Running your own business is an exciting journey, filled with both rewarding wins and valuable lessons. However, there’s a significant difference between being self-employed and being a business owner. Some might think these terms are the same, but they actually represent two different approaches to navigating the world of entrepreneurship.
This difference often forms the foundation of your financial success and ultimately leads to personal freedom and security. In this article, we’ll explore this self-employed vs business owners. Learning the difference can help you unlock your potential, expand your goals, and maintain your values as you strive for growth.
What Is Self-Employment?
Self-employment means working for yourself instead of an employer. As self-employed, you’re running your business, doing work for clients and your their time for money. This path gives you direct control over your work, the freedom to choose projects, and the flexibility to set your own hours. However, being self-employed means you’re always working, and your income is directly tied to the time you can work.
Creating wealth can be slower because it’s limited by the number of hours you can physically work. This is often the first step in the entrepreneurial journey, providing valuable experience and understanding of the challenges of running a business.
Types of Self-Employment
When it comes to self-employment, we need to understand that it’s not a one-size-fits-all situation. Instead, it comes in various forms, each with its own set of challenges and rewards.
By understanding these different variations, you can align your entrepreneurial journey with a model that truly reflects your vision and values. Let’s explore the different types of self-employment and how they contribute to your wealth and business growth.
A sole proprietorship is like taking the first step on the entrepreneurial journey. It’s the simplest form of self-employment where an individual owns and runs their business single-handedly. They’re responsible for everything – making decisions, managing finances, handling operations, and taking on every risk. They get to enjoy all the profits, but also bear all the losses.
This form of individual working for oneself offers freedom and control, but there’s a catch. It’s not easy to scale up. The growth and success of the business depend on the proprietor’s capacity to work and the hours they can dedicate. While it’s a great learning experience, it’s important to recognize the limitations of this model when aiming for substantial growth and wealth.
A partnership is a collaborative arrangement where two or more people combine their resources, skills, and experiences to operate a business. Unlike sole proprietors, partners share the workload, responsibilities, profits, and losses. This model can lead to increased work capacity, diverse skill sets, and greater financial resources, giving an advantage over sole proprietorships.
However, it requires navigating potential challenges such as conflicts of interest, role disagreements, and shared financial risk. The success of a partnership relies on the synergy between partners, based on shared values, open communication, and a common vision.
Independent contractors (often called freelancers or 1099 employees) present a unique form of self-employment that involves offering specialized services or skills to clients on a project or contract basis. The benefits include flexibility and control, but drawbacks include the absence of guaranteed work, often low pay, and the lack of employee benefits such as sick leave or a healthcare plan, including Medicare and Social Security.
Gig workers need to be disciplined in managing taxes as they do not receive W-2s and are responsible for handling all tax withholdings independently. They are expected to receive a 1099-MISC tax document from customers or clients and are required to disclose their earnings on Schedule C of the 1090 form, serving as the non-employee counterpart to the conventional W-2 form.
That said, being an independent contractor can be a valuable stepping-stone on your entrepreneurial journey, giving you valuable experience and insights. To truly unlock substantial wealth and experience exponential growth, you may need to transition from self-employment to business ownership.
What is Business Ownership?
Embarking on the entrepreneurial journey of business ownership is like reaching the pinnacle of success. It’s not just about trading time for money anymore; it’s about nurturing a self-sustaining entity that can generate wealth independently.
This transition from self-employment to business ownership offers not only financial security but also personal freedom and incredible growth. In this section, we’ll take a closer look at the concept of business ownership, exploring its key aspects and how it fundamentally transforms the way you create and accumulate wealth.
Starting a new business
Starting a new business from scratch is one of the most common routes to becoming a business owner. It’s like embarking on an exciting journey, filled with endless opportunities for creativity, innovation, and growth. At first, the new business needs a lot of investment from the entrepreneur, requiring them to take on multiple roles, making strategic decisions and handling day-to-day operations, just like a sole proprietor.
But as the business grows, they transition into a leadership role, focusing on strategy, growth, and vision, while entrusting skilled professionals with daily tasks. This is when the true power of business ownership emerges. The entrepreneur is no longer bound by their work hours; their income and wealth creation now rely on the collective productivity of their team. It’s a remarkable transformation that unleashes the full potential of their business.
