Last Updated Jan 19, 2011 12:35 PM EST
Of course, most people start out in business being self-employed but soon reach a crossroads where they have to decide if they want to run a company. To turn self-employment into a business, you have to take one step backward financially to get two steps ahead. This is what I call the valley of self-employment -- a time when your profitability actually goes down when you make the transition to a business. Getting to the other side of the valley is expensive because you have to reinvest your profits into building the essentials of a business: operating space, people, a website, marketing, etc.
Are you willing to take a pay cut to traverse the valley?
The self-employed individual who works from home and relies on a small group of loyal customers and friends can make a lot more money than someone in the valley. I know of executive coaches, for example, who charge $10,000 a day and keep most of it because their expenses are limited to a MacBook, a home Internet connection and a $99 accounting package. I know home-based advertising copywriters who charge $400 an hour, which means they need to bill only five hours a week to have a six-figure income.
But being a self-employed copywriter or business coach is different from building an advertising agency or a coaching company. There will always be a limit to your income if you're billing by the hour, no matter how much you charge. For example, as obscene as it sounds, some New York City architects charge $1,000 an hour. If they bill 1,600 hours a year (on the low side for a partner at a big firm), they generate $1.6 million for their firm and get to keep a big chunk for themselves. Not bad, but even at the top of the hourly billing charts, a New York City architect will never be Zuckerberg-rich.
If you decide to go through the valley and climb up the peak on the other side, the leverage and scale of a business can be much more profitable than peddling time.
I hit the crossroads in front of the valley soon after leaving college in 1996. I worked as an independent producer of a radio feature and lived with my fiancÃ©e (now wife) in an $800-a-month apartment. One day I landed an advertiser who guaranteed me $70,000 a year in revenue. Suddenly I had a decision to make: I could decide to be a radio feature producer, stop thinking of myself as a fledgling entrepreneur, and live comfortably as though I had a $70,000-a-year job. Seventy thousand dollars per year felt like a lot of money and would have given us a significant bump in our lifestyle.
Or I could pour the $70,000 back into creating a real business by finding office space, hiring an employee to do the producing so I could do the selling and creating a brochure and business cards. I knew I would blow through the $70,000 a year quickly and not be able to pay myself anything in the first year.
Do you want to create a job or build a business?
It took me a couple of days, but eventually I decided I wanted to own a business, not be self-employed. Twelve years later, that business was acquired by a public company.
I was lucky that my fiancÃ©e had a job and could support us through the lean months. I'm mindful that not everyone has that kind of flexibility, but I think every self-employed individual will, at some point, reach this crossroads.
And like with most things in life, you can't get through the valley by only going half way. People who pretend they are running a business but pull all of the money out of their company to fund their lifestyle starve their business of the things it needs to become a real company. They end up creating a job, not a business.
My advice to start-ups who want to create a business: Keep your personal living expenses to a minimum and squirrel away enough to live on for a year before you start your business so you can get through the valley without stalling to pull money out to pay yourself.
Have you decided to go through the valley? What kinds of investments have you made to get past self-employment and up into the world of running a business? Or are you intentionally avoiding the valley, riding high up on the ridge by billing by the hour and keeping most of what you make?
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