Everyone makes mistakes—even the savviest entrepreneurs. And there’s no shame in making mistakes! But, if you’re like us, your business is your baby and you want to do everything the right way, the first time.
You don’t have to be a biz wiz to avoid making mistakes. Instead, you can learn from what others have done wrong. Knowing the most common, and biggest, mistakes that people make when starting a business helps you avoid the very same problems.
We’ve compiled a list of 12 of the biggest errors that new businesses make.
Avoiding these “dirty dozen” mistakes could help give your fledgling company the very best start.
Please note that, while we’ve made every effort to ensure that this information is accurate and up-to-date, it doesn’t constitute legal advice, and it isn’t a substitute for legal advice. Consulting with your attorney is the optimal way to get guidance regarding all aspects of running your business.
1. Not Having a Business Plan
Don’t have a business plan in place? That’s a problem.
But, wait, what’s a business plan?
Basically, it’s a document that lays out your goals for your business.
More specifically, you’ll hone in on your goals for the next three to five years—and that includes financial projections.
With the help of your business plan, you’ll outline how you plan to achieve all of your goals. Starting a business without this plan is kinda like going on a road trip without Google Maps–you risk a lot of wrong turns and dead ends.
A business plan is a must if you want to raise money from investors or obtain a bank loan.
Your plan should include sections that describe your business, as well as the products or services that you’ll sell.
It should also contain an analysis of your market, including competitive research on other similar companies.
And it should discuss:
- How your company will be structured and managed
- What your marketing and sales strategy will be
- What your funding requirements are
- What your financial projections are for the next three to five years
What if you don’t plan to raise outside funding for your business?
In that case, you might not need a formal business plan. Instead, you can use a much shorter plan, which is also known as a lean startup plan.
Even if you never show your plan to anyone else, it’ll still help you think objectively about your goals and how you plan to achieve them.
Ready to get a plan together for your freelance business? It isn’t as hard as you might think!
There are dozens of business plan templates and examples online. Plus, the Small Business Administration has even created a free online Business Plan Tool that you can use to write up your plan.
2. Not Enough Startup Funding
Want to know the single biggest reason why businesses fail? Lack of money!
Surprised? We didn’t think so.
Some businesses require a lot of money to get up and running, like a restaurant. Others can get off the ground with less money, like a freelance writing business.
The amount of money that you’ll need from the start depends on the type of work that you’ll be doing and the resources that you’ll need to do it right.
In terms of funding your company, your business plan (*wink wink*) can help you figure out what you need. Your plan should include an estimate of your startup costs, along with how much you’ll need to invest or finance.
While obtaining financing is often a huge hurdle for startups, there are many ways to finance a small business, so you aren’t limited to just one option.
Here are some strategies to consider:
- Starting a part-time business while working another job? Think about using part of your salary to fund your new venture.
- Use some of your personal savings to give your small business a boost.
- Obtain a home equity loan to get some much-needed funding for your startup.
- Tap into your retirement savings and move some of that money into your new company.
- Use personal credit cards, or get a credit card specifically for your business, to help with covering the costs of launching your company.
- Apply for loans or investment capital from relatives, friends, and business associates. You might be surprised by all of the people who are willing to help.
- Apply for a bank loan, which can give you a nice chunk of money that you can use towards your business costs.
- Raise money online with the help of a crowdfunding campaign—a strategy that has become hugely popular for entrepreneurs from a wide range of industries.
3. Keeping Poor Business Records
When it comes to small, one-person businesses, one of the biggest mistakes that owners make is failing to maintain adequate records. In other words, your income and expense tracking is a hot mess.
Sure, keeping accurate records about your company can be a time-consuming chore, but it’s something that you just need to do.
Why are business records so important? It’s, by far, the single biggest reason that business owners lose tax deductions when they’re audited by the IRS!
Take, for example, the thousands of business owners who’ve lost their mileage deductions because they didn’t keep an adequate log of their business-related driving. See what we mean? Keeping records literally pays off.
Here’s the thing: if you’re ever audited, it’ll be up to you to prove that you’ve accurately reported both your income and expenses on your tax returns. An IRS auditor isn’t going to just take your word for it; you need clear records to back up your returns and prove their accuracy.
