers. To set up the business, I need to create a web site with some expertise info. My common sense tells me that I should list all things I have done to increase the chance someone will find one of my skills to be interesting, but my MBA education tells me I should be focused as a small business.
I am a nigeria and these kind of service is not very common in the country. do you think i can succeed in in self employment because am being tempted to quit job as it does not give me the desired fulfillment.
thank you.
Generally speaking, you should pick a niche market and go for that. Just because you have all these other skills doesn’t mean you’re ever going to use them, nor is a customer going to care about skills they didn’t hire you for. Try to pick something that interests you. People will pay for just about anything. You just need the right contacts and need to find those people.
That being said, I’m certainly not the person you should be asking if you can succeed. The only one who can answer that for you is sitting in your chair reading this reply. It’s a very difficult question to answer because there are so many factors.
I’ve heard people in the past say some ridiculous things like “You have to want it bad enough.” I don’t buy into that. You have to be so afraid of failing that you’ll do anything to not fail, including things like marketing or business development that you can’t stand and aren’t any good at, but need to do in order to survive. That’s how you succeed.
If you’re so afraid of failing that you will do anything to avoid failing, then you’ll eventually succeed. Also, don’t be afraid to change gears a bit. Even with my business, I’m in a much different place now than I thought I would be two years ago, but that doesn’t mean that things aren’t going well.
Awesome article…
I have a question… How did you get from the I have $5000 to the point where you had a staff. I’m trying to understand how you make the transition to building a pipeline of projects and start hiring people…? Thanks!!!
Mike,
Your article is inspiring and helpful. I am a software developer for past 16 years and I started a company in 2006. I started as a consulting and a custom development company, however my long term goal is to develop and market products and become a full time software product company. During the past 3 years I only got 3 business, wit total revenue of $40,000. What are tips to get clients.? Do you have any articles referring to this. Please advice and help
George
I’ll give some thought to writing an article on how to land new consulting clients. There are a number of different ways that have worked for me.
[…] than cover the business aspects of consulting, or even the how to make the jump article, I thought I’d share the secrets of successful consultants I’ve come in contact […]
[…] than cover the business aspects of consulting, or even the how to make the jump article, I thought I’d share the secrets of successful consultants I’ve come in contact […]
This read was very timely. I was becoming a bit concerned that my client wasn’t going to pay me at all and they still may not. I completed a full month of work for them in May and on a net45 they have still not paid their May invoice of almost 6k. It’s July 16th and I believe it was supposed to be mailed out on the 12th.
I’m an eLearning Developer and Instructional Designer and just decided to market independently since I had been laid off. Thank you for providing such timely information. I do want to know if you suggest Independent Consultants to send out mailers to companies or if cold calling is still acceptable. I have been reading quite a few articles and researching marketing best practicies but there is a lot of information out there and I am not sure of the best way to get out there in front of clients. My website, although a bit lack lusture, provides insights to my expertise. I am just income strapped and few and far between clients at the moment.
I feel like online marketing probably has the biggest ROI because if you do your search engine optimization properly, you can get huge returns on your effort. The problem is the materials you’re offering. I briefly looked at your site and it’s obvious that it’s a labor driven business. I would give some serious consideration to building it out into a product, rather than into a custom endeavor every time.
By making it into a set of training videos, you could build once, sell everywhere. The effort is much lower, and the returns can be greater, as would the scalability of the business. I know it really drives a stake into the heart of your current sales pitch of “custom training”, but is that really what sells your training? Or is it you?
Hi Mike,
Nice article. I have a simple question. I am planning ot start consulting company but I am not sure when you provide information about type of business, do you need to say “software consulting and products” or you can start getting into product development by just saying “software consulting”?
There is a difference between application development (usually IT job) and software development (software engineering dept does). If one is involved in application development and product configurations then still can the type of business say “software consulting”?
Also do we need to get some kind of business license in state of California for consuting and/or product development business?
Thanks.
The people you’re doing consulting for don’t really care if you have a products business. I don’t think I would complicate things by telling them you’re also doing products because it would imply to them that your focus is going to be split between products and consulting.
Generically, this is software consulting, regardless of whether it is for internal IT applications or product development. But the latter is typically more of a staff augmentation than product development.
As for getting a license, you’ll need to talk to an attorney. I’m not familiar with the laws in California. Typically, you need to have a business of some kind but not always. You might also need to have insurance, but depending on the state and exactly what you’re doing, the type of insurance will differ.
As an aside, and I know you didn’t ask this, but if you’re really interested in ultimately building a products business, don’t go the consulting route. Skip right to products because doing consulting is a huge energy and motivation drain. The money is really good, but it hurts a lot more than it helps I think.