Franchising an existing business
Franchising is like having your own business but with the added benefit of established security and support. It’s all about getting the rights to operate under a well-known brand’s name and business model. As a franchisee, you gain access to a proven business model, brand recognition, and ongoing support, which reduces the risks of starting from scratch.
However, it’s important to note that franchising also means following the franchisor’s rules and standards, which may limit your creative freedom and flexibility. When it comes to making money, franchising offers a steady and reliable income stream by leveraging the parent brand’s market presence. However, the level of wealth you can accumulate depends on factors such as franchise fees, operational costs, and the brand’s reputation in the market.
Buying an existing business
When you buy an existing business, you embark on a unique journey of business ownership. It comes with its own set of benefits and challenges. By acquiring an established business, you not only gain tangible assets but also operational processes, a client base, and the market reputation built by the previous owner. This opportunity allows you to tap into an existing customer base and operational structure, accelerating your path to profitability. It’s an attractive alternative to starting from scratch or franchising.
However, conducting thorough due diligence is crucial to understand the business’s financial health, market position, and potential hidden liabilities. Buying an existing business can provide an immediate income stream and, with effective management, the potential for increasing wealth. Keep in mind that the initial investment is often substantial, and the success of this path depends on your ability to maintain and enhance the business’s value.
7 Key Difference Between Self-Employed People and Small Business Owner
The journey from being your own boss to owning a business is truly transformative. It goes beyond just changing your income and responsibilities. It’s a shift in mindset, ambition, and personal values. In this next section, we’ll explore the seven fundamental differences between being self-employed and small business owner.
These differences highlight how you evolve from creating your own job to leading a thriving enterprise. Whether you’re a passionate freelancer or an aspiring entrepreneur, understanding these distinctions will illuminate your entrepreneurial journey. It will empower you to make informed decisions that align with your personal and financial goals.
1. Scope and Scale
One of the main differences between being a business owner and being self-employed is the size and scale of what you do. When you’re self-employed, you typically focus on your specific skills and what you can personally do. It’s like having a niche service or product, and how much you can grow depends on how much time and energy you can put in. On the other hand, a small business owner works on a bigger scale.
They have a team of people with different skills and roles that all contribute to the overall goals of the business. This allows them to offer different products or services, expand into new markets, and have more room for growth. Unlike someone who is self-employed, a business owner’s income isn’t just based on what they can do individually, but on how productive the whole team is.
2. Ownership Structure
The way you own your business is another important difference between being self-employed and owning a small business. When you’re self-employed, you’re like a one-person show. You have complete control and take all the risks. Your personal and business finances are connected, which can be good and bad. On one hand, you get to enjoy all the rewards of your hard work. On the other hand, you’re personally responsible for any debts or problems your business has.
Small business owners often have a more complicated ownership structure, like a limited company or a partnership. These structures create a separation between the owner’s personal stuff and the business. This means you’re not personally on the hook for any business debts. It also gives you more opportunities to get extra money for your business, so it can grow faster and you can make more money. The balance between risk and control in these different ways of owning a business affects how much money self-employed people and small business owners can make.
3. Scale of Operations
The difference in scale of operations is another important aspect that sets self-employment apart from small business ownership. When you’re self-employed, you tend to operate on a smaller scale, focusing on your own expertise. This limits the range of services or products you can offer and ties your income directly to your personal output. Your growth is dependent on the time and energy you invest.
On the other hand, as a small business owner, you have a team to support you, allowing you to operate on a larger scale. This means you can offer a wider range of services or products and reach a larger customer base. Your income is no longer solely tied to your personal effort, but is influenced by your team’s performance as well. This scalability not only opens up more growth opportunities but also allows for significant wealth accumulation over time. However, it also means managing a larger workforce and dealing with more complex operational processes, requiring a different set of skills and a shift in mindset compared to self-employment.
4. Legal Structure
The legal structure of a business has a significant impact on how it operates, manages risks, and creates wealth. As a self-employed individual, your business is typically structured as a sole proprietorship, which means you and your business are legally considered the same entity. While this provides you with complete control, it also means that you have unlimited liability – your personal assets could be at risk in case of business debts or legal issues.