What’s the big deal about losing deductions? It’s expensive! Depending on your income, every dollar in deductions that you lose could cost you 25 to 50 cents in extra taxes. It adds up!
What records you need to keep depends on the nature of your business.
No matter what, you need to have a record of some kind in order to track every penny you spend and earn in your business.
And, while some expenses need to be backed up with a receipt, many smaller expenses don’t require receipts.
How do you keep adequate and accurate records?
There are a bunch of outstanding accounting software packages that can help you maintain your records.
You’ve probably heard of a few different bookkeeping programs that are great for those running a Business-of-One. Be sure to test out a few of them to see which one works best for you.
Bottom line: keeping good records will help you in many ways, particularly when it comes to monitoring your progress, preparing financial statements, and preparing tax returns.
4. Not Getting the Right Insurance
Ugh, insurance. It’s a boring topic, for sure, and it can be expensive. But it’s something that’s super important if something were to go wrong with your business.
Let’s say a client or customer slips and falls at your office, or your work computer is stolen. Having liability insurance helps protect you from business-related lawsuits, and business property insurance can protect you if equipment is destroyed, lost, or stolen.
What type of insurance, should you get?
That depends on your specific business activities.
Rest assured that there is a wide variety of policies available for every type of business.
And if you don’t know which form of insurance is right for you, you can contact an insurance broker who deals with businesses just like yours to get the answers, advice, and guidance that you need to make the best choice.
5. Selecting the Wrong Business Entity
Some people start a small business by just selling their product or service to the public. They don’t give much thought to how their business should be legally organized, and they don’t take any steps towards forming a legal business entity.
In this case, they end up with the default business entities: sole proprietorship if it’s a one-person business, or partnership if the business is co-owned by multiple people.
While sole proprietorships and partnerships certainly have their benefits, they do come with a major drawback: when you’re a sole proprietor or partner, you’re personally liable for all of the debts that are incurred by your business.
Translation: a business creditor (a person or company to whom you owe money for items purchased by your business) can go after all of your business assets and personal assets, such as your personal bank accounts, car, and house.
Plus, a personal creditor (an individual or company to whom you owe money for personal items) can go after your business assets, such as your equipment and bank accounts. Not good at all!
Beyond that, when you’re a sole proprietor or a partner, you’ll even be personally liable for business-related lawsuits.
Let’s go back to our earlier example of someone slipping and falling in your office. In that instance, you can be personally sued for damages.
And it doesn’t end there. Partners in partnerships can also be personally liable for wrongdoing by their fellow partners. Now that’s scary!
How can you avoid personal liability and the stress that comes with it?
It’s surprisingly simple: form a limited liability company (also referred to as an LLC) or a corporation.
Here’s how it works:
- The LLC or corporation owns the business, including all of its assets. You, in turn, own and manage the LLC or corporation.
- LLCs and corporations can have a single owner or any number of owners.
- LLCs and corporations give their owners limited liability. Business creditors can’t go after your personal assets unless you personally guarantee your business’s debts. Plus, you’ll avoid personal liability for some types of business-related lawsuits. Sweet!
Ultimately, for most small businesses, the entity of choice is the LLC. It provides the same amount of personal liability as a corporation, but it’s easier to form and run. It even provides great flexibility when it comes to taxes.
Head over to our Guides page for more information about how to form an LLC in your state.
6. Undercharging for Your Product or Service
Yet another big mistake that a lot of small business owners make when they’re first starting out is undercharging for their products or services.
You might think that charging less than your competitors will help get you more customers, but this isn’t always true.
Lowballing your fees won’t necessarily generate more business. Instead, many potential clients believe that they get what they pay for, so they’re actually willing to pay more for a higher quality product or service.
Don’t undercut yourself- know your worth!
The best way to know how much to charge is through experimentation.
Try out different payment methods and fee structures with different clients or customers. See which one(s) work best for you.
And, if you’re really talented and performing work of unusually high quality, don’t be afraid to ask for more than others with lesser skills.
Remember: you’ve worked hard to develop your skills and you deserve to get paid well for them!
Don’t be afraid to ask for more money per hour than employees earn for doing similar work.
It’s not unreasonable for a self-employed business owner to charge a higher hourly rate than employees, since hiring firms don’t provide the self-employed with any employee benefits (think: paid time off, retirement plans, and health insurance).
