Five things to consider when becoming an IT contractor

Leaving a steady job to become an IT consultant - or an IT contractor - can be nerve-wracking. As with anything, though, there’s plenty you can do before you become an it contractor that can help make the transition a little easier.

Should you be a contractor or a consultant? What about a limited company or a sole trader? What kind of safety nets should you put in place before you leave your job? And what about finding your first client?

This article will cover all these topics and more, and give you a thorough rundown

of everything you need to know about becoming an IT contractor (or consultant!). So if you’re ready to go it alone, but aren’t sure exactly where to begin, here are five things you need to consider before you become a freelance IT consultant.

1. A financial safety net

Let’s face it - the main thing that holds people back from going self-employed is the initial financial uncertainty. You could be surrounded by self-employed people who all seem to have more customers than they can handle, but when the time comes to make that leap yourself, you start to get cold feet.

The best advice you’ll ever get before going self-employed is to build up a decent financial safety net - we’re talking a nest egg that can cover up to three or four months of your most pressing expenses, like rent, food, and utility bills.

This should be a long enough timeframe to not only get your new IT contracting venture up and running, but also to cover yourself if things don’t go to plan. Becoming a contractor is a risk worth taking, but you need to prepare for the worst-case scenario.

2. Consultant or contractor?

You might’ve noticed we’ve not settled on either term so far during this article; that’s because the difference between an IT consultant and an IT contractor runs a little deeper than simple semantics. Each carries their own weight and meaning, and imply different responsibilities and skills.

For instance, a contractor issues their clients with invoices exclusively based on their time spent providing services – whether this is calculated hourly, daily or project-based. By contrast, a consultant invoices their clients based on the quality of the solution and the consumer demand for it – not solely the time spent providing their services.

A consultant will be more readily sought by a company looking for a quick and immediate fix, whereas a contractor will be a longer-term investment. A consultant will often come in as an advisor of sorts, make a judgement on what work needs to be performed, and then go about delivering that solution. A contractor is more likely to get their hands dirty, to be instructed by their client on exactly what they want, and then be tasked with delivering it. They may well take up an advisory role, too, but their main duty will be delivering the work.

The title you choose can have an impact on the kind of fees you can negotiate and/or command, too. If you need some more guidance on this topic, you can check out our “Do you call yourself a consultant or a contractor (and why does it matter)?” article.

What is a consultant?

A consultant is typically a self-employed, experienced professional who brings to the table bags of knowledge, skills, and training in their area of expertise.

They’re drafted when a client has a pressing issue that they neither have the time nor the capacity to resolve. Exercising their independence and professional judgement, a consultant then does whatever they see fit to deliver a solution that meets the client’s needs.

A consultant often works in an advisory capacity. In return for an agreed fee, they carry out an assessment of an entire business or a particular business area and make suggestions about how to make improvements.

So, more often than not, a consultant won’t actually get involved in the daily grind of managing change. Instead, they advise their client on how best to implement their recommendations.

Excelling as a consultant

Spend some time learning about evolving concepts and theoretical approaches to problems without getting weighed down by the ins and outs of the practical execution.

Your grand plan should be to find out why certain things work and others don’t. For example, as an IT consultant working on transforming a clients CRM or IT infrastructure, you may need to swot up on a number of different tools and how they integrate with a clients existing technology, as well as how much they cost and how easy they are to scale. Understanding your clients needs at a deep level will mean you can offer truly valuable insights.

What is a contractor?

Much like a consultant, a contractor tends to be a skilled, self-employed professional.

Clients pay for their services on a contract basis usually for a fixed period of time. A contractor may work onsite at the client’s premises and under direct supervision. If they’re told what to do, how to do it and when it needs to be done, they need to consider the impact of IR35 rules as they could be deemed an employee - it’s a real minefield and each contract, and associated working practices, needs to be looked at in isolation to see whether the assignment falls inside or outside IR35 rules. If your contract is inside IR35 then you’ll need to pay tax and National Insurance as if you were an employee.

Although a contractor can (and often does) advise their client, their main focus is on getting the work done.

The most valuable consultants have insights and skills across their area of expertise and stay abreast of industry developments.

Excelling as a contractor

As a contractor, your task is usually more straightforward. All you need is the ability to do the job you’re contracted to do. Occasionally, you may get a chance to crossover from contracting to consulting. Opportunity knocks when a client brings you on board as a contractor but has precious little idea of exactly what it is they need you to do.

This is your chance to shine by volunteering advice that would ordinarily fall within the remit of a consultant. Whilst you may not get paid for the advisory aspect, it could give you a wealth of experience and put you in good stead for nailing a consulting role in the future (if that’s what you’re after).

Irrespective of whether you call yourself a consultant or a contractor, a client will ultimately hire you on merit. But if you position yourself as a consultant by providing tailored solutions for your client’s pain points, you can ease your way to a much higher fee.

Why is the choice so important?

