Deciding whether or not to become a contractor is a difficult decision. Many spend months teetering on the edge, not fulfilled with their current work life, but also not confident enough to quit their full time job. Others may have already made the leap, but started off badly, whilst some may have been forced into contracting through redundancy or firing.
Whichever stage you’re at, the world of contracting is full of uncertainties, and requires hard work, intelligence, perseverance, and the occasional stroke of good luck. But once you’ve mastered it, contracting can be the best way to work in the world, giving you the freedom and flexibility to do what you love, whilst living life to the full.
This guide will help you to look at the situation objectively, giving practical tips and advice on how to succeed as a new contractor.
What is a contractor?
Broadly speaking, a contractor is “a person or firm that undertakes a contract to provide materials or labour to perform a service or do a job”. It’s kind of like being halfway between an employee and a freelancer. You aren’t tied down by all the trappings of an employment contract, but the jobs are usually longer and more secure than with freelancing.
Like freelancers, contractors are self-employed people with no entitlement to the usual perks of employment, such as sick or holiday pay. They aren’t permanent members of staff. They can be contracted as themselves, through their own company, or through an agency.
Contractors may spend a period of weeks or months working closely with clients, effectively becoming part of their team (but not quite, as we’ll see later on). So it’s important that contractors are good at working with new people and adapting quickly to new colleagues and working environments.
Is contracting right for me?
Contracting is increasingly popular because it gives you more control over when and how you work, but also provides a good amount of security. If you’re the kind of person who doesn’t want to be stuck in one place, and who wants more control over their own destiny, location and work/life balance - contracting could be a good choice for you.
However, it’s worth considering what’s actually driving you in the direction of contracting. Some motivations are less positive than others, and could suggest that contracting isn’t the best option for you, after all.
Here are some examples of good motivations:
• You want to improve your prospects
• You want to pursue your own good ideas
• You want to do the kind of work you love
And here are some bad motivations:
• You hate your boss
• You’re keen to work less
• Contracting sounds cool
• Your mates are doing it
Of course, you probably have a mixture of reasons for wanting to become a contractor. For example, you might not be so keen on your boss, but you might also be interested in exploring new fields.
Just make sure that you’re making a balanced decision and that you have good, solid reasons for making such a radical change to the way you work. This is important, because without a foundation of solid motivations, you may struggle if/when things get tricky.
Contracting might seem like a fast route to easy cash - you may have heard some of your contractor friends talking about daily rates like £200, £300, or maybe more.
Although these rates are out there for the taking, the reality of contracting is that in the first month you might only manage to find 6 days’ work. You’ll also need to put about 25% of your money into savings to pay for tax, accountants, etc.
Taking this into account, even if you do manage to get a £200 day rate from the off, your finances are more likely to look something like this:
6 days work x £200 day rate = £1200
25% of £1200 is £300
Amount of available pay = £900
To put this in perspective, the equivalent annual wage from a full time job would be around £13,000 a year - hardly the cash cow you maybe expected.
What time of month you get a job will also affect your circumstances. If you invoice near the end of a month, you might not see that money for another two or three weeks, depending on your payment terms.
Save as much money as you feel comfortable with, but try at least to have enough to cover a month’s basic costs. Consider things like:
• Bills and debts
Your business model
What’s your business model going to be? Will you be you, or will you be a brand? Will you be Tom P Quigley or Tompq Ltd? Before you make a decision, consider how a particular identity will affect:
• Website domains – is the domain available?
• Limited company name – check your name is unique
• Branding – how will it look on business cards, etc.?
• Recall – will anyone remember you?
• Longevity – is it a name that can adapt with you?
You have a few options, with pros and cons to each:
A limited company is an organisation that you can set up to run your business – it’s responsible for any legal and financial decisions and its finances are separate from your own.
If you’re a sole trader, you’re running your business as an individual – you’re self-employed.
Umbrella companies act as intermediaries between contractors and their end client. The umbrella company deals with a lot of the administrative side of things, particularly in relation to tax and payroll. When you get paid, the umbrella company will collect your cash, deduct National Insurance Contributions (NIC) and income tax, as well as their fee, and then pass the rest onto you.
Advantages of going Limited
This protects your personal assets so that, if your company becomes bankrupt, your personal bank account, house, car etc. can’t be claimed.
Potential for greater profitability
As a Sole Trader, you’ll be taxed on your income, which means you end up paying 30% tax on your gross income. Through operating as a Limited Company you will pay Corporation Tax and can pay yourself through a combination of dividends and low wage. This’ll minimise the amount of income tax and NICs you pay.
