Q: I started my business last year, and it's beginning to make some real money. Should I pay myself a salary or reinvest the money back into the company?
A: Unlike our friends and neighbors in the corporate world, entrepreneurs like us generally don't work for a paycheck. What gets us up in the morning is the desire for financial freedom, personal fulfillment and the hope that, one day, that sapling we've nurtured all these years will grow into one very valuable tree. That said, the bank, the power company and the supermarket probably don't share our entrepreneurial dreams.
That's why, unless you have investments or other income streams, you'll probably want to start paying yourself a salary from your business as soon as your company can afford it. You need to recognize that your company is a business, not a hobby, and that its goal is to make a profit.
"You should not be building a business if the model does not lead to sustainable operating income and cash flow out of which a salary can be taken in a reasonable period of time," says Frances Spark of Spark Consulting LLC, a New York firm that provides business consulting, operational restructuring and interim CFO and COO services to entrepreneurs and small to mid-size companies. There are also taxes to consider.
"If your business is structured as a sole proprietorship or an LLC, you are probably better off taking distributions from the company and paying taxes on an estimated basis during the year," Spark says. "If you have employees, you will have to set up a payroll and ensure that you withhold and pay the necessary employment taxes to the IRS."