FOR YEARS YOU'VE toiled to
keep your boss happy. You've clocked in early, stayed late and
managed to juggle deadlines with your kid's school plays.
Takeout dinners at the office? You've had a few. And now that
you've risen up the ranks, the thought hits you: What if I
were the boss?
What if, indeed. More and more Americans have been
wondering the same thing lately, and many have chosen to
strike out on their own. But the traditional startup, the kind
that involves making or selling a physical product and often
requires a costly setup and investor dollars, has been
eclipsed by a new breed of so-called knowledge-based
companies. These outfits revolve around one thing: what you
know.
Knowledge-based businesses can run the gamut from
management and public-relations consulting to market research
and legal services; the hottest area for startups is
computer-related consulting. From 1999 to 2002, "these
segments clearly enjoyed a much higher rate of entrepreneurial
activity than the national average," says Jon Brandow,
president of BizMiner, a business research firm in Camp Hill,
Pa.
Knowledge-based businesses aren't just popular, they're
profitable. Data from BizStats.com, which tracks the net income
for sole proprietorships, shows profits at knowledge-based
businesses, measured as a percentage of sales, are often well
above the 22 percent average for all sole proprietorships. For
instance, computer-system design companies posted a net income
of 40 percent, and legal services, 45 percent. Consulting
firms — including management, scientific and technical — do
the best, pocketing 55 percent of sales.
Ready to join the club? Well, while you won't have to hawk
some new invention, selling your expertise does come with its
own set of pitfalls. "A lot of people have know-how, but they
don't know how to package it, position it or sell it," says
Austin K. Pryor, a Greenwich, Conn., counselor with the
small-business advisory organization Score, formerly known as
Service Corps of Retired Executives. To help you on your way,
we spoke with dozens of knowledge-based-business entrepreneurs
and industry experts so you can learn from their mistakes.
Here's their advice on how to handle everything from copy
machines to copyrights.
Stay
Focused
When Todd Walter launched a company back in
2001 to help struggling businesses get back on track, he
thought he would have clients signed in no time. After all,
the 38-year-old had a fat Rolodex from his years working with
financially troubled companies at Chemical Bank and at a
nationally recognized turnaround firm. But after months of
beating the bushes, he and his partner had yet to sign their
first client. Then, during a meeting with a friend at J.P.
Morgan Chase to discuss possible leads, Walter had a
revelation: "As we were going through what markets we were
trying to serve, we realized we needed to focus on one
particular area," he says. His niche wasn't struggling
companies, most of which wanted big turnaround firms like the
one he'd left to pull them out of trouble, but their
creditors. His firm could help banks assess the viability of
companies they had lent money to. Three months later Walter
landed his first job, and his New Jersey-based company has
been busy ever since.
Your instincts tell you to cast a wide net for clients, but
you'll get a bigger payoff if you focus on a specific market.
"The smaller you are, the more focused you need to be," Walter
says. "You can't be all things to all people." Before you quit
your day job, ask your future competitors about the services
they offer and to whom. Try to attend gatherings at the trade
associations of your potential clients, and chat with
executives to find out what kinds of expertise they need.
Pryor suggests focusing on clients of a specific company size,
within a geographic area or in a particular industry.
Protect Your
Ideas
Since your business is nothing without
knowledge, protecting it should be top priority. An
intellectual property lawyer can examine your business
methodology, presentations and written materials, and spot
items to patent or copyright. This step is especially
important if you're looking to attract investors, who may be
turned off if competitors can easily copy your business plan.
And it can keep you from mistakenly stepping on someone else's
turf.
Anthony Ilutzi learned that lesson the hard way. In 1993,
Ilutzi's company, Grace Consulting, started offering advice
and services to customers who use software from Geac Computer.
Within a year, Geac slapped him with a lawsuit, saying
Ilutzi's service violated its software copyright. After eight
years of litigation, an appeals court ruled in Geac's favor
last September. Copyrights aside, a lawyer can also help
trademark your company name. You don't want someone else using
it, and you want to avoid a lawsuit for accidentally
appropriating another company's moniker. Narrow down your list
at the U.S. Patent and Trademark Office's Web site, http://www.uspto.gov/, where you can perform
a free trademark search. Then have a lawyer do a more
comprehensive search on the name you'd like to use and draw up
a report on your trademark's validity. The cost: $1,500 to
$2,000.
Of course, protecting your intellectual property is a
never-ending process. If you have employees, have them sign a
confidentiality agreement. A lawyer can build that into your
company's employment contract, which will usually cost $500 to
$3,000. But don't stop there, advises Victoria Prescott, an
intellectual property lawyer in Indianapolis: "Physically mark
things Ôconfidential,' and make sure the employee knows
they're proprietary." It may seem like a small measure, but
it'll give you a much stronger legal case should an employee
share your company's dealings with a competitor.
To Incorporate or Not
to Incorporate?
