To Pay or Not to Pay?
How do you know when--and how much--to pay yourself? Our startup expert explains how to set your salary.
When I worked in corporate America, my paycheck was directly deposited into my bank account every other week like clockwork. Once I negotiated my salary when starting a new job, I never really thought about it again until performance reviews when I'd find out how much of a raise I'd be getting or whether there would be a bonus that year. As an entrepreneur, it's not a given that you'll get paid at all. In fact, when times are tough you're the last in line on pay day anyway. So how do you decide when and how much to pay yourself?
There are many schools of thought here but most of the entrepreneurs I know follow a few consistent patterns. At least in the first few months of operation as your business is launching, don't plan on drawing a salary at all. It's quite common for many founders to accrue their salary without actually cutting themselves a check for a while. Once your business starts to gain momentum and your customers/clients are paying in regular cycles, then the founder can make distributions with more confidence.
Should business slow again, a capital call may be required, so don't buy the new luxury sedan, sports car or sailboat too quickly. Keep some cash reserves handy just in case. As business picks up, you can pay yourself a bit more. I know founders who started with a quarterly draw then moved to a bi-monthly and then monthly distribution as their business grew. But they held money back as well to invest in infrastructure to keep up with growing demand. I'm not a lawyer or an accountant, but I do know that if your business can afford it, you should be paying yourself a "fair" level for your experience and industry.
Here are a few tips to help you figure out how to pay yourself fairly:
- Determine how much you're worth by researching ranges of what others are paid in your industry, then budget that into your cash-flow projections so you know how much operating capital you'll need in the beginning. If you have "X" amount of capital, you should be making "X" amount over that before you start paying yourself.
- Put together a personal financial statement that lists your living and credit expenses, goals, loans, etc. Determine how much you'll need to cover everything. In my experience, it's much more common than not for your expenses to come in higher and your revenues lower than your initial forecasts. As one entrepreneur I know says, "Double your expenses and half your revenue, and if you're still making money then you're in the right business."
- After the startup phase, if your business is bringing in a certain amount above what you've budgeted to cover your basic expenses, you can take a percent of that and increase your salary.
- Make sure you pay your quarterly taxes. Many entrepreneurs owe Uncle Sam his due every June, September, January and April. He doesn't have a sense of humor and neither will your landlord or credit card company, so plan accordingly. My business model is such that I get a percentage of every transaction, which means I was able to pay myself from the very start. I self-funded all of the startup expenses, though, so for the first few months I didn't really make much money. I was fortunate that I had enough reserves set aside during our ramp-up phase to keep things moving forward. Accounting and payroll aren't how I like to spend my time so I outsource my payroll and tax preparation to the experts. It's a small price to pay to sleep better (and longer) at night.
To me, having started my career with big companies, I wanted to pay people regularly, including myself. It felt like an important milestone to be "real." For the first few years I only ran payroll monthly, but as we've grown and expanded, I've been running it more often. I still foot the bill for all expenses, but seeing the direct-deposit line item on my bank statement every few weeks makes me smile knowing that our business is healthy, growing and--most importantly--I'm still having fun. I've had jobs in the past where the only explanation of why I was there was the salary. I never want another job just because it pays me well. But I love creating jobs to pay others well, and by doing so I've found a meaningful way to pay myself regularly, fairly and easily.
My professor used to say that happiness is positive cash flow, and I really believe that when you find the right career that makes you happy, the pay checks start to be more regular too even though it doesn't always feel like work. Bob Dylan had a great quote I'll always remember, "What's money? A man is a success if he gets up in the morning and goes to bed at night and in between does what he wants to do."
The most successful and happiest people I know are ones who don't confuse their bank account with their true value. The real goal is to make a life, not just a living. There are plenty of ways to pay the bills, some more lucrative than others. I'm fortunate that what I enjoy doing also happens to be something people are willing to pay for. One thing I've learned though is that you can't assume others are motivated by the same things that drive you. Ever since my first paycheck, I've always set aside money for savings. When I received raises, I would pretend that the increase never happened and put the extra funds into investments or savings.
I'll leave you with a great quote by Bette Davis "To fulfill a dream, to be allowed to sweat over lonely labor, to be given the chance to create, is the meat and potatoes of life. The money is the gravy. As everyone else, I love to dunk my crust in it. But alone, it is not a diet designed to keep body and soul together."