There are many reasons for an entrepreneur to start a small business and salary is not usually the prime motivator. Obviously, everyone wants to earn a fair wage but the challenges and satisfaction of running your own business often trumps the desire for an immediate large payout.
Still, the small business owner must determine what salary to pay themselves that will make them feel secure and yet allow sufficient funds to operate successfully. As small business owner you will be giving a lot of your time to your business but remember the bigger picture- growing your company.
At the beginning of a company, it can be hard if not impossible to take any salary. It’s not even an option. But after the business starts to earn some money, business owners face big questions. Do you hire a new employee? Buy equipment? Test out marketing? Invest in inventory? Rent a retail space? Of give yourself a salary.
The trade offs are not easy and there’s no rule book but here are some general principles.
Take reasonable compensation.
If the owner faces financial strains at home then it will affect business. Making sure you can cover basic living expenses is critical. Many entrepreneurs will sacrifice a lot and live on very modest monthly expenses. They figure that if they can invest in their business, they’ll have a bigger salary later and a business worth more money. Think of it this way, you might only get three percent interest in the bank, but if you can grow your business by 15 percent, that’s a great investment.
Everyone wants to determine what they are worth. First, calculate your monetary needs to cover personal living expenses. Be realistic but objective. Remember your primary goal is to give your business the best opportunity for growth and survival.
You may compare your position or business with similar positions in your region.
There is no average salary but there are guidelines that you can use to evaluate your decision based upon the specific industry, your skills, your experience and the geographic area.
Payscale reports that small business owners “boast more than 10 years of experience in their profession. Salaries stretch from $26K to $153K per year, and the median is $59K per year.” SBA.gov also produces Income Statistics that provide income and earnings information for various fields and geographic areas.
Take a minute to analyze your company’s structure.
The legal structure of your small business impacts your salary determination. Most commonly, small businesses are set up as sole proprietorships, partnerships or Sub S-corp entities. Understand the difference between salary and dividends as they pertain to each type of business.
Sole proprietors and partnership members are not required to take a salary. You are able to pay yourself out of profits and make no payroll withholding. Be aware that the consequences of doing this may affect future Social Security payouts, contributions to Roth IRA’s and may affect your ability to obtain credit or loans if there is no W-2 salary.
A Sub S-corporation will allow dividends to be drawn by the owner in addition to W-2 salary. The dividends may be drawn as a return of capital to the owner and would not be taxed. The IRS will flag businesses that are not paying “reasonable” compensation to owners. Consult a tax advisor to avoid problems and if salary needs to be restricted, try to at least cover up to the Social Security base so that all payroll taxes are covered.
This is where a small investment in a tax advisor can lead to big returns.
Be patient and flexible.
You are working hard and deserve to see rewards. But remember, cash flow in a new small business is unpredictable and difficult to gauge without a track record. You want your resources to be focused on growing the business and it is helpful to have the extra cash funds.
Flexibility is key and hopefully you will be able to increase your compensation at a steady rate as you grow. You can always pay yourself more but it’s hard to invest money back in the business once it’s been taken out.