The Hidden Costs of Starting Your Own Business
Many people start a business because it's a lifelong dream, or a passion; some do it because they're desperate to make money.
Whatever your reasons for becoming your own boss, just remember the old saying that it takes money to make money, and that's never been truer than when you're starting your own business. It sounds romantic to think of yourself going from rags to riches, but most businesses need to start off with a little of the green stuff.
In other words, when you're drafting your business plan, don't forget about these hidden costs (and probably a million more that aren't listed). Knowing what expenses are coming could help you not only start your business but ensure you stay in business.
Business insurance. If you're just starting out, you may well not need business insurance. But it's something you'll want to consider early on. For instance, if you have a lot of inventory in your garage, and a fire taking it out before you sell it would financially devastate you, there's a good reason to get property insurance. If there's any risk of being sued by a customer, you probably want liability insurance.
But you'll want to consult an insurance expert because there are a lot of different types of business insurance, and not all policies will be practical or necessary for many startups.
Rob Marsh, a Salt Lake City resident who started his business, logomaker.com, in 2010, knew before he started his website, which allows people to design their own logos, that he would buy business insurance.
He wasn't concerned about that, but Marsh says, "because my business runs online, I also had to secure insurance to protect against data breaches and online security issues."
Marsh planned to spend $1,000, and he says that was pretty accurate. "The cost of worker's comp and basic business insurance was just under $900 a year. But coverage for the risks associated with a data breach were far more expensive than I thought. That was a surprise."
He ended up spending $5,000 a year for what's sometimes called cyberinsurance. "Given the expense, I wouldn't surprise me if many online business owners skip this kind of protection and simply hope nothing bad happens," he says.
Taxes. This can be an unpleasant surprise for a lot of new entrepreneurs, especially if the money isn't rolling in, because you figure that if you aren't making much, there isn't much to tax.
Still, odds are you're going to pay Uncle Sam something, and that can be jolting -- especially when you aren't bringing in much money.
"The first year I was self-employed, I discovered I had to pay self-employment tax. It's not a small number -- over 8 percent of my adjusted gross income. Yikes. Nasty surprise," says Mike Scanlin, CEO of borntosell.com, a website for covered call investors.
And Scanlin, who lives in Long Beach, California, set up his company as a limited liability company, or an LLC. He says he has to pay additional taxes of $800 a year, "no matter if I have revenue or not."
He says that $800 tax hurt him the first two years, when he wasn't making money but instead writing the software his company now sells. Then once he finally did get revenue, he had an LLC fee of $900.
"Note, they call it a fee, not a tax. What a scam," says Scanlin, who isn't too pleased with how his home state handles LLC taxes.
Professional fees, permits, licenses, etc. You may well need to hire a tax professional or lawyer to help you set up an LLC (yet another cost), and of course, you may need a professional to help you apply for a permit or license. Those, too, cost money.
Mark Aselstine, who lives in El Cerrito, California, and his brother-in-law Matt Krause, who lives in San Mateo, California, started their wine club and gifts website, UncorkedVentures.com, in 2010. They were taken aback at how much they wound up paying in licenses and permits.
"Granted, alcohol is worse than most [permits]," Aseltine says. But, still, he says, "It adds up pretty quickly when bootstrapped."
He and Krause each need a license for their home office. That costs them each $100, which they have to renew and pay for every year.
"Our warehouse is licensed, also [at] about $100," Aseltine says. "Price wise, these aren't an issue, just more of a hassle and yet another thing to keep track of."
But the permits were expensive, in part because they took so long to get.
"We had to sign our warehouse lease, before applying for our permit. Alcohol Beverage Control needs you to be in control of the space and they do come out and check before issuing permits for the location," Aseltine explains.
Aseltine and Krause paid $800 a month in rent to the warehouse while waiting nine months for their permits to be approved. That was $7,200 in costs they hadn't planned for.
Once they actually had the alcohol permits approved, Aseltine and Krause had to pay $2,000 for two permits, one for off-site sales, so they can ship wine to a customer's front door, and the other allows them to buy wine directly from wineries.
"Each of those two permits have to exist separately at both our home office address, as well as our warehouse address, so it really functions like four separate permits," Aseltine says. In permits alone, that's over $15,000 spent in their first year of business, much of that year without customers.
Time. It's easy to think this doesn't belong here. You're starting a business. You expect to spend time on the business. No surprise there.
But what's easy to miss is how much time will be spent working on the parts of the business that don't excite you.
"The largest cost for me starting a video production business was my time doing administrative responsibilities and being compliant with the government," says Rep. Tim Ryan, D-Ohio, founder of TAR Productions, a digital video production company based in San Diego. "I've been able to automate a lot of these tasks, such as utilities and payroll taxes, but setting it up was a disaster ... When starting my business I was excited about putting my name out there, marketing and meeting prospective clients, not thinking about the legalities and tax requirements."
Eric Allen agrees that time is a casualty of starting a business, and it can do more than eat up the hours you'd rather be doing cool work stuff. It can also spill into your personal life.
Allen, based in the District of Columbia, is a co-founder of Admit Advantage, an admissions consulting company and president of Admit.me, a website that helps college applicants connect with college students and alumni for support through the admissions process.
Allen says his largest expense in starting and running his business has been in opportunity cost.
"Opportunity cost is the cost that you're giving up while choosing to do something else. I learned the concept in business school, but I didn't realize it would include disappointed children, angry wives and annoyed business partners," Allen says. "There is a significant physical and emotional cost of starting a business. It's hard. That's why most people fail."