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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 1: 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.
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:
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.