On the other hand, small business owners often choose a more formal legal structure, such as a limited liability company (LLC) or corporation. These structures treat the business as a separate legal entity, offering an additional layer of protection for the owner’s personal assets. This separation allows the business to have its own debts and liabilities, which is crucial for wealth preservation and risk management.
Furthermore, these structures offer more flexibility in terms of ownership transfer and investment opportunities, which can be vital for raising capital and growing the business. However, it’s important to note that they also involve more complex administrative, legal, and financial obligations. Understanding these implications and choosing the right legal structure for your business is a critical step in your entrepreneurial journey, as it directly affects your potential for creating and accumulating wealth.
5. Employment of Others
Self-employed people earn from their own work. But there’s a limit to what one can accomplish on their own, which naturally limits income and growth potential. Hiring independent contractors or full-time employees is a defining characteristic of transitioning from being self-employed to owning a small business.
As a small business owner, you build a team that works together towards a common goal. This means expanding your business’s capacity to deliver more products or services and generate greater revenue. Moreover, a well-composed team brings together a variety of skills, perspectives, and ideas, fostering innovation and efficiency within your business.
That said, hiring employees also comes with additional responsibilities, such as managing staff, payroll, complying with employment laws, and creating a positive work environment. Navigating this transition effectively, from being a sole trader to managing a team, is a critical aspect of your journey to creating wealth. It requires a delicate balance between expanding your operations, nurturing your team, and maintaining a sustainable and thriving business model.
6. Income and Profit
For someone who is self-employed, income mainly comes from their own hard work and the hours they put in. However, there is a limit to how much they can earn because they only have a limited number of hours in a day. So, their income is often equal to the revenue they generate, once they deduct their business expenses.
On the other hand, for a small business owner, things get a little more interesting. Robert Kiyosaki, author of the “Rich Dad Poor Dad” series, says that business owners earn from a system they created. While they may draw a salary from their business, a significant portion of their income comes from the profit generated by the company. This profit is a result of the efforts of the entire team and the efficiency of the business model. It’s not just tied to the owner’s direct labor, which means it has the potential to scale and generate more income. A successful small business owner knows how to create a profitable business model that generates wealth beyond their personal efforts.
7. Long-Term Goals
Setting long-term goals is like having a guiding light on your journey to creating and accumulating wealth. They give you direction and motivation to stay focused and overcome challenges along the way. As a self-employed individual, your long-term goals might be centered around achieving a certain income level or attaining financial stability. However, these goals are often limited by your personal capacity.
On the other hand, small business owners have the potential to set more ambitious goals due to their scalable business model. This could include expanding into new markets, increasing market share, or even going public. These goals not only offer opportunities for wealth creation but also provide a sense of purpose and a vision for the future. Clearly defining long-term goals helps you develop effective strategies, motivate your team, and align efforts towards achieving them. A business guided by a compelling long-term goal is more likely to succeed, innovate, and generate substantial wealth.
Setting these goals also requires introspection about your personal values and vision, reinforcing the importance of personal integrity in your entrepreneurial journey. It may require stretching your ambitions and stepping out of your comfort zone. Remember, the journey to wealth is not just about financial gain, but also about personal growth and fulfillment.
How Business Owners Take Money From Their Business
As a business owner, understanding how you can take money out of your business is crucial. There are several ways to do it, each with its own implications for your personal income and the financial health of your business.
One common way that business owners extract money from their businesses is through a salary. This provides a steady income stream and can be a simple approach if you’re the sole owner. However, you must ensure the salary you draw is sustainable and doesn’t negatively impact the cash flow of the business.
For business owners of corporations, dividends are another popular method. Dividends are payments made out of the company’s profits to its shareholders. They offer more flexibility than a salary as they can be adjusted based on the company’s profitability. However, they also come with their own tax implications that should be carefully considered.
In smaller businesses, particularly sole proprietorships or partnerships, an owner’s draw is often utilised. This is when the owner takes money out of the business for personal use. While this method provides flexibility, it’s important to be mindful of the impact on the business’s liquidity and financial stability.