The importance of the consultant/contractor distinction lies in the power of perception and how that can affect the kind of fee you can charge your client. While a consultant typically advises their client’s business at an executive level, a contractor may be viewed as somewhat subordinate – or even part of the workforce. Consequently, a consultant can generally attract higher fees than a contractor. Rather than just offering their time to their client, a consultant markets solutions to their client’s problems and this is reflected in their fees.

3. Sole trader or limited company?

Settling on the business structure that’s best for you isn’t as tricky as it may seem. It’s a case of weighing up the kind of business you expect to be running, and then matching the business structure to it.

There are differences to each structure, particularly when it comes to tax issues, but it’s really a case of figuring out what kind of business you want to run, then matching the business structure to it.

A limited company is a separate legal entity to you - that means that, even if you’re a one-person business, you and your business are separate from one another. You’ll be the director of your company, and you’ll be in charge of making all of the important business decisions on behalf of the company. 

Your company, however, has its own assets and liabilities that are completely separate from your own - it pays your wages and/or dividends, and should it all go belly-up, your creditors will recover any monies due from your limited company, rather than from your own pocket.

Many larger companies and recruitment agencies prefer to only work with IT consultants who operate as a limited company, and if you’re likely to be making more than about £35,000 in profit, you’ll probably pay less in tax and National Insurance.

As a sole trader, you and your business are one and the same. You can keep all of your business’ profits after you’ve paid tax on them, but you’re also responsible for any losses your business makes.

What is a sole trader?

As the term suggests, when operating as a sole trader, you’re running your business as an individual. Being a sole trader merely means that there’s no legal distinction between the owner and the business. As a sole trader, you’ll be personally responsible for:

• any losses your business makes
• any of your business’ bills
• keeping accurate records of your business’ sales and spending.

Many freelancers begin as sole traders, due to the relative ease of setting-up and the comparatively small administrative burden involved and lower costs. There’s a simple three-step process to starting out as a sole trader:

1. Let HMRC know you’re self-employed
2. Register for Self Assessment as a sole trader
3. Pick a business name.

As a sole trader, you’ll have to keep accurate records of sales and expenses, but operating in this manner is much simpler thanks to the fact that you’re only submitting a Self Assessment (and perhaps a VAT return). You won’t need to worry about the impact of IR35 rules on your work, as the HMRC rules surrounding it only apply to those operating as a limited company.

So, as a sole trader, you’ll spend less time doing paperwork and hopefully more time earning money, but you may be limited in the kind of contracts you can take on - many companies and agencies only want to work with limited companies. You may also find you pay more tax than you need to, as working through a limited company can often be more tax-efficient.

What is a limited company?

A limited company, broadly speaking, is a legal structure for a business in which the liability of each shareholder is limited to their individual investment – this is known as limited liability. There is no upper or lower size limit on limited companies, and so many freelancers and contractors choose to do business through a limited company for a variety of reasons, including:

• Limited liability – your personal assets can’t be touched if your company goes bust
• Tax efficiency – company taxation rules mean you may be able to keep more of your income through a limited company setup
• Easier to agree assignments with clients – incorporating makes all your dealings straight business-to-business transactions, meaning your clients don’t have to worry about your personal tax affairs
• Easier to find work - you’ll be able to take contract roles from agencies - many agencies won’t place contracts with sole traders
• Easier to grow – if your business expands it’s easy to issue shares and take on employees.

Setting up a limited company is a little more complex than setting up as a sole trader, but we can set up the company for you and help you with the incorporation process, as well as with your limited company accountancy.

Through operating as a limited company, you’ll pay Corporation Tax on your company profits, and can pay yourself through a combination of dividends and salary, usually set at the primary threshold for National Insurance Contributions (NICs). This will minimise your PAYE (tax you pay on your salary throughout the year) and NIC outgoings. Any further payments you make to yourself will usually be taken as dividends. The dividends will be taxed but usually at a lower rate than your personal tax rates. There are a number of responsibilities you’ll have to take care of as a limited company director, the administrative overhead is definitely higher. But that’s where a good accountant, such as Crunch comes in. With our easy-to-use online accounting software and unlimited support and advice from a team of client managers and expert accountants we make managing your limited company accounts a breeze, we take care of all your filings to HMRC and Companies House for you. 

You can also claim a wide range of business expenses through your limited company, which includes business-specific items such as stationery and business cards, mileage allowance, business trips, employee mobile phones and meals bought while working away. It’s important you speak to an accountant about which expenses are allowable, as HMRC have strict rules about what can be claimed.

When a limited company director in the UK sets up a limited company or files a Confirmation Statement at Companies House, they’re required to provide a ‘service address’. This is in order to receive correspondence from Companies House and HMRC, among other important official bodies.

As anyone is able to see your company’s service address on the public record, many people prefer to provide an alternative to their home address. When a company is incorporated Companies House does require directors to provide their “usual residential address” as well, but this is not shown on the public record and is only made available to credit reference agencies and specified public authorities.

At Crunch, we can act as your registered address for official correspondence and, if you’d rather not have your home address publically available we can provide your director service address as well. You can learn all about service addresses in our “What is a director service address and why do I need one?” article.