When it comes to the legal structure
of your business, the options can be confusing. Because it's
convenient, many entrepreneurs establish their business as a
sole proprietorship. But it's a risky choice. True, all you
have to do is register the name of your company with the
county clerk. And you don't have to file a separate tax return
since your company's profits are considered personal income.
But that also means creditors can come after your personal
assets if your business gets into financial trouble. Also, you
can't have any outside investors.
You're usually better off keeping your company's assets
separate from your own. To do this, you have three basic
choices: Create an S or C corporation, or a limited liability
company. Out of these, an LLC is the simplest and most
flexible way to go, says Russell Cox, a corporate lawyer in
Indianapolis. Why? Your personal assets are protected, and you
can add more owners, which means more room for your company to
grow. Best of all, profits won't be taxed twice, first at the
corporate level and then at the individual level when they are
distributed to owners, as they would be with a C corporation.
LLCs are taxed at the individual rate only. An attorney can
draft the proper documents for $700 to $1,000.
An S corporation also escapes double taxation. But unlike
with LLCs, you must set up a board of directors, meet strict
record-keeping rules and file a separate tax return. Walter,
the turnaround specialist, structured his company as an LLC.
He considers it "the best of both worlds." It offers tax
advantages and liability protection.
Look Like a
Pro
You've got the brains. Now what about your
image? With no product to sell, how you present yourself is
critical to winning clients.
A Web site for your company is a good idea. Just be sure to
have it professionally designed. A dinky site suggests
mediocre service. Use an e-mail address with your company as
the domain name, rather than an AOL or Hotmail account,
advises Janet Attard, founder of Business Know-How, a
small-business resource center in Centereach, N.Y. And
consider having a graphic-design firm create your stationery.
Michael Drapkin, a technology and management consultant in the
New York City area, spent around $10,000 to have a
professional design a Web site, business cards and letterhead
for his company, Drapkin Technology. "It was very important
for me in looking larger than I am, to establish myself as a
serious player," says the 46-year-old entrepreneur.
If you work from home, it can be even more difficult to
appear professional. Drapkin, who works out of a spare room,
also invested in a $3,000 Toshiba telephone system, so he
never misses a call. When someone leaves a message, the system
calls Drapkin's cell phone to alert him to check his voice
mail. To lend cachet to his company, he asked a
friend-of-a-friend with a British accent to record an outgoing
message.
And don't forget face-to-face meetings. Your kitchen table
is no place to give a PowerPoint presentation. Michelle L.
Matthews, a 42-year-old management consultant in Atlanta,
offers a good solution: She joined the One Ninety One Club, a
local professional group. As a member, Matthews can use the
club's conference rooms. "It really adds to the
professionalism of the business," she says. Look into joining
a club near you that's suitable for meetings.
Cover Your
Back
When you were a salaried employee, you didn't
need to worry much about lawsuits against the company. But now
that you are the company, you want to play it safe. Marietta,
Ga., public-relations consultant Marilynn Mobley, who owns
Acorn Consulting, wasn't thinking about lawsuits when she
landed her first job building a campaign for IBM back in 1996.
But she was told that the deal was off unless she got a $2
million professional-liability insurance policy, which would
protect her — and IBM — in case her work sparked a lawsuit
over, say, false advertising claims. "I was surprised I needed
that," Mobley, 46, says. To save the deal, she had to scramble
to get a policy within the week. Since then, other
corporations have asked her if she has the insurance.
Professional-liability insurance can cover a wide range of
businesses, and it's worth considering no matter what field
you're in. Technology companies, for example, might look into
errors and omissions insurance. It covers you in case you're
sued for, say, bugs in your programs. Expect to pay a minimum
of $1,500 a year for $1 million in coverage. To research the
kind of policy you may need, go to insurepro.net. And see if
you can get a deal at a trade association.
Work With Uncle
Sam
Knowledge-based businesses usually require just
basic equipment, such as a phone, copy machine, computer and
printer, all of which you can purchase for a few thousand
dollars. But if you need a major piece of equipment, such as a
server or a professional scanner, it may be more advantageous
to lease the item rather than to buy it.
There are two types of leases — capital and operating.
Operating leases can make sense if you use equipment that
needs to be replaced every few years. Technology companies,
for example, upgrade hardware fairly frequently. Payments on
an operating lease are tax deductible. At the end of the term,
you can buy the item at its fair market value, which you can
also write off. But most likely, you'll want new equipment.
With a capital lease, you essentially buy office equipment
without paying up front. That way you can write off the
original cost of the item in the first year of your lease.
When the lease is up, you can buy the item, often for just $1.
The lease payments are usually higher than those for an
operating lease, and you can deduct the interest on the
payments. Generally, "this is a more valuable upfront tax
benefit than the operating lease," says Giles Almond, a CPA
and financial planner in Charlotte, N.C. "It's like bonus
depreciation." Of course, this type of lease makes sense only
if you plan to use the equipment for the long term.
Perhaps the biggest break you'll get, though, will come
straight from Uncle Sam: The new tax bill that's being debated
contains a provision that would increase the limit for
small-business expensing to $100,000 from $25,000 a year.
