How Much Should You Pay Yourself as a Small Business Owner?
There are two main schools of thought when it comes to how much salary you should draw from your small business. Some experts think you should take only what you absolutely need to survive, while others believe your salary should be based on market value. As an entrepreneur, it’s important to know the arguments on both sides so you can make an informed decision.
Argument: Just Enough to Get By
In order to get your business off the ground, you’re going to need all the cash you can muster, whether you’re funding it yourself, getting a bank loan, or getting financial support from investors or partners. Lack of cash flow is the main reason most small businesses fail. If you draw too much out of the company to fund your lifestyle, you may not have enough cash to support the business if sales decrease or you run into unexpected expenses. That’s a good reason to take only enough salary to cover absolute necessities. If you’re still working at a job and starting a business on the side, you may not even need to draw a salary. Hopefully, this will only be necessary for a short time, until your business gets established.
There are several arguments against this plan. One is that it creates an unrealistic picture of how your business is doing. You may think you’re making money because your business bank account is increasing each month, but if you had paid yourself even a modest salary, you’d be in the red. This argument says that if you can’t afford to pay yourself a decent income, it’s time to admit that your business model isn’t working. You may also be sacrificing your personal finances on the altar of entrepreneurism. If you’re not drawing a salary sufficient to support yourself and your family, you may fall behind in payments, go into debt or ruin your credit rating.
Counter-Argument: Pay What You’re Worth
Paying yourself a market-based salary has several advantages. An accurate picture of your company’s financial status should make it easier to get financing if you need it -- not drawing a salary might be a red flag for potential lenders. Drawing a decent salary also allows you to live comfortably so you’re not stressed out by personal finances.
- Check websites such as salary.com to see what jobs in your industry are paying. Be sure to adjust for the cost of living in your area.
- Look at filings of publicly traded companies to see what they’re paying their executives.
- Consult the Income Statistics section of the SBA website.
- If you’re moving from employee to CEO in the same industry, you should make at least as much as you did as an employee, plus additional income as compensation for your increased management responsibilities and your investment of personal capital.
- Calculate what you’d have to pay a vendor or contractor to perform all the tasks you’ll be doing.
- Once your company starts to make money, you can pay yourself whatever is left over after expenses, contributions to your “rainy day” savings plan, and allowances for future expenses. This would obviously be a variable amount, not a fixed salary, which may make personal budgeting difficult.
Is There a Happy Medium?
While it may be necessary to live on ramen noodles and peanut butter sandwiches while your business is just getting started, this can be considered an investment in your future success. Here are some suggestions to make this option more practical:
- Set a deadline for your financial austerity plan. If your business hasn’t grown enough to support your taking a decent salary within a period of time (perhaps six months), it may be time to close up shop and try something else.
- In order to get a realistic picture of your company’s finances, each month post the amount of salary you would have given yourself if you could have afforded it, and balance it out with an IOU to yourself. You can then see how you’re actually doing, and when you achieve the success you’re expecting, you can start paying yourself back.
- After you reach the break-even point, tie your salary amount to the company’s growth. If your bottom line increases 5%, you should be able to give yourself a 5% raise.
As the business owner, the decision is yours, but no matter what you decide to do, there will be tax implications for you as an individual and also for your company. Be sure to consult your tax accountant or attorney before making a final decision.