And hiring firms don’t have to pay payroll taxes either, so they save quite a bit of money by hiring freelancers.
To put all of this in perspective: employee benefits and payroll taxes add at least 20-40% to employers’ payroll costs.
7. Forgetting to Get a Business License
Many states require that you get a general business license. You can get this from the city where your business is located (if you’re in an unincorporated area, you’ll get it from your county instead).
Forgetting to get a business license is surprisingly easy, especially if you work from home. But doing so is definitely a mistake.
In the event that your city or county finds out that you’re doing business without a license, you’ll likely pay a fine, which can be much more than the original license fee.
And if you fail to pay the fine and get a license, additional bad things can happen, such as your business losing the right to file lawsuits.
The best thing to do is get your license once your business is formed.
It’s super simple, and you might even be able to do it all online.
Plus, license fees vary from as little as $15 to a few hundred dollars, so you might not even have to pay much.
To access more details about this topic, check out our Guides page, which has information on how to get a business license in different states.
8. Insufficiently Protecting Your Intellectual Property
Every business will have intellectual property of some type, and failing to legally protect it can be extremely costly.
What’s intellectual property?
If you use a name, logo, slogan, or similar item to identify and market your products or services, you have a trademark. Registering that trademark protects your ownership of it so that no one else can steal it and use it.
Register your trademarks with the United States Patent and Trademark Office.
Doing so gives your trademarks the strongest legal protection possible. But if you fail to do so, you make it possible for competitors to register the same or similar trademarks, which could prevent you from using them.
Trademarks are just one form of intellectual property.
Another example of intellectual property is the federal copyright law, which protects works of authorship, such as writings, artwork, photography, film, video, and computer software.
So, if you create works like these for clients, you need to have a written contract that establishes which copyright rights you’re selling to your clients.
On the other hand, if you purchase works of authorship from others, you need a written agreement that establishes which rights you’re purchasing from them. Without these contracts in place, you could end up in expensive disputes about copyright ownership.
Need to register valuable works of authorship to protect your intellectual property? You can do so with the United State Copyright Office.
9. Using Your Personal Bank Account for Business
When you establish your business as a partnership, limited liability company (LLC), or corporation, you also need to set up a separate bank account for your company.
If you’re working as a sole proprietor, you automatically personally own all of your business assets and any money that your business earns. That’s why you aren’t legally required to open a separate business bank account. Instead, you can just use your personal checking account for your business. But it’s still not a good idea.
Even though lots of sole proprietors use their personal account for their business, it’s a mistake. Instead, you should open a separate account for your business. This will be the home base for all of your business income and expenses.
You can deposit all of your income, like checks and digital payments from clients, into your account, and you can also make all business-related payments from that account.
Even if you accept payments or pay expenses through PayPal or other payment processors, you should always have that money deposited to, and deducted from your business checking account.
Words of wisdom: don’t use your business account for personal expenses, or your personal account for business expenses.
Keeping a separate business bank account provides you with a host of benefits:
- It’s easier to keep track of business income and expenses because they won’t get mixed up with your personal expenses and your personal household income.
- It’s helpful if you’re ever audited by the IRS because you’ll have everything related to your business finances in one place.
- It helps convince the IRS that you’re running a legitimate business, rather than merely engaging in a hobby (hobbyists typically don’t have separate bank accounts for their hobbies).
- It establishes that you’re an independent contractor, not an employee (employees don’t have separate business accounts).
If you want to learn more about business banking, check out A Comprehensive Guide to Banking for New Business Owners.
10. Waiting to Set Aside Money for Taxes
Things change when you’re running your own business and you have to pay taxes.
That’s because, when you’re working as an employee, your employer ordinarily withholds taxes and submits the money to the IRS.
When you’re self-employed, no money is withheld from your pay when clients pay you. That means it’s up to you to pay all of the taxes that you owe.
When you’re paid for your products or services, set aside money that you’ll need to send to the IRS in order to cover your income tax and Social Security and Medicare taxes.
If you don’t set money aside, you could wind up with a giant tax bill come April and no way to pay it.
Tip: Open a separate bank account to save for taxes.