You decide

Whether you choose to be a sole trader or a limited company, you’ll have to inform HMRC (and Companies House if you’re setting up a limited company) so you can file your annual Self Assessment and, if necessary, register for company taxes and register for VAT.

If you need more support with deciding which business structure is best for you, check out our “Sole trader vs limited company, or umbrella: what’s best for you?” article for more information.

4. Settling on your rates

If you’re new to the IT consultancy or IT contracting business, you might not know what the going rate is for someone in your sector. Of course, you don’t want to undercut yourself with your rates, nor do you want to price yourself out of clients early doors. What to do?

Part of this will come down to whether you choose to be a consultant or a contractor, but there are still a number of ways to decide what kind of rate you want to charge your clients.

One way to start is by deciding how much you want to earn a year, and working backwards from there. Let’s say you’ve got a year of experience under your belt and would like to take home a salary of £50,000. You’ll be looking to work for 225 days of the year, discounting weekends and 28 days holiday per annum. Your simple day rate is £222.22 (£50,000/225 working days).

You can continue to break down the numbers to identify an hourly rate, if you’d prefer, or you could base your charge on how much you want to bring in per month, and then work towards that target. The important thing to remember, especially at the beginning, is to be prepared to negotiate. Once you’re established and your reputation speaks for itself, you’ll be able to settle on a stricter rate if you’d prefer.

5. Finding your first client

Your first client is often the hardest client you’ll ever have to find. As your business starts to gain a reputation and the testimonies and reviews begin to pile up, you’ll find work a lot easier to come by.

You can break down the key steps you need to take to find and secure new clients and contractor gigs into three easy steps:

• Initial preparation – things to do or consider upfront before you start applying for gigs
• Daily activity – things to do each day as you hunt for another contract
• Role-specific activity – things to do for specific gigs you’ve applied for.

You can read our entire breakdown in our “Find your perfect gig: The ultimate contractor job hunt checklist” article. You don’t need to do everything on the list – use this as a starting point and do the things that are relevant to you and your circumstances. You can also check out our guide to landing your dream contractor gig with the ultimate contractor CV article for all the details and a complete breakdown of what goes into the perfect CV.

The six degrees of separation theory suggests you’re only ever six or fewer steps away (by introduction of course) from any other person in the world, so when the time comes to find your first client, ask around. Tell your friends you’re looking for work, and browse LinkedIn. Build up your contacts and use them to your advantage.

Another great way to get the word out about your new business venture is to attend networking events. They’re the perfect environment to pitch your business and your skills to like-minded folk who could become customers, business partners, or helpful friends able to point you in the direction of work.

Make sure you’ve got a pen, a notebook, your phone, and some business cards on you at all times, too. You never want to get caught on the hop when someone offers you their information, or when they ask for yours.

Improving your CV

Updating your CV can sometimes feel like a painful chore, but with more and more people creating colourful, eccentric, eye-popping CVs, you need to make sure yours stands out from the crowd.

The good news is that the quest to update your CV is actually a lot simpler than you may think, and even small tweaks can improve your odds.

Recruitment agencies

Recruitment agencies are another route you can explore in your hunt for work. The benefits of recruitment agencies are clear: they have access to thousands of jobs and often, contacts with thousands more employers and companies. The chances of finding work will naturally improve when the pool of possible employment opportunities is as large as that.

However, recruiters won’t help you for free, and could charge anywhere between 10% to 25% in commission fees. They may also continue to take a commission fee if you go on to do more work for the company they put you in contact with, arguing that the opportunity wouldn’t have been available to you had they not first put you in touch.

One of our Crunch IT contractor clients, Tadas Tamosauskas, offers the following advice on dealing with recruiters:

“Recruiters will email you with vague information about positions for unidentifiable clients. Sometimes they will ask you to sign an agreement that you will not try to circumvent them and reach out to the client directly. Don't sign anything. Ask what companies are they recruiting for. If they are not willing to disclose the company names, chances are they've just [crawled LinkedIn for positions] and are not working for their ‘clients’. They are merely forwarding your CV to random companies. Try to avoid this kind of recruitment agents if possible. Employers do not like dealing with this type of recruiter either.”

Bonus tip: Get an accountant

Now, you might be thinking, “Of course they’d say that - they’re accountants”, but hear us out. 

Going it alone doesn’t mean you should be on your own, and that’s why having an accountant on your side who’s walked this path with dozens of clients before is invaluable. 

They’ll remind you of important tax dates and when certain payments are due, show you ways of keeping your accounts in excellent shape, advise you on allowable expenses and how to report them so you’re as tax efficient as possible.

They can help you with things like estimating how much tax and NI you’ll need to pay every six months or quarterly for VAT. They’ll also help to ensure you’re not forgetting a payment on account, which catches many people out every year. A good accountant is there to ease your worries, not to add to them, after all.

Find out more about how Crunch’s online accountancy platform supports start-ups, whether you’re a sole trader and limited company, and discover how we can help your new business venture succeed.