Consumers and businesses are being more careful with their money now, but they are still buying software if it will save them time and/or money. If you have been laid off in the current recession, perhaps now is a good time to start that microISV you have been thinking about. But starting your own business can be a bit daunting if you haven’t done it before. What is actually involved in the day to day running of a small software business?

Disclaimer: The information below is based on my my experience of running a microISV as a UK-based limited company for 4 years. It is far from comprehensive and is merely intended to give you some pointers. I am not an accountant. I am not a lawyer. Some of the information will not be relevant to businesses based outside the UK. Seek appropriate professional advice.

Accountants

Probably the first thing you should do when you decide to go into business is to get an accountant. An accountant will be able to advise you on bookkeeping, tax, VAT, company rules and regulations and any number of other topics. As you aren’t a large or publicly listed company they don’t have to be a chartered accountant. Changing accountant later may be painful, so try to get it right first time. Ideally try to find your accountant by personal recommendation and someone you think you will get on with. Everything can be done by phone and email, so they don’t have to be in the same town.

Setting up a company

You don’t have to have a company. But it does have some advantages:

It makes it easier to separate your personal and business finances, which can only be a good thing.

It gives you some legal protection. If someone decides to sue due to a bug in your software, they will have to sue your company, rather than you personally. So you have less chance of losing your house.

It has some tax advantages.

You can impress members of the opposite sex by putting ‘Director’ on your business card.

Having a company also has certain obligations, such as filing annual returns and company accounts. Much of it can now be done online. The company annual return is pretty straightforward. You just need to list who the company officers and shareholders are. The tax return is more complicated and something I wouldn’t want to do without the help of an accountant.

Setting up a limited company in the UK is fairly easy, simple and cheap. In theory you could read all the necessary documents and do all the paperwork yourself. But surely there are better uses of your time when you can get an accountant to do it for you for as little as £90.

Banking

When you choose a bank you need to consider:

Charges – per month and per transaction.

Services – e.g. foreign currency accounts.

Customer service – how long will you have to wait on the phone to speak to someone?

Convenience – you don’t want to have to drive to the next town to pay in a cheque.

Interest – are their rates competitive?

Guarantees – is the money guaranteed if the bank goes bust?

It may also be a good idea to choose a separate bank from your personal bank, to keep your business and personal finances separate. This could also be important if you ever got into a dispute with your bank.

Having had very good experiences with HSBC through FirstDirect, I chose HSBC for my business banking. However I was unimpressed by the service I received. This included queuing 40 minutes to pay in a cheque and calls to the branch 2 miles away being routed via India (I got fed up of spelling out H-i-g-h W-y-c-o-m-b-e). I was also irked by the service charges. £0.60 to pay in a cheque! When I told them what I thought of their service they made an appointment for someone to come and see me. They never turned up. No apology, nothing.

I have since switched my banking to Alliance and Leicester business bank. I have been happy with the service and there are no charges as long as you pay in at least £1,000 per month. I can also pay in cheques at any Post Office (if the UK government doesn’t close them all).

Invoices

If you are selling to other companies, rather than just consumers, you will have to deal with invoices. Invoices are a subject of mystery to many developers, but really they are just a note to someone that they owe you money. In theory the sequence is:

Customer asks for a quote. You send a quote (include an expiry date). Customer sends a signed purchase order. You send the software licence key with an invoice. Customer pays the invoice within the time specified by the invoice.

Yeah, right. In reality many companies pay months late. This helps to improve their cash flow at your expense. But, according to Hanlon’s razor, one should ‘Never attribute to malice that which is adequately explained by stupidity’ and I am sure that the apathy and incompetence of accounting staff is also a large factor.

The invoice itself is nothing special. It should include:

The word ‘INVOICE’ in large letters.

Your company details (including your VAT details, if registered).

A unique invoice number.

The date.

Customer details, including their purchase order number.

A description of the product sold and the price (including the currency).

Details of how to pay, e.g. your SWIFT/IBAN code and/or who to make the cheque payable to.

The payment terms (typically 30 days).

You might want to number your first invoice 0100, rather 0001, if you don’t want early customers to know you are a newbie.

Dealing with the late payment of invoices is a whole topic on it’s own. Personally I don’t invoice for payments of <£100 or $200 – it just isn’t worth the hassle. And I always pay my bills on time. It is the right thing to do.

Bookkeeping

Don’t fight the system, you can’t win. Computing is <70 years old. Accounting is as old as recorded history. Suck it up and learn the appropriate terminology. Consider doing a class on basic bookkeeping.

An accountant is not a bookkeeper. They may agree to do your bookkeeping, but it is likely to be expensive. Personally, I do my own bookkeeping. It is a bit tedious, but it means I know exactly where every penny goes and I can listen to a podcast at the same time to alleviate the boredom.

I started off using Excel for my bookkeeping. In retrospect this was a mistake.