Deposit a portion of every payment you receive from clients so you’ll have enough money to cover your taxes.
How much you’ll need to deposit will be based upon your federal and state income tax brackets, as well as the amount of tax deductions.
Depending on your income, you might need to deposit 25-50% of your profits. The good news is that, if you deposit too much, you can keep the money and spend it on other necessities…or that Star Trek cruise you’ve been dreaming about.
11. Using Only Verbal Agreements
Did you know that most contracts don’t have to be in writing in order to be legally binding? It’s true!
For example, if you and a client enter into a contract over the phone or during a lunch meeting, no magic words need to be spoken, and nothing needs to be put in writing. You just have to agree to perform services for the client in exchange for something of value (that’s usually money).
Theoretically, an oral agreement is as valid as a 50-page contact that’s been drafted by a high-powered law firm.
But, when you take things into the real world, using verbal agreements is a lot like driving without wearing your seatbelt—things will work out fine as long as you don’t get into an accident.
A verbal agreement can work if you and your client agree completely on its terms, and if you both obey those terms.
Unfortunately, things don’t always work out, which is why courts are inundated with lawsuits that have been filed by individuals who enter into oral agreements and later disagree over what they said.
So, what does this all mean?
It means that you should consider drafting a written client agreement whenever you enter into a contract.
This really could be your legal lifeline! If a dispute develops, your agreement provides ways to solve the dispute. And if you and your client end up in court, that written agreement establishes your legal duties to one another.
Get your agreement in writing before you start performing any work.
Keep in mind that this doesn’t have to be a long, fancy contract that’s been drafted by a lawyer.
Instead, you can use a short letter agreement or a detailed email.
At the very least, just make sure that you have, in writing, what services you’ll perform, when performance will be due, and how much you’ll be paid.
12. Doing Everything on Your Own, without Expert Support
No businessperson is an island, and no business owner knows everything. So don’t ever be afraid to seek help from an expert when you need it.
You might require assistance from the following experts:
- A CPA or enrolled agent when you have questions about taxes
- A business attorney when you aren’t sure what type of entity to form, or when you need help forming the entity you choose
- A PR and/or marketing pro when you need help getting your business in front of more people to generate a buzz and boost profits
- A bookkeeper when you need help setting up your accounting and bookkeeping system
You might be reluctant, or even ashamed, to ask for help. Don’t be! Hiring experts will have a huge impact on growing your business.
And the money that you spend on good expertise could be repaid many times over because you avoid costly mistakes along the way.
Plus, the best part is that these expenses are often fully tax-deductible!
There’s Another Way to Avoid Mistakes!
When you’re setting up your business, there’re a lot of things on your to-do list, from submitting the right documents to legally forming your business, to writing up an operating agreement, choosing a registered agent, setting up your bank account, and getting your EIN.
Then, once your business is up and running, there are more deadlines to keep track of in order to legally keep your business going. It can be super overwhelming, and it’s easy to forget about papers that you need to file or taxes that you need to pay when you’re working with clients.
This is where Collective come in. We’re freelancers, too, so we know firsthand how hard it can be to run a business all on your own. And we know how easy it can be to make costly mistakes. That’s why we set out to help fellow freelancers avoid common errors, especially when they’re first starting out.
We created a platform that can help you at every step, so you can focus more on making money while doing what you love. Reach out to us to learn more about how we can support your efforts at growing your unique brand.
Reap the Benefits of Working Smarter
With the freedom that comes with working for yourself comes a lot of responsibility.
But, being aware of the most common mistakes means that you can be proactive about doing things like writing a plan, getting the right amount of funding, protecting your assets, and keeping accurate records.
Taking care of business before you, well start your business, means that you’ll have more time to devote to your business down the road and start embracing your inner biz wiz.
Stephen has dedicated his career as an attorney and author to writing useful, authoritative and recognized guides on taxes and business law for small businesses, entrepreneurs, independent contractors, and freelancers. He is the author of over 20 books and hundreds of articles and has been quoted in The New York Times, Wall Street Journal, Chicago Tribune, and many other publications. Among his books are Deduct It! Lower Your Small Business Taxes, Working with Independent Contractors, and Working for Yourself: Law and Taxes for Independent Contractors, Freelancers & Consultants.