Ask SCORE: As a business owner, how should I pay myself?

This is an excerpt from an article by Hal Shelton for Read more here.

Pay Strategies

Depending on the maturity of your company and your plans for the business, you may adopt different compensation strategies.

  • Start-up mode: It is typical for a start-up to be cash-flow negative in its early months, if not years. This results from one-time start-up expenses like buying equipment, building out a facility, stocking inventory, marketing to attract customers, building products or websites, legal and accounting costs, and rent and utility deposits. Also at start-up, there are no or few customers. As such, during these times, your compensation will be light as there are no funds to pay more. Hopefully, you had prepared a business plan, including a cash-flow forecast, so you knew the range of your compensation during this period, and if there was not enough to “live on,” you have made other arrangements.
  • Lifestyle vs. ramp and sell: If you intend to own and operate your company for many years, which is what 95 percent of entrepreneurs plan, then you will want to develop, over time, a predictable compensation plan both to meet your personal needs and be predictable for yourself and the company.

However, if you are in the 5 percent who plan to start a company, ramp up products/services and sales quickly and then sell the business, your main reward will be when you sell. In this scenario, you will have very modest compensation during the time you are ramping up the company. The good news is that the sale of the company will probably be taxed at capital gains rates, which are lower than ordinary income and payroll tax rates. Of course, while this compensation plan applies to you and other owners, your employees will need competitive compensation and benefits to attract and retain them.

  • Wait and see: Obviously, you need cash to pay compensation, and in a start-up or growing business, the cash on hand is often very unpredictable, so you need a flexible pay calculator. You can either pay yourself a percentage of cash profits, or you can pay yourself modestly during the year and a larger amount at year-end when you know the results for the year.

What to Do With the Compensation Received

Your compensation belongs to you and not the company. So first deposit the compensation received in your personal bank account. Then you can decide to use it for personal needs or reinvest in the company, which will take the form of providing equity or a loan.

What Am I Worth?

This is a good statistic to know as you have options to continue to work for yourself or join another team, but you will not find this number in any financial statement or wage report. Revisit the compensation information you found in your research for comparable positions. If your company does not have the cash resources to pay you this amount, you might consider working for someone else.

Key Lessons

  • There is less flexibility in setting one’s compensation than many entrepreneurs anticipate.
  • Compensation strategies are different for startup vs. ongoing businesses, and for business that you plan to operate for many years vs. quickly grow and sell.
  • You need a business plan with financial forecasts to know if will have sufficient cash to pay yourself a reasonable compensation

Hal Shelton is a SCORE mentor who is passionate about helping small businesses start and grow. He has been a CFO and board member for NYSE/NASDAQ publicly traded companies and nonprofits. He is currently an active investor in early-stage technology companies and is the Amazon bestselling author of The Secrets to Writing a Successful Business Plan. For more business planning tips on creating a business plan and key mistakes to avoid, you can view Hal’s other posts here.

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