Three questions to ask when setting your own salary(Read article summary)
Entrepreneurs should set their minimum salary based on a number of factors, including what the company's revenue is like during both the ups and the downs and what their lifestyle demands.
Josh Stilts/Berkshire Eagle/AP/File
How much should I get paid? This is a question that every owner of a successful business faces at some point in time.
Setting compensation for the owners of a business needs to start with separating your job in the company from your role as an owner of that business.
As an employee of the business you own, your compensation should be based on three issues.
First, what can your company actually afford to pay you?
Too often I see business owners rush to set an unrealistically high salary as soon as their businesses begin to have some success. The early growth of a business is more akin to a ride on a roller coaster than a rocket.
Businesses experience peaks and valleys in revenues during early growth. Three strong months of growth may quickly be followed by several lean months.
Entrepreneurs should set their initial minimum salary based on the valleys rather than the peaks. Look carefully at your revenue history to find a level of pay that your company can afford during both the ups and downs.
Second, what do you really need to earn from the business to cover your current cost of living?
Take a careful look at your personal budget and use that as a guide to set a target income for the first few years of the business. Don’t be in a rush to enhance your lifestyle.
Even if the business begins to see more success, commit to investing excess cash back into the business to build cash reserves and to minimize your need for using debt to fund the business.
Third, what are you worth?
If your personal expenses serve as the basis for the lower end of your salary, what the market would pay someone to do your job should be the upper end of the range for your salary.
Determine what it would cost to hire someone to run your company if you were to decide to step aside and just be the passive owner of the business. The market rate of pay should be the most you would ever pay yourself in your role as CEO.
Does that mean you will never make more than the market rate for pay as CEO from your business? Absolutely not!
As owner, you are entitled to a return on your investment in the business. This includes your actual investments, your reinvestments of cashflow, and of course, your sweat equity.
As your business becomes financially secure, it can do what most publicly owned companies do. It can begin to pay returns to its investors.
You may hear many schemes from other entrepreneurs about how to minimize your compensation to reduce your tax liability. Quite frankly, this is a bad idea.
First of all, with the increased attention that the IRS is placing on small businesses, trying to be too clever on what you call your salary could lead you to some uncomfortable conversations with an IRS agent if your business ever gets audited. Assume that eventually your business will get audited and make all decisions on your compensation with that assumption in mind.
Additionally, trying to minimize your salary is just a bad business practice. It distorts the true profitability of your business, which can lead to bad business decisions at some point down the line.
When it comes to setting your compensation from your business, be patient. A conservative strategy on managing your personal and business cashflow will payoff down the road. An entrepreneur’s primary goal should be to build wealth, not just maximize monthly income.