The Independent Worker’s Field Guide: Rates and Finances

Posted on 8 November, 2008 at 1:05am

Going independent is a scary thing. You have to convince yourself to leave your job, be your own boss and be responsible for your own fate. There seems to be a dearth of good, specific documentation about how to take this step, so I’ve tried here to compile the best of what I’ve learned over the years. This advice is specific to design, but much of it also applies to consulting in any field.

Chapter One: Rates and Finances

Rule #1: You have to budget.

The first thing you should do (nay, must do) is to sit down with your favorite spreadsheet application and write up a budget. Figure out what your monthly expenses are, how much spending money you’d like to have, how much you want to save, and the cost of your health care (either estimated expenses or private insurance if you’re buying it). Add them all up and divide by 0.6 to account for taxes. Voila! That number is about how much you should aim to earn per month.

Remember this number. Cherish it. It’s your new best friend. Look at it when you get anxious about money – it will comfort you.

And I hope you caught that bit about taxes. You don’t have a company withholding money for you anymore, so you’ll have to be responsible in order to be ready when April comes around. Don’t worry though, I’ll explain how to prepare for that in a little bit.

Rule #2: Don’t work forty hours a week.

Now, what I mean is that you shouldn’t work forty billable hours a week, especially if you maintain multiple clients at the same time. There are a few reasons for this. First, people are simply not productive for that much time. It’s required in an office because of the inevitable inefficiency that happens in any company of reasonable size, but you are independent now and you can be a lot tighter about when you work and when you don’t. Work when you’re productive, rest when you’re not. What a novel idea!

Second, you should plan to spend about 5-10 hours a week doing off-the-clock work. This includes finding potential clients, writing estimates and contracts, and networking with your peers. This is absolutely essential to your success and if you don’t give yourself time to do these housekeeping tasks it won’t be long before you’re burned out and signing up to flip burgers at the local In-N-Out.

Rule #3: Be pragmatic about your rates.

Many people struggle with setting rates, especially as it can be difficult to figure out what others in your field are charging. A good starting point is to take your current salary, convert it to an hourly number, and multiply by 2. (Note: a commenter below points out this should be closer to 2.5 or 3. This is more in line with what your company pays for you and is necessary if you have overhead to cover. When in doubt, take the higher multiplier. It is far better to start high and adjust down than to start too low and have to scramble to make up the difference.)

Divide it into your magic number from Rule #1, and then divide by four to find out how many hours a week you’d have to work to make your target. You should be aiming for 20-25 hours a week, so adjust accordingly. If you want to work less, you have to charge more. If you want to (or have to) charge less, you have to work more. Work out an ideal balance that you’re comfortable with.

Now get out there and find some clients. The only way to find the sweet spot with rates is to do some actual work and collect data. Note the kinds of companies that you’re working for — you will probably find that smaller companies have less money in their budgets but more work to offer. Bigger companies often come with good rates but a lot of overhead. Many consultants have a sliding scale depending on the size and visibility of the company. Over time you’ll naturally develop a small range that gives you some wiggle room for negotiation.

Rule #4: Don’t be afraid to negotiate.

When quoting rates, always start high and negotiate down. I’m going to teach you a trick of sorts that can be used when a client is gunshy about your rates. Read the interaction below for an example of this trick in action.

Joe the Web Designer is working at Psuedonym Software for $70,000 per year. He decides he wants to strike out on his own, so he uses my formula to calculate a starting rate comparable to his current salary. His $37/hr multiplied by 2 is about $75/hr. His target monthly income is $6500, so he divides that by 4 and then by $75 to figure out how many hours per week he needs to work. He comes in at 21; looking good so far. Now he’s in negotiations with his first client, XYZZY Industries. They have a conversation something like this:

Client: So what would you charge for this kind of work?
Joe: Well, I estimate that it would be about 25 hours. At $75 per hour that comes out to $1,875.
Client: Ooh. That’s a little high for us.
Joe: I might be willing to negotiate. What’s your budget?
Client: About $1,500.
Joe: I can do it for $1,600 with a budget of 25 hours. That’s a ten dollar discount off my normal rate. Any hours above that 25 would be billed hourly, of course.
Client: Sounds great, let’s do it!

Let’s go over what has just happened. First, Joe now has a data point about his rates. XYZZY was a little nervous about $75/hour. That doesn’t mean he should lower his rates for all clients, of course. But it does help inform his decisions about XYZZY or companies similar to it in the future.

Second, let’s discuss why Joe got a good deal even though he lowered his rates. Notice that he negotiated from an hourly rate to a flat rate – $1,600 for the whole job (up to 25 hours). In some ways this is a false discount for the company. It’s only $65/hour if he takes the full 25 hours to do the work, and if Joe is smart about how he uses his time there is a good chance it won’t actually take that long. He was also careful to quote the upper bound to the client. If you think a project will take 20-25 hours, always quote them 25. It’s good “potentially saving your ass” practice.

