After 30+ years working with clients, I have been witness to a lot of really costly bad advice and ill-informed decision-making by people who want to start a “side hustle” to supplement their W-2 income and perhaps at some point transition into a full-time business. I am all for the side-business and have engaged in several myself over the years. As a result I have formed my opinions about the best approach both from a business perspective as well as a legal structuring perspective.
Vertical Growth Is Preferred
The advice I hear repeated most often is to “follow your passion” and to turn your hobby and what you love into your side-business. There are certainly some who have pulled it off. However, most people never convert their hobby turned side-business into a viable business endeavor. What started as a supposedly clever way to make a hobby tax deductible turns into an expensive tax and legal morass that needs to be unraveled.
What I recommend is to look at where you are currently earning a living. There you will likely find a marketable product or service that is already producing revenue for you in the form of a W-2 paycheck. The key take-away here is that you are likely already producing sufficient value that someone else is paying a salary to you for that work so that they can sell it to someone else or, at a minimum, they prefer to pay your salary to have your services in-house as opposed to paying a third-party service provider. Either way, you are already delivering value that someone else is willing to pay you full-time to provide.
Social media marketing is a fast-growing industry. I have seen more than a few social media managers who have full-time jobs take on clients as a side hustle. These clients cannot afford the required spending to work with a full-scale agency but investing a few hundred each month in a social media presence is often in their budget. Bookkeeping is another area I have seen successful side hustle businesses launch. The key here is that you are repurposing an already existing skill set.
The benefit of this approach is that most of what you learn for your full-time job will benefit your side hustle.
Sole Proprietorship Is a Good Starting Point
If you spend any time on online small business forums, watch enough YouTube videos, or get pixeled by small business advertisers you have been told that you need a limited liability company or LLC to get started in business. It is not true and it is going to cost you money that you do not need to spend at the start.
The primary reason a small business owner forms an LLC is because they hope to protect their personal assets from the debts of the business. It is an entirely legitimate use of an LLC, just not one that applies to most people starting a side business. At the outset, you are probably not signing contracts that create significant liabilities and there is nothing “magic” about an LLC that absolves you of your personal liabilities.
Most people I talk with who form LLC’s at the start of a side hustle business do so because they heard or read that this is what they need to do. The second reason is based in ego and the desire to present as a bigger enterprise than just one person working on a laptop at the kitchen table. Until you are ready to bring on one or more partners, hire employees, or begin signing your name to large contracts, consider operating as a sole proprietorship.
To do so, there is very little that you need to do. In most cases there are no government filing requirements other than perhaps a local business license. My advice to such clients is to open a separate checking account for the “business” and to work with an accountant to set up their books. I do not even encourage a QuickBooks subscription at this stage as the bookkeeping is typically not complicated with income and expenses easily tracked on a spreadsheet.
Income will be reported on your personal IRS Form 1040 and your business expenses will be reported on your personal Schedule C. You will be paying your tax preparer to prepare one personal tax return.
But what about personal liability? The first line of defense is always insurance regardless of whether you form an LLC or not. Work with an insurance professional and ask them about a “BOP.” Many carriers offer a Business Owners Policy which tends to be affordable and provides the basic coverages you will want in place. That’s it! A separate checking account, a BOP, and a low cost and low stress start to your side hustle.
Unexpected Costs of Forming an LLC
Forming an LLC for many is exciting and perhaps it leaves you feeling like “you have arrived.” That feeling wears off quickly when you learn that your LLC is now suspended with the Secretary of State for failing to file an annual report. Did you take an s-corporation election for tax purposes? Now you are paying for a second tax return but probably not receiving any benefit and you just learned that the Franchise Tax Board wants $800 from you every year just because you formed the LLC.
But you have the protection of the corporate shield, right? Perhaps, but have you put an operating agreement in place? Operating agreements are not created equally, so what protections does your LLC’s operating agreement support? Are annual meetings being conducted? Are minutes and resolutions from those meetings being recorded and added to the corporate records? There are a lot of questions that I ask new clients who want help with the business entity.
Form an LLC is the easy part. Structuring that entity and maintaining it is where the work and expense come into play. The reason I favor the sole proprietorship at the beginning is because you can get started generating revenue and transition when the revenue and your circumstances are benefited and not burdened by the LLC formation.
Forming an LLC Yourself or with a Lawyer
As mentioned earlier, forming an LLC is easy. It is everything that happens afterward that becomes complicated, costly, and labor intensive. During my career I have worked with clients who had formed the LLC themselves or through a filing service as well as those clients who came to me at the beginning and engaged my office to handle the process for them.
The cost of formation varies somewhat depending upon complexity, but on average I think most clients will invest about $3,000 to $4,000 with me to form, structure, and maintain the entity for the first year. When the client comes to me with an existing entity and asks that I help them, the cost is always much higher. How much higher depends upon how tangled a mess has been created.
Probably the worst-case scenario I have witnessed was not the fate of my client. My client was interested in purchasing a business that owned and operated out of a house. They wanted to purchase both the real estate and the operations. I was hired to look over the deal. I quickly had growing concerns and advised my clients to “slow down” to make sure they were not walking into something they would regret.
Within a couple days the business was served with a lawsuit. The business had let their insurance lapse so there was no insurance coverage. The LLC was formed through a filing service and the owners did not understand enough about California limited liability law to know which boxes to check or not check on the Articles of Formation, the one-page document filed with the Secretary of State. The box that was checked created unlimited liability for both the person running the business and his silent investor.
With unlimited personal liability now in play the plaintiff’s lawyer turned their sights on the real estate and the personal assets of the two members. My clients were spared the worst of it, I was able to get some of their capital returned, and a valuable lesson was learned. The sellers were not so quick to figure things out and spend hundreds of thousands of dollars to have a law firm defend them. They lost the business, the real estate, and probably a chunk of their personal savings.
If you choose to form the LLC yourself or through a filing service, understand that there is a downside risk. As the business’ revenue can support it you will want to establish a relationship with a legal professional who can guide you going forward. The same is true in the areas of tax, insurance, and financial planning. Do not underestimate the value of having a team of seasoned professionals on your team of trusted advisors.
Starting the Side Hustle
The advice is to keep things simple but get started. Internet forums and Google are not a substitute for competent accounting, financial, legal, or insurance professionals. In fact, they can be far more expensive when the time comes to clean up the mistakes that were made. One IRS audit and the money you thought you were saving is gone and then some.
Your immediate needs from a professional will be limited, but a small investment with them can go a long way as your business begins to experience growth. That team of advisors will help you navigate many decisions and if you can avoid the larger “potholes” when making those decisions, your money will have been well invested.