You can also claim business expenses through your Limited Company, which includes business-specific equipment, such as stationery, business cards etc, mileage allowance, business trips, meals spent while working away. Any money you claim in expenses will be deducted from your company’s profit and will therefore not be taxed, saving your company money at the end of the tax year.
As a Sole Trader you rely on your personal credit rating to borrow capital used to grow your business – a limited company, however, can establish its own credit rating, which they can then borrow against. This is good news for those who don’t have the squeakiest credit ratings.
Advantages of staying Sole Trader
Less paperwork both sole traders and directors of limited companies are required to submit a personal Self Assessment to HMRC, but those operating a limited company must also submit extra paperwork, which sole traders don’t.
The accounting process is much simpler for sole traders – there’s less paperwork, fewer expenses, and often fewer clients – as such, if you do have an accountant at this stage, it’s often much cheaper than it is for limited companies.
Legally, limited companies must be transparent and share certain information with the public, such as names of directors and shareholders. As a sole trader you don’t have to provide this information to Companies House.
Advantages of an Umbrella Company
As a contractor working under an umbrella company, you’ll be afforded a much simpler way of doing business. The paperwork is done for you, which includes deduction of income tax and NIC. Sole traders sometimes get caught out with massive tax bills because they have not put their tax aside throughout the year – working via an umbrella company removes this potential. Lack of commitment working via an umbrella company is said to be a good option if you’re not sure about committing to contracting long-term. It’s free from the stress of running your own company, which does also mean you have less control over your business.
What is IR35?
IR35 is a piece of legislation designed to stop people using contracting as a way to avoid tax. It came into force in April 2000 and affects all contracts that the self-employed work under that don’t meet the HMRC’s definition of self-employment - to help out, we've created our own free guide on understanding IR35, so be sure to check it out.
If your contract isn’t compliant with IR35, HMRC can treat you as an employee for tax purposes, and tax you the full amount, including National Insurance Contributions. So, it’s obviously crucial that you understand the rules.
For the brave amongst you, HMRC’s full IR35 guidance can be seen here along with an FAQ which you can see here. Otherwise, here’s a short summary of what to look out for.
Three criteria must be fulfilled for IR35 to apply, so be wary if:
• The contractor must personally perform the relevant work for the Client
• An intermediary company must be used (e.g. your limited company) rather than the contractor contracting directly with the client
• The terms of the arrangement must be such that the contractor would have been treated as an employee of the client for NIC purposes, were they to have been contracted directly.
A few key factors can influence HMRC’s decision. Their guidelines say they’ll take into account the following:
• Are you ‘part and parcel’ of your client’s organisation?
• Is your contract project-based?
• Can you provide a substitute contractor to do the work?
• Is your contract period fixed?
• Is your contract a service contract rather than a contract for services?
• What is your pay structure (do you get holiday pay)?
• Can you choose the hours you work?
• Do you receive any of the same benefits as employees?
• Do you have more than one client?
• Do you use your own materials?
Be warned that it’s your duty, as a director of your limited company, to make sure that your contracts are IR35 compliant. If you come under investigation and are found out, the consequence can be severe, especially if it can be proved that you knowingly ignored the legislation.
Setting your rates
How much are you going to charge? What is the going rate for someone like you? To find out you could try checking your competitor’s websites, asking an agency, looking at industry sites or calling a contractor and asking them (pretending to be an interested client).
Get an idea of what people are charging, and charge something comparable. If you’re starting out, and don’t have years of experience, it might be appropriate for you to charge at the lower end of the pay spectrum. Increase your rates as your experience, skills, and knowledge grows.
Don’t be tempted to undercut the market. You may think that because you’re new you should aim lower than everyone else, but don’t. If you get a reputation for being cheap you’ll find it hard to raise your standards and your prices.
Your rates can be flexible. Sometimes it’s worth working for a lower rate if the work is interesting, charitable, or good for your portfolio. On the other hand, some projects are unpopular and unappealing – so charge more for the inconvenience.
It often pays to ask a client what their budget is before you discuss rates. Once you know what they can spend, you can decide whether their budget is enough for you.
When to increase your rates
It’s difficult to know when you should inflate your rates, but tell-tale signs can include the following:
• You’re constantly busy
• Your enhanced skills mean that clients get more bang for their buck
• You’re offering clients a better service by investing in better systems
• Your clients are always happy with your work.
How to increase your rates
Tell your clients why you’re doing it. Explain your rationale. Don’t go into endless detail, but remind them of the benefits that you bring and explain why/how they’re getting a better deal.
Understand where your pricing puts you in the market. Remember that new clients may ask you and several other contractors for quotes. If your rates are higher than your peers’, make sure you’re offering more than them. Be better qualified, better equipped, more professional, friendlier or just plain better to beat your competitors.