So let’s say he really boogies and it takes him 20 hours to finish the job. Doing the math, we find out Joe got $80/hour for that work, even higher than his original estimate. And the client is happy because they got it done on their budget. Everyone wins.

Now let’s say it really does take him 25 hours or more and ends up being $65/hour. It’s not such a good deal anymore, right? You might be surprised. Keep in mind that every client you have brings some amount of unbillable overhead in the form of communication, estimates, and contract writing. This means there is an advantage to taking fewer, longer projects. The fact that Joe now knows he will get at least $1,600 for his time is worth something.

Let’s take a detour and quantify what a longer-term contract is worth. I usually estimate about 5 hours of overhead for a new client. That includes the work I do to get that project rolling as well as the work I have to do to find them. At Joe’s rates this is about $375 worth of his time. He’s essentially saving himself this money in taking a steady project, so it is still worth it to him even if he has to lower his rates a little.

Of course, this isn’t quite as cut-and-dry as I’m making it out to be here. There are many factors that go into what you charge for a job. Here are just a few possible scenarios:

1. Web design for John’s startup. John is a friend of Joe’s and his company doesn’t have a lot of cash. Joe decides to discount to $60/hour.

2. Building a CMS template in PHP for a local school. Joe really hates PHP and quotes $120/hour, because that’s what it would take for him to actually do it.

3. Design contracting for BigCorp, Inc. Joe raises his rates a little to $85/hour, because he knows the large company can afford it and he has to deal with their annoying marketing team.

The more work you do, the more you’ll know how far you can push different kinds of clients, and how much you believe your time is worth. Use your monthly magic number (see Rule #1) as a guide, and remember that you’re free now to make your own choices about what you earn. No more begging for raises – you just have to earn them yourself.

Rule #5: If you’re not turning away clients, you’re not charging enough.

This is related to Rule #4. Negotiation is good and can improve your relationship with the client. However, if you find that you’re negotiating a lot and not often getting jobs at or above your target rate, you probably need to toughen up a bit and push harder for the higher rates. Some clients won’t be able to afford you and will go elsewhere. However, assuming your rates are fair and appropriate for your experience and work, some will stay and pay it. You never want to be in the situation that you are known for your low rates. Competing on price is the kiss of death.

Think of it as a form of supply and demand. The more you work and the more experience you have, the more your time will be worth. Your rates will go up over time to match the increased demand for your services. Think of it as a promotion, indie-style.

Rule #6: Give yourself a salary out of the “company” bankroll.

One final rule that will help keep you prepared for tax season. You probably want to set aside about 40% of everything you earn for taxes. One way to make sure that you do this diligently is to deposit your checks into a “company” bank account. (You did set up a fictitious business name, right? Of course you did!) Give yourself a “paycheck” out of this bank account once or twice a month, making sure to leave at least 40% of what you earned. If you find that you need to take out more than that to cover your expenses, you need to go back to Rule #1 and revisit your budget. Maybe you need to work more hours or ask a higher rate in order to make your target.

If you’re feeling saucy, you can use the company bank account for business-related expenses as well. Come up with a fair wage for yourself and leave everything else to reinvest into the company — purchasing advertising or office supplies, for example. Working for yourself takes discipline, especially financial discipline. Keeping your accounts separate is a good way to establish a mental boundary between what you earn and what you actually get to spend.

And as a corollary, doing your taxes as an independent is extremely complicated. You will probably want help in the form of a small business accountant. They can help you plan, deal with expenses and invoices and keep your taxes under control.

***

Well, that was a hefty chapter! But finance is a hefty topic when it comes to being your own business. The next chapter will cover writing contracts, details of invoicing and payment, and making sure your butt is covered legally. Feel free to leave any comments or questions you might have and I’ll try to answer them here. Angry tirades also accepted. Everyone is welcome!

That’s all for now. See you next time for Chapter Two: LeChuck’s Revenge.

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The Discussion

9 Comments on “The Independent Worker’s Field Guide: Rates and Finances”
  • Great article!

    A few little tidbits I’d like to note about working with the bigger clients:

    1) If they’re not complaining about your rate, you’ve left money on the table. Most small companies will complain about any rate, but the bigger ones will often suck up $75/hour for most projects and not even blink.

    2) Larger companies expect and can afford communications, project management and such overhead to be billed and considered in the realm of billable hours. Almost any large outsourcing company includes project management and such hours as a default anymore. If you really want to get quirky, you can charge a different rate for this as an indie, but be aware that you don’t have to just suck it up with the larger companies. Also consider doing all communications and project management hours as by-hour, not by-job, because they can expand amazingly fast with a large company. In those realms, you’ve often got multiple people to please and communicate with and the communications overhead can expand dramatically.

