How to Transition From an Employee to a Freelancer

How to Transition From an Employee to a Freelancer

Facing Uncertainty

Leaving the security of a full time job to become a freelancer comes with some amount of anxiety.

The best way to deal with this uncertainty is to identify what you may be giving up and decide if the trade off is is worth it for you. While you may be rewarded personally and financially as a freelance career, you’ll also have to consider some risks. These risks can cause anxiety, so you need to carefully consider them and whether or not you can address them.

Freelancers lose the financial stability of earning a salary, and you’ll no longer have access to company-provided benefits and retirement plans. You can pay for these benefits as a freelancer, but the cost may be much higher for you. You’ll also have to manage every aspect of your business, or hire experts to help you.

To get your freelancing work off the ground, you may have to borrow money or dig into your savings account, and these decisions put your personal finances at risk. Perhaps most importantly, you may feel a sense of failure and shame, if you can’t support yourself as a freelancer.

Broadly speaking, you’ll face far more uncertainty as a freelancer. Is that something that you can live with?

What You Could Gain From The Transition

If you choose to work as a freelancer, you can find some great benefits. You’ll have more freedom to do the work you prefer, and to choose the clients that are most attractive to you.

Freelancers can use more creativity in their work, and in how they market themselves to prospects and customers. Finally, you have more control over your career’s direction, and you have the opportunity to earn far more money than you might as an employee.

What Skills Do You Have?

Once you think through the pros and cons of freelancing, consider the skills you have, and what you can charge for those skills.

Your goal is to determine how much income you can potentially generate as a freelancer. Here are some data sources you can use to make your assessment:

Salaries

How much do you earn for your work, and what is the salary range for work in your field? Let’s say that you’re a graphic designer, and you earn the equivalent of $35 an hour.

Do some research to determine what you would likely be earning in the next five years, assuming reasonable salary increases (2-5% a year) at your current job. You should also consider wage increases due to a promotion.

If you think you may have the opportunity to get promoted into management, what does that salary look like? Talented people often get promoted, so that needs to be a part of your analysis. Consider this the “what if I decide to stay” part of your analysis.

Overhead and Profit

The difference between the $35 rate you’re paid and the amount your employer charges a client is important. That dollar amount covers the other costs, such as a portion of office rent and marketing costs, and the company’s profit. If, for example, a client is charged $4,000 and the hourly costs for the designer total $3,200, the remaining $800 covers overhead costs and profit.

This data is important, because you’ll have to cover some overhead costs as a freelancer.

Freelancer Rates

What do freelancers in your industry charge for their services? If you can pin down an hourly rate, that’s most helpful. Even if a freelancer bids on projects, a Google search may reveal the hourly rate that the freelancer assumes when they bid on projects.

If freelancers typically charge $42 an hour, for example, that rate will have to include your overhead costs, such as your email, website, and other marketing costs.

Assume, for example, that Charlie works for Sunburst Furniture, a firm that produces customized wood furniture pieces for homeowners and businesses. Each piece of furniture is designed based on the specific preferences of the customer.

In addition to making the furniture pieces as a skilled craftsman, Charlie discusses design ideas with clients and works with the company accountant to estimate the cost and pricing of customer orders. Many clients are repeat customers, and they ask for Charlie’s expertise on their furniture orders.

After five years at Sunburst, Charlie starts to consider a transition to freelance work as a furniture maker. He has the ability to discuss design issues with clients, and he has some experience estimating the total cost and pricing of the product. Charlie knows that he’s lacking in some other skills that he will need to operate as a freelancer.

Why Do You Need a Business Plan?

“If you don’t know where you’re going, any road will take you there.”

This quote from Lewis Carroll describes a freelancer that does not take the time to create a business plan.

An effective business plan should contain these components:

• Executive summary: Think of this document as the elevator pitch for your business. A page or less that describes the problem your product or service addresses, the size of the market, and how you will differentiate your business from competitors. After reading this document, would a potential investor be interested?

• Business description: This section describes the nuts and bolts of your business, and this description is similar to an “About Us” page on a website. In addition to location, principals in the business, and legal structure (partnership, corporation), the description briefly explains your business model, including your customer base and sources for revenue.

• Market analysis: Here is where you make the case that there is a large enough market for your product or service to operate a successful business. This analysis explains the size of your market, in terms of total customers and annual sales dollars.

• Organization and management: The organization chart for your business, and possibly some comments on the background of company management.

• Funding requirements: This section is as important, as it is often neglected. If you’re raising funds, how much do you need, and what will you do with the money? The answer might be to add employees to develop a new product line, or to buy sufficient inventory to address your expected growth in sales.

• Financial projections: Here’s where business plan software comes in handy. Software allows you to input data and produce linked financial statement projections for three years or longer. This process forces you to take a realistic look at your entire financial picture.

Business plan software also allows you to address each of these categories in detail, and you can find great software for a reasonable price.

Every freelancer should invest the time to write a formal business plan, the process forces you to consider each important aspect of your work.

As you write the business plan, you’ll identify areas of weakness, and you can take steps to address them. This process is the only way to find out if freelancing can generate a reasonable level of income.

Charlie meets with Julie, a friend who has worked as a freelance photographer for three years. The two of them brainstorm about Charlie’s potential freelance work. After a long discussion, they determine that Charlie will need help with marketing, accounting, and legal services. The cost of these services must be built into the financial projections for the freelance business.