You are on your own when it comes to generating reports, such as profit and loss.

Mistakes are easy to make and hard to find in large Excel spreadsheets.

Excel doesn’t scale very well to hundreds or thousands of transactions.

Your custom Excel spreadsheet is much more difficult (=expensive) for your accountant to work with than the package he normally uses.

Sales receipts, advertising, salary, dividends, ISPs, postage, stationery, professional fees etc. can add up to a lot of transactions. Even with sales batched up into weekly blocks, a one man business such as mine can easily generate over 600 transactions a year. You really don’t want to be trying to track all this in Excel. Much better to use a purpose-built accounting package.

The market leading package for small businesses worldwide appears to be Intuit Quickbooks. Others are Sage (popular in the UK) and MYOB. I recommend you chose whatever package your accountant is happiest to work with. Get your accountant to set it up for you. Trying to use a personal finance package, such as Microsoft money, to run a business is almost certainly a bad idea.

I switched from Excel to Intuit QuickBooks. Initially I hated it. But once I accepted that it was written for bookkeepers, not software developers, we reached a grudging acceptance of each other. Now I just spend an hour or so updating Quickbooks every 1-2 weeks and making sure it tallies with my bank statements. I then send my accountant a copy of the database at the end of each financial year. He then uses this data to create the company annual accounts and tax return.

Don’t leave the bookkeeping until the end of the tax year. You will end up with hundred of scraps of paper to match up with hundreds of transactions. This is an N^2 problem. As with any polynomial problem, you should try to keep N small. Also, your accountant has lots of other clients and won’t thank you for asking him to create your annual report by midnight to meet the filing deadline.

Try to get a receipt for everything. I number receipts sequentially, write that number on the receipt and include it in the Quickbooks transaction memo. I then file the paper receipt in a folder partitioned by month. This should mean that I can easily find the appropriate receipt if (when?) I get audited by the tax man.

In my experience it is common to be invoiced for the wrong amount or twice for the same things. Some companies will even try it on by invoicing you for things you didn’t agree to buy. So check every incoming invoice. Companies don’t appear to put their best, brightest and most cooperative in the accounts department. Get used to it.

Managing cash flow is a huge issue for businesses. Any number of healthy and profitable businesses have gone to the wall due to cash flow problems. This shouldn’t be an issue for most microISVs as we don’t have to spend a large proportion of our income on equipment or maintain expensive inventories. Hooray for software.

Currencies

I accept payment in various currencies through PayPal. PayPal charge a 2% fee for converting these payments to pounds sterling on top of their other fees. I have previously looked into opening a US dollar account, but it didn’t seem worth the hassle or expense. The Alliance and Leicester Bank charge a £10 fee to cash a cheque in US dollars.

Tax

MicroISVs, like other one-man limited companies, typically pay themselves a minimal salary (around 5k per year) and the rest as dividends. This means that no income tax is payable on your salary. Instead you pay corporation tax on the dividends. As corporation tax is typically lower than basic rate income tax, this is more tax efficient. However you still have to pay higher rate income tax if your income exceeds the higher rate income tax threshold.

Whenever I pay a dividend I transfer the amount of corporation tax that will be due on the profit to my business reserve account. At the end of the tax year I then know I have enough in this account to pay my corporation tax.

If you sell more than £67k per year (currently) of goods inside the EU you must register for VAT. If you sell less than this, registering for VAT is optional.

Advantages of registering for VAT:

You can claim back VAT on all purchases.

Not having a VAT number may make you seem ‘not a real business’ to other businesses.

Disadvantages of registering for VAT:

You have to charge VAT on all sales inside the EU. Businesses can claim this back, but consumers can’t.

More paperwork.

Consequently a B2C software vendor with large profit margins probably shouldn’t register until they have to. But VAT registration might be much more attractive to a B2B software vendor with lots of expenses. Apparently you can claim back some of your VAT payments retrospectively when you register.

Some other points on tax:

You can give your spouse shares in the company and pay them that proportion of the dividends. This is tax efficient if they earn less then you. But will only add to your woes if they ever run off with the milkman/milkwoman.

When you are applying for a mortgage some banks will only count your salary, not your dividends. A £5k salary doesn’t go far, even in the current housing market.

If you work at home you can charge a percentage of your heating, electricity, council tax etc or rent part of the house to your company. But you may then be liable to pay capital gains tax on any increase in value of the house.

In the UK you can claim £55 per week tax-free in childcare vouchers. The childcare provider must be registered with OFSTED. You don’t need a physical paper voucher – just pay the childcare provider direct from your company and keep all the appropriate records (including their OFSTED number).

The UK government pays a reasonable rate of interest on early payments of corporation tax. You might get more interest paying your corporation tax early than leaving it in a savings account. Also you don’t have to worry about the bank going under with your savings. Of course you will still have to pay tax on the interest next year.

I have also written an article on the basics of VAT for software vendors.

Additional resources