    3) Always keep a log of your time suitable for sharing/giving to your client. If you’re doing work “by the job” and estimated 25 hours, and it takes you 30 – you can either suck it up and do better estimating in the future, or you can use Anne Kate’s suggested “if over 25, I’ll bill you the additional hours” clause. In those cases many businesses (especially small ones) will want to know where you spent your time. You should be using this as a defense mechanism in case your client goes wack-job on you and tries to demand you do all their changes, new ideas, and other such crap for the same original job price. It’s not realistic, and keeping a log of hours can really make a difference in what you have to push back with.

    It’s a well known secret that most outsourcing companies nail down an estimate for an original job that’s well below what you might consider reasonable, fully expecting to make it up on the “change request” end. I might even go so far as to suggest that some don’t worry about doing crappy work (this in the programming side of work, not so much design) with the expectation that it’ll increase the need for future programming efforts, and hence more work for the company in the future. Not everyone is that way – but it’s worth being aware of.

  • The 2 multiplier may work if one has zero overhead, and doesn’t mind putting in a ton of billable hours. A fully burdened employer rate is 1.5-2.5X the hourly rate depending upon overhead and such. A multiplier of only 2, pretty much means a significant salary reduction. I know you stated for folks to run the numbers and look at the budget, but my concern is folks will end up with a 3X or a 4X number and then shift downward more towards the 2 figure. I’ve seen too many solopreneurs struggle or go under after a year or so, as they set their rates much too low. Unlike many other businesses, service doesn’t lend itself to leverage, thus one is trading time for money on a 1:1 basis. The key imho is to start out such that one nets something pretty close to ones previous employee take home, and then build efficiencies in to do better. Otherwise, starting out with a paycut, plus the additional non billable hours can end up being pretty demoralizing, to say nothing of setting oneself up to fail. Overall though, you give a lot of good advice here, just wanted to make sure folks don’t feel bad about charging enough to ensure sustainability.

  • Joe: Good points. I’ve never worked with a large company as an independent and I would imagine, as you say, that it is a bit of a different ballgame. You’re right that you should always be billing for things like project management and communications, but it seems to me when you’re dealing with the hassle of working with the corporate food chain that you end up with a lot more headaches and slowdowns that are difficult to quantify. But maybe I’m just burned out and cynical about that culture. :)

    Ron: You make a good point here, and I originally had that number as 3 before I adjusted it down to 2. This is because I personally started out at 3x, then found I routinely had to adjust down to get enough work, at least until I had enough experience and exposure to move back up. Depending on their industry, others may want to do this too – start at 3x and see how it goes from there. I definitely want to drive your point home that going independent should be a financially *lateral* move (or better). If you’re not making as much in your new job as your old (accounting for employer expenses) you aren’t charging enough.

  • I agree with your points in general, but your dialogue between Joe and the Client is not an ideal outcome for Joe. I spent several years as a contractor, and in Joe’s position I think the tack I would take would be stick with the initial rate, but emphasize quality and satisfaction.

    Rather than coming down to $65/hour, which he would then be relatively locked in to for the term of the relationship, it might make more sense to stick to the $75 figure and make it easy for the client to get comfortable with his work at a lower commitment rate.

    I like the structure of a trial run for this kind of scenario. For instance, if Joe can state with confidence that his clients will be thrilled with his work, and they need to only give him 4 hours to prove it, then they might be convinced and satisfied that spending the extra $300 was well worth it not only for this project, but for the long run.

    If Joe’s a liar, then they are only out $300 instead of $1500. If Joe’s the real deal, then they’ve got somebody who’s worth the money and knows it.

  • Daniel: Interesting idea! I have never done anything like the “trial run” you propose, but it makes perfect sense, especially for designers (who are often plagued by the fact that their portfolios represent their clients’ tastes more than their own). That could be a good strategy when you like the company and want to have a long relationship with them without backing down on your rates. Or you might offer to discount your rates for this project in order to prove yourself, but on the understanding that any future work would be at the usual rate.

    One thing I didn’t mention, but which is very important to me, is the happiness factor. It’s true that Joe’s scenario in this example is not ideal, but I find juggling clients stressful and personally value a steady client perhaps more than I should (at least, for the sake of my pocketbook). That’s why I would consider being flexible in that scenario.

    I definitely want new contractors to understand that no matter what the scenario, they have options when it comes to negotiating contracts. If one month you want to sacrifice a little cash in exchange for lower stress or to work on a fun project, go for it. Of course, the silver-tongued among us can probably get away with better. ;)

  • Flexibility is definitely key, especially if dealing with smaller clients. But speaking of happiness, sometimes paying more makes clients happier. Chalk it up to human psychology but the “you get what you pay for” cliche is burned into everybody’s brain. If Joe is *utterly* worth $75/hour, and he convinces the clients of this, then they’ll be HAPPIER paying him $75 than “settling” for a $65 person ;)

    Believe me I can relate to the difficulty of selling oneself. But I would say it becomes less and less about silver-tonguing and more and more about speaking honestly to clients about your abilities.

    In any case, when any new contractor is just getting started, it’s definitely true that it makes sense to aim for maximum happiness. It’s the only thing that will keep you going.

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