How to Create a Marketing Plan

Perhaps the most important component of a business plan is market research. Broadly speaking, you need to assess the demand for your product or service, the price potential clients are willing to pay, and the amount of business you can generate.

This process helps you validate your plan, and you may conclude that you can’t generate enough sales and profits to justify working as a freelancer.

To visualize this process, imagine that you were an investor, and that you’re reviewing a business plan as a possible investment opportunity. What would you want to see in the marketing plan? Consider these factors:

• Attractive product or service offering: The business offers a product or service that people want and need, and the company is run by experienced professionals. You need to document your own skills and experience, and the product or service you offer.

• Differentiation: What might motivate someone to do business with you, rather than someone else? Do you have a reputation in the field as an expert, or maybe an extensive list of existing contacts who need the product? Do you offer something new, different, or more interesting? Write it down, because this is the basis of your marketing approach for prospects.

• Size of the market, price points: How many people buy your product or service, and what are they willing to pay? Besides your industry knowledge, you may read industry publications, newsletters, or attend an industry conference to get this data.

Here’s where the rubber meets the road: when you read your marketing plan, would you be convinced to invest in the idea?

You’ve already addressed the “how much can I charge?”. The more difficult part of the marketing plan is identifying the size of your market, and how you will attract clients.

Use your personal network to find as many freelancers as you can. Ideally, you want people who work in your field, or related industries. If you’re a graphic designer, for example, a photographer or marketing freelancer is close to your line of work.

The key question to ask: how long did it take you to support yourself financially?

The answers may vary, because some freelancers work a part-time gig while they build their business. If you notice that a majority of the answers include some part-time work, you may need to incorporate that into your business plan.

To put some numbers to this question, let’s again consider Charlie’s potential freelance furniture business:

Fortunately, Charlie’s experience can help him answer some of the market research questions.

He knows, for example, that Sunburst generated $5 million in sales each of the past three years, and that five companies generate total annual sales of $12 million in his city.

The custom furniture business requires a face-to-face meeting with each customer, so Charlie must do business locally.

Gross profit is defined as (sales less cost of sales), and Charlie also knows that the average gross profit on custom furniture is 15%. It’s also a standard practice to ask for a 50% deposit when an order is placed, which the furniture marker uses to pay for the initial material and labor costs.

Customer deposits reduce the amount of cash Charlie needs to operate the business, which means he can cover initial operation cost more easily. Charlie has some savings to finance the remaining business operations.

Charlie discusses his marketing plan with Julie, and with a group of customers that have requested his services in recent years. Essentially, Charlie’s questions are a combination of a customer satisfaction survey, and a product pricing study.

He asks clients about their satisfaction level with the product, and if they felt that the price was reasonable. Charlie asks if his industry expertise helped them decide on their furniture purchase, and if he was responsive enough to design change and deadlines.

After his conversations with current customers and evaluating the local industry he concludes that he can capture 3% of the $12 million local custom furniture market in the first 12 months.

This means Charlie projects that he will generate $360,000 in sales, and a $54,000 gross profit for Charlie in year one.

The Burn Rate

Startup companies refer to the amount of money they must spend each month as the “burn rate”as a freelancer you will want to use this concept as well. While you may be supporting yourself financially after nine months or a year, you’ll need cash to make up for a lower amount of income as you start.

Where will that cash come from?

Assume, for example, that Charlie’s sale and profit projections indicate that he’ll be short $10,000 in living expenses in the first three months after starting as a freelancer. That means that he must use up $10,000 in savings, liquidate investments, or borrow money. If the months four through six don’t go as planned, he may need more funds to make ends meet.

Which brings us to the most difficult problem you face as a freelancer: when do you decide it’s not working, and you need to get another full time job?

Part of the answer is to consider your monthly results, compared to your projections. If you’re way behind in month three, you may need to pull the plug. If, on the other hand, you’re only 10% below your projections and you have a growing number of prospects who are interested, you may keep going.

Keeping a part-time source of income can help you avoid the burn rate issue as you make the transition.

Considering Other Costs

To calculate profit accurately, a business must be able to recover every cost incurred by selling a product or service. If the price of a product only accounts for your salary, the profit calculation will be incorrect. Charlie needs to deduct other cost from gross profit to compute the net income for his business venture. Here are some other costs that Charlie will incur:

• Marketing: Charlie plans to hire a marketing firm to manage his new website, email, blog, and other marketing efforts.

• Building space: The furniture business will require a 2,000 square foot space for production.

• Tools and equipment: To pay for tools and equipment, Charlie plans to take out a bank loan, using an investment portfolio that he inherited as collateral for the loan. He can pay for material and labor costs using his personal savings.

• Insurance costs: As a freelancer, Charlie must purchase medical and other insurance costs on his own.

After considering these other costs, along with the cost of an attorney and a CPA, Charlie computes that his net income (sales less all costs) will be $42,000 in year one.

His first year earnings will be less than his current salary of $50,000, but Charlie, thanks to his projections, believes that he can grow the business and meet or exceed his company salary by the end of year two.

To keep his business on track, Charlie uses an app that pulls data from his accounting software and presents his current financial status in a dashboard. The app helps Charlie monitor his results and make changes to increase profitability.

Think Carefully

Your transition from working as an employee to a freelancer status can be challenging. This is an important life decision, and you should carefully plan for the transition by writing a formal business plan. In addition, think about the additional responsibility you must take on by working on your own, and co-workers you are leaving behind. With careful thought and planning, you can have a successful transition to freelance work.