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FEATURE STORY

How Much are You Worth?

Paying Yourself in Your Small Business

You’ve successfully started a small business, managed inventory and even covered some marketing chores, but there’s still one lingering issue; you’re barely getting paid! Don’t fall on the small business crusader sword and think that you’re doing yourself or your business a service by not taking a livable salary. The time and energy you commit to the business deserves compensation, but just how you decide to receive that payment relies largely on your vision for the business and setting a rate that makes sense for you.

Which Entrepreneur Are You?

There are two basic types of small business entrepreneurs, those that have plans for growing the business fast and those that have chosen to become small business owners for lifestyle or personal reasons.

The former entrepreneur is more likely to take most or all of their salary and bonuses (compensation) and immediately put it back into the business as a form of seeding future growth. This is a highly competitive and different track than the lifestyle entrepreneur takes because motivation for the owner is to grow the business to the point of selling to investors. That means that the books need to be meticulous and your salary as CEO will be scrutinized by future investors. What you pay yourself, if anything, reflects in part your commitment to the business. Venture entrepreneurs are often very savvy about this fact and refuse to take a salary at all or squeak by on a paycheck that will just barely cover their personal expenses while they grow the business. Some stay in super-growth mode a little longer than they should and need to re-evaluate their books and make them as realistic as possible. Why? Investors want to see an honest view of the business and need to know what fair compensation is and should be for a person in your position. Remember when the company is sold, you may not stay on in the same role if at all. Investors need to know what the business would pay someone else to do your job and have your level of expertise and risk so they aren’t blindsided by a $250,000 expense once the business is bought.

The lifestyle entrepreneur is happy to own a small business and has no designs to sell or start a second business with profits from the first. In this case, salary is basically everything that’s left at the end of the month. It’s much easier to plan for and establish a set salary when you want a healthy business that grows slowly. But that doesn’t mean that the salary or draw should be erratic or inconsistent. A healthy business needs consistency as much as an individual household. You can’t plan for personal events if the salary you’re bringing home changes from month to month or even week to week. The best bet? Set a monthly amount and stick to it, in good times and in bad. The business needs to be able to stand on its own merits and survive through both profitable and tight times. By taking a consistent salary, you’ll be able to see trends in the business and plan for those leaner times with new strategies and marketing efforts.

Whatever approach you choose, make sure that you take some profit out of the company and leave a safety net of reserve for those times when sales slow or the market slumps. Build up to a six month reserve of cash to cover business expenses.

A Fair Wage for an Honest Day’s Work

Now that you’ve established that your salary is important and even necessary depending on your future plans for your business, it’s time to set your rate. Establishing a salary, bonus or dividend payment for yourself is part bartering and part science. Find out what the market rates are for CEOs in your industry and your size business. The web site www.salary.com, which aggregates salary data by geographic area, is a good starting point and trade associations can be very helpful in providing this information.

Much in the same way as you prepared your business’ books for outside evaluation, e.g. benchmarking and third party valuation, you’ll want to do your homework and research comparable salaries for CEOs in similar industries, size businesses and sales. From here you can estimate a salary and then translate it to your geographic region of the country. For example, a salary of $250,000 in San Francisco would probably translate to $175,000 in North Carolina or Tennessee . Use U.S. Census data, aggregate information from your Business and Industry Association and then talk with fellow business associates about their experiences.

Avoid Run-ins with the IRS

Don’t pay yourself so much that you cripple the company or so little that you trigger IRS scrutiny and penalties. Because dividends are taxed twice, once at the corporate level and once on the individual level, the trend is for many small business owners to elect salaries over dividends. There are two issues to consider when weighing the consequences of salary versus tax implications. First bear in mind how you are compensated for your time, efforts and risk at the business. Salaries that are too low when the business’ earnings are substantially higher will raise a flag for the IRS. Conversely, a large salary expense on a business’ less than stellar tax filing will also draw attention. If a court decides that the salary you received is actually a "disguised dividend," it will disallow the deduction; and you will pay, big time. Balance corporate sales, profit and losses with salaries and whenever possible keep them in line with others in the same industry.

Second, be careful not to go a little crazy with ‘personal expenses credited to the business as business expenses’. It should go without saying that personal and business should be kept separated, but the temptation for small business owners to do some creative financing is often greater than the threat of an audit or tax fraud penalties reaching as much as 75% of the tax debt owed. Don’t try to expense that new Ford Explorer, if your wife drives the kids in it to soccer practice and don’t take family vacations as ‘business travel’ unless you’re attending a conference in the same hotel and only deducting your portion of the room, food, and conference fees to attend.

If you were paid little or nothing in the first years of the business don’t be ashamed of compensating yourself well when the business is successful – you’ve earned it. Bear in mind the tips from above and use common sense. If something jumps out on your profit and loss sheets, it will undoubtedly do the same to outside reviewers or investors.

If you’re still unclear about how to determine executive salaries or how to fairly compensate yourself, talk with a Fiducial Advisor by calling 866-FIDUCIAL or visit the web site at www.Fiducial.com.