Finally, some business owners may opt to take a loan from their own companies. In this scenario, the business lends money to the owner, which is then paid back over time. This can be a viable option, provided it is done in a way that is legally compliant and doesn’t jeopardise the company’s financial position.
Many self-employed individuals or small business owners can greatly benefit from carrying business insurance. In certain scenarios, it may even be obligatory. Legal disputes can have significant financial implications, with lawsuits potentially costing tens or even hundreds of thousands of dollars, regardless of the outcome. Attorney fees alone can be a burden, even if you win.
There are various policies that can help you, such as general liability, professional liability, and a Business Owner’s Policy (BOP). These policies prove beneficial for both self-employed individuals and small business owners. It’s worth noting that small business owners with contractors or employees may be required to obtain workers’ compensation insurance. Since regulations for workers’ compensation insurance vary by state, it’s crucial to thoroughly review and comply with your state’s specific requirements.
Paying Business Tax for the Self-Employed and Business Owners
Understanding and efficiently managing your tax obligations, including being responsible for paying taxes, is not only a legal requirement but also a key factor in wealth preservation and accumulation. It’s advisable to seek professional advice to ensure that you are complying with all the relevant tax laws to avoid unintentional tax withholding and taking advantage of any allowances or reliefs that you may be entitled to.
Individuals who work but aren’t employee are self-employed. This includes independent contractors, although not everyone who is self-employed is an independent contractor. The difference depends on their relationship with customers and how they work, rather than the field they work in. For self-employed individuals, personal earnings are usually subject to income tax.
They must file annual taxes and pay estimated quarterly tax. Taxable income is determined by subtracting allowable expenses. Maintaining accurate records is crucial to substantiate these expense claims and maximize local tax deductions.
As a sole proprietor who reports, your business income is treated as personal income, and you are taxed accordingly. The tax is calculated on your profits after taking into account all allowable expenses. You must ensure that you submit your tax return by the deadline to avoid penalties.
In a partnership, each partner pays tax on their share of the business profits. Partners must each submit a Self Assessment tax return, and the partnership also needs to submit a separate income tax return.
Limited companies must pay corporate taxes. Owners or directors can receive a salary, subject to Income Tax and National Insurance contributions. Dividends distributed to shareholders face separate taxation through the Dividend Tax. Understanding these structures is crucial for effective tax planning and optimizing business tax deductions.
To arrange a chat about differences between self-employed and business owner, contact us.
Can I be self-employed and not have a business structure?
Yes, you can be self-employed and not have a formal business structure like a corporation or a limited liability company. This is often the case for sole traders and freelancers. As a self-employed individual, you’re essentially operating as a business under your own name. You have the freedom to work for multiple clients and manage your own workload. However, this also means you are personally responsible for adhering to all business regulations and tax payment obligations. It’s important to consider the potential benefits and drawbacks of this approach in relation to your specific circumstances and long-term goals.
Is owning a corporation considered self-employed Individuals?
Yes, owning a corporation can be considered a form of self-employment. While a corporation is a separate legal entity, as an owner or shareholder, you have a level of control and influence over its operations, similar to the autonomy found in self-employment. However, it’s worth noting that you are not personally liable for the corporation’s debts or liabilities. This separation of personal and business liabilities is one of the key advantages of owning a corporation. However, it also carries additional administrative responsibilities and regulatory compliance compared to other forms of self-employment. Properly managing these responsibilities is essential to maintaining the financial health and integrity of the corporation.
How does the IRS know if you are self-employed?
The Internal Revenue Service identifies self-employed individuals based on the information provided on their tax returns. If you are self-employed, you typically report your business income and expenses on Schedule C, Profit or Loss from Business, which is part of your personal tax return. In terms of Social Security and Medicare taxes, you would file Schedule SE, Self-Employment Tax. It’s crucial to accurately report all your income and deductible expenses to the IRS, as failure to do so can lead to penalties. The IRS may also receive information about your income from other sources such as Form 1099-MISC, which businesses use to report payments made to independent contractors. Always consult with a tax professional if you have questions about your specific situation.