Successful contractors are constantly looking for more work – something not everyone has the patience for. Many people don’t even know where to begin to look. It’s wise to try everything in the hunt for jobs, using a broad mix of techniques – never rely on one source of work, because you’ll be exposed to the risk of that source drying up.
Go where the work is
The sensible contractor focuses not on the skills he wants to sell but on the skills that people want to buy.
If you’re fighting over scraps of work with a thousand other contractors, why not leave them to it? Competing in an over-subscribed market is never going to be profitable. So go elsewhere. Specialise in something unusual, something that people need and will pay for.
Look for a niche that is unpopular, unexploited or emerging.
Speak to a recruitment consultant or two. Get on the books of any agency that’s relevant. A few suggestions:
As long as you don’t mind potentially being mistaken for a double-glazing salesman, cold calling can be the perfect way to start a relationship with new clients. Sending emails can sometimes work, but most company directors get so many that your pitch will probably be ignored entirely.
Calling people takes more time, requires more effort, and it shows more determination. Many employers prefer a polite, friendly, concise, and purposeful phone call to a bland, standard email that you’ve clearly sent to everyone else.
Search for networking events in your area. Try a few. If you feel uncomfortable talking to strangers, or trying to sell yourself, remember that it gets much easier with practice. Before long you’ll be an unstoppable machine.
Think of it as an opportunity to create, develop, and utilise a group of friends, colleagues, and contacts - and remember, all kinds of social engagements are potential networking opportunities, not just the ones explicitly called ‘networking’ events.
That’s why you should always carry a business card and, however annoying it might sound, always mention what you do. But don’t just say “I’m a programmer” or “I’m a graphic designer” – give examples of what you do. Help people to make sense of what your skills are. If someone doesn’t understand your brilliance, how can they ever recommend you?
There are also a host of social media websites which allow you to create profiles and to connect to clients, contacts, and the people you’d like to work with. Use them, but remember to maintain a professional image at all times. Always remain positive, professional, polite, and friendly.
The main networks used professionally are LinkedIn, Twitter, and Google+.
Get a website
Having a website allows you to:
• Be discovered by anyone
• Display your portfolio
• Show off your design and copy skills
• Include testimonials to increase your reputability
Websites can be created cheaply and quickly with blogging tools like WordPress. If you can’t afford to pay for a website, try making your own - there are plenty of free, online tutorials on DIY website building.
If the thought of making a website is too scary, you could always just buy a custom domain and have it point to your LinkedIn profile.
Being found on the web – search engine optimisation (SEO)
If you don’t know anything about SEO, it’s worth doing a bit of research. Your website can be a useful way to find new clients, but it won’t help you if nobody finds it. Search engine optimisation ensures that search engines interpret your website in the way you want – which in turn ensures that searchers can find you.
Download our SEO for Beginners Guide for free.
Your ‘elevator pitch’ is a summary of what you do. It should be short enough to be delivered during an elevator ride, and concise enough so that it completely sells you and your skills.
Before you start networking, work out how you will explain what you do. You may want to have two versions of your elevator pitch. One version for potential employers (which assumes some prior knowledge) and one that’s better for random people who might not know anything about your industry.
A good elevator pitch doesn’t just say what you do, it says why you’re useful to your clients. Mention all the benefits your clients get from working with you. If you can drop in any big names you’ve worked for, or a particularly successful contract, then all the better.
A bad elevator pitch:
“I’m a graphic designer.”
A good elevator pitch:
“I’m a graphic designer – so I help businesses find the best way to appear to their clients, and take care of things like logos, adverts, packaging, posters, signs and basically anything that needs to look great.”
Financial & legal decisions
Value Added Tax (VAT)
Once you start invoicing over the VAT registration threshold, you’ll need to register for VAT. This means that you become a VAT collector for the government, collecting tax every time you invoice a client. You’re allowed to offset the VAT on your purchases, paying the difference to the government each quarter.
Some contractors choose to register for the VAT flat-rate scheme, which allows you to offset the VAT on your purchases, but means you have to charge your clients VAT. Ask your accountant if the flat-rate VAT scheme is right for you.
Bookkeeping, accounts and organisation
Contractors aren’t just dynamic and creative. Under every good contractor is a solid organisational foundation. You should always maintain an ordered enterprise.
Why maintain records?
Bookkeeping doesn’t just exist for the sole purpose of creating more paperwork. Without accurate bookkeeping, you wouldn’t know how much revenue you’d made, nor how much. Without knowing your sales figures, profit, and how your profit compares to sales, you can never know what can be improved.