Get
Paid
One trap that the independent contractors we
spoke with brought up again and again is underpricing. "I have
a famous motto," says Terry Douglass, a 65-year-old software
consultant in Costa Mesa, Calif. "When determining your rates,
figure out how much you think it's going to cost, then double
it and add 50 percent, and you might end up pretty close."
Douglass got burned once when he bid $3,000 for a project that
took three times as long to complete as he had thought, and
ended up costing him $8,000.
Why the big price difference? As a business, you have all
kinds of expenses that you wouldn't have to cover if you were
working for someone else. For instance, there's insurance —
health, disability, professional liability. And then there are
unexpected costs, such as those for research. Donald Regener,
a computer consultant in Anaheim, Calif., was surprised a few
years back that he had to pay $2,000 annually to access
Microsoft's developer network, which offers resources for
programmers who use the company's software.
And that's not all. Independent consultants spend at least
half their time on nonbillable activities, such as
bookkeeping, networking and preparing tax returns. And don't
forget that two-week vacation and sick leave. The worksheet on
this page will give you an idea of the hourly rate you should
charge. Call your competitors and compare your rates with
theirs as well.
Speaking of competitors, a word on undercutting them: Don't
go too far. Score's Pryor advises that you charge no less than
20 to 30 percent below what the major firms in your field
charge. Otherwise, clients may view your services as inferior.
Higher fees help you "earn respect," Pryor says.
Once you have your rate, if you're relying on one client
for a large chunk of your income, you should run a credit
check. You want to know if a company can pay you and if it has
ever been late with payments before. For $57 you can purchase
a Dun & Bradstreet credit-scoring report, which includes a
company's credit risk level, net worth and frequency of
delinquent payments. If the company isn't tracked by D&B,
request a credit report from Experian, which costs $20.
Be a Preferred
Member
You've got the office set up and the
stationery printed. You just need clients. Wouldn't it be
great if instead of you pursuing them, they came to you?
That's what happens when you're a preferred vendor with a
company. Corporations look to these "preapproved" contractors
first when they need services. To make it onto a company's
vendor list, you'll have to go through a rigorous application
process that includes a lengthy questionnaire and a reference
check. But the hassle is worth it. "A lot of my clients are
Fortune 500 companies because I've made it easy for them to do
business with me," says Mobley, who is an approved
public-relations vendor at IBM and a number of other major
corporations. "They can just do an electronic purchase order,
and things start happening magically."
The U.S. Small Business Administration offers similar
opportunities. In March the SBA cofounded the Business
Matchmaking program, which lets entrepreneurs set up live
meetings with corporations and government agencies online.
"This year the federal government will buy about $230 billion
worth of goods and services," says SBA administrator Hector
Barreto, "and 23 percent of that is supposed to go to small
businesses." Go to http://www.businessmatchmaking.com/ to sign
up.
Sell
Yourself
Since you don't have a product, the regular
channels of advertising, such as commercials, may not be your
most effective marketing tools. It's hard to explain how
you'll revamp a company's public- relations strategy without a
conversation.
Many entrepreneurs we spoke with who have tried direct
marketing or ads have had mixed results. And these methods can
be pricey. If you want to give direct marketing a shot,
though, check out the U.S. Postal Service's new NetPost
service. For 50 cents apiece, you can create mailings online
and have them sent out all in one go.
You could also try attracting clients in the cyber world.
For instance, you can get prime billing for your Web site on
Google's search results pages by paying $5 up front and a fee
for each click you get. Yahoo offers "Sponsor Listings," which
come up first on a search, for $50 to $300 and up.
But your best bet is a word-of-mouth campaign. You know to
join trade and community organizations. Try to volunteer for
leadership positions. Matthews, the management consultant,
offers workshops to such groups as the Georgia Center for
Nonprofits and the Society for Human Resource Management, from
which she often generates leads for her business. "Multiple
company executives are usually present," she says, "and they
can see my work firsthand."
Pasadena, Calif., market researcher Karl Kasca, founder of
Kasca & Associates, moderates Yahoo groups for people in
his field. As a former auditor, the 49-year-old also
coordinates speakers for the Los Angeles Association of
Certified Fraud Examiners. Members have referred him to others
who need research services. "It's a way of getting your name
out there," he says.
Another effective networking tactic is public speaking.
Many organizations, such as the local chamber of commerce or
Rotary club, are always looking for community professionals to
speak at various functions. You'll have a captive audience,
and you'll instantly be regarded as an expert in your field.
No matter what your strategy, there is one rule of thumb: Be
ready to sell your services anytime, anywhere. Kasca can
attest to the payoff. He got his most recent lead at a
Starbucks in the Los Angeles International Airport. It was
5:30 a.m., and he struck up a conversation with the woman in
front of him, a lawyer who was flying out of L.A. He then
eased into a quick pitch for his research services. The
result? He got a lead on an associate whom the lawyer thought
could use his expertise. Now that's what we call networking.
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