How to Pay Yourself as a Small Business Owner
Even the most socially responsible entrepreneurs and established business owners will tell you that they still have bills to pay. In light of those bills, it's not a bad thing to think about how you will pay yourself. An American Express OPEN survey found that nearly half of small business owners pay themselves a regular salary that averages approximately $68,000 a year across a range of industries.
There is no one right way to handle your compensation. To determine a good figure, you have to consider many things. These include a wide range of revenue and business models, the varying levels of experience and skill sets, and the unique factors that mean one industry may have a higher prevailing wage than another.
Here is a guide that can direct how you look at paying yourself through all stages of a business.
Account for Your Personal Responsibilities
Look at your personal budget each year to determine how much you need to cover living expenses, utilities, groceries, insurance, family expenses (if you have a spouse, children, and/or pets) and an emergency fund. Don’t forget other expenses, including income and property taxes. This should create the baseline for what you will need at the very minimum to get by each month. If your business' amount of income is small, then try to save—even if that amount is small.
As a startup, you may need to think of creative ways to reduce your monthly personal expenses in order to get by on less until the business is up and running. If you have a partner who also works, it’s important to sit down together to figure out what is fiscally possible that provides a way for you to pursue your business dream while still covering the bills.
Assess Your Company’s Fiscal Health
You shouldn’t necessarily write a paycheck just because money is starting to flow into your business and the bank account shows a positive balance. Go deeper than that before determining if—and how much—you should pay yourself. Start by making sure you have accurate, updated financial records to review how the business is doing and if money will continue coming in at the same rate in the near future.
It’s great to see a positive balance today, but if you start taking money out and there are no future revenues on the horizon, then you are damaging your business. Earnings and cash flow don’t always align, so look back while also forecasting for things like future expenses (e.g. taxes, equipment, expansion, etc.) before you pay yourself.
Let’s not forget the well-intentioned entrepreneur who is paying himself and everyone else in the company a $70,000 salary. While it may sound good, it’s not prudent to the long-term vitality of an organization.
Consider Payment Models
You may need to look at non-traditional ways to collect some of the compensation you deserve:
- As a startup, you may opt for stock options that can be converted or cashed in at a later date when the business is thriving. This puts a significant amount of compensation farther down the line, and gets you to focus on ensuring the business succeeds.
- As your business grows but is still young, you might consider a commission-based payment structure. This way, you're paid during periods of profitability or, likewise, not paid when business is slow.
- For a business that is more established, it makes sense to move to an experience-based salary that is now able to compensate you for the experience, knowledge and skills that you have put into the business. At this point, conduct research among industry peers to determine the average pay rate for the number of years you have under your belt.
- For a developed business, you could pay yourself by using a market-based wage. Again, research helps to determine what the average pay rate is in your particular industry, position, age of the business, revenue and your experience.
Supplement With Alternative Income Sources
You may need to supplement your income with alternatives, at least while you are in the startup stages and cannot draw a paycheck. This is why so many entrepreneurs consider themselves part-timers or moonlighters because they have retained a full-time “regular” job to cover their personal monthly expenses. The aforementioned American Express OPEN survey also found that nearly 15% of small business owners hold down a second job while they get their companies up and running in order to cover the necessary personal compensation.
As your business grows, it will require more of your attention and should be starting to provide you with enough revenue to start drawing a paycheck. You can migrate to a part-time “regular” job, do freelance work or consulting and/or work out an arrangement with any investors you may have to use some of the funding to collect some compensation.
Revisit Compensation Amounts
While your team gets performance reviews to gauge any possible salary increases, don’t forget to include yourself in this annual analysis. Consider the company’s financial position as a measurement for the amount you give your team and yourself.
Focus on Checks But Also the Balances
The most important lessons here are to strike a balance between sustaining your company and ensuring that you cover your own expenses and compensate yourself fairly. This means creating a budget for your business that keeps operations lean while still fully compensating the talent that fuels success and keeps cash flow positive. The moment you strike that balance is the moment you really have a successful business.