Finding work is just the first step in your ongoing battle to maintain financial security. But let’s assume that you can find work and carry out the work with success. Now, you might think it’s time to get paid. Well, it is, if you’re lucky. Before you get paid you’re going to have to invoice.
Tell your clients when you will be invoicing them. And when that time comes, make sure you send it. Never delay sending invoices, because it will delay when you get paid. If you raise invoices on project completion, make sure invoicing is on your task list. Always invoice as soon as you can - these handy free invoice templates will help.
It’s easy to forget that someone hasn’t paid you if you don’t have a system for recording your invoices. You’ll need every penny, so make sure nothing can ever go unpaid. Accounting software is generally quite affordable, but even keeping a simple spreadsheet will make sure you don’t miss a thing.
You can decide on whatever payment terms you like. Whether or not your clients accept them is another matter. Some companies insist on payment after 30 days, regardless of what you want. So you may have to be flexible, or change your terms depending on the client. Contractors often demand shorter payment windows because they have to protect their cash flow.
Discuss your payment terms with clients before you work with them. Tell them when you will expect to be paid, and ask them to confirm that your terms are acceptable. It may feel awkward to discuss payment terms, but your clients will respect you for having the foresight to ask before it becomes a problem.
If you suspect a client might be troublesome, ask for payment in advance. Or ask for a 50% deposit. How you work is entirely up to you.
This is one of the biggest things that you’ll need to monitor as a contractor. You may be busy working, you may be invoicing vast sums for awesome work with fantastic clients, but if cash isn’t flowing into your bank account you could soon end up penniless and desperate.
The best way to avoid disputes with clients is to have a written contract which details every aspect of your working relationship. With a contract there is less room for ambiguity and any disputes that arise will be easier to settle.
If invoices go unpaid, don’t be shy about chasing your clients for payment. A polite inquiry will often be enough to jog someone’s memory. We’ve got a whole guide on how to chase your clients for outstanding invoices. Download it here.
Here are a few ideas to help you keep happy, profitable relationships with your clients.
Be certain that you and your clients are on the same page. Make sure that you’ve discussed the job at length and that both of you understand what you’re being contracted to do, how you’re going to deliver it, and when.
If you don’t do this, you could end up putting a lot of work into something the client doesn’t want, leaving you out of time and out of pocket.
You may end up taking on clients that haven’t hired contractors before and aren’t exactly familiar with how the arrangement works. This can easily lead to misunderstandings and unscrupulous demands. To counter this, it’s worth explaining your process and how you work. Make sure you don’t talk down to anyone though, rather find out how much they know and fill in the gaps.
Know when to say “no”
We’ve all heard the popular saying “the customer is always right”. The reality of contractor work is that the customer is often wrong, and it’s your job to make them realise this in a delicate and professional manner.
You might feel as if you don’t want to annoy your client by saying no, but it can often actually have a positive effect. As long as you can give a good reason why, and prove that you’re right, saying no can actually gain your clients’ respect, and save you a great deal of hassle too.
• That your client is going to do something
• That your client does or does not want something
• That your client is happy with your payment terms
• That your client understands how you will deliver work
• That you both have the same understanding of the brief
Call Clients on the Telephone
If you don’t work in your client’s office, they’ll appreciate a phone call every now and then. It’s also the best way to diffuse disputes. If you find yourself bickering over details by email, pick up the phone. Be friendly – it will disarm your client. Then talk over the issue in a calm, considerate way.
Use Email for Important Chats
When agreeing rates, deadlines, deliverables, payment terms and every other important detail of your client work, do it by email. Having these conversations by phone is fine, but make sure you follow up the call with an email that documents every important detail.
It’s not unusual for clients to expect a great deal from a contractor. Clients may forget that you work with a number of different, equally important people. They may also forget that you have a life outside of work, or other interests beyond completing their project. So, be polite and firm, but make it clear to clients that your work must remain within certain boundaries, and that you will only step outside that perimeter if cash or benefits are agreed.
The choice is yours
We’ve covered a lot of ground, and considered many of the aspects that will affect your life if you start contracting, but has it been enough to help you make a decision?
You should only start contracting after careful consideration. It’s not an easy way to make a living, and there are no guarantees that you’ll make money. If you decide to become a contractor, plan an escape route – an alternative way to make money – just in case it doesn’t work out.
Contracting is a hugely rewarding way to work, but it only rewards those who work hard, and to be a successful contractor you will need to work hard at many things beyond the thing people pay you for. You must be prepared to become the marketing, sales, accounts, management and admin departments, all rolled into one.
To get advice on contracting or running your own business or expert sole trader accounting support, get in touch with our experts to get your questions and queries answered. We've also got a comprehensive, free guide on becoming a contractor, so you can find even more helpful information online at Crunch.