Surviving the first year as a new small business owner can be difficult, to say the least. Let’s dispel some myths about the first year and provide some real information about your foray into the small business world.
A Question for Entrepreneurs
In 2018, John Doe decided to launch his own advertising agency, called “Familiar Creatures.” In doing this, he gave up a six-figure salary as a copywriter, a risky move for a married man with three kids. The family moved from the East Coast of Boston to Richmond, Virginia, so that Bajan could be near his business partner.
Although they only had one client at first—a local brewery—and John Doe was unsure if the venture would even be viable, he couldn’t resist the pull of the entrepreneurial world. John Doe describes the entrepreneurial world as full of potential, a place where there is a chance to make something for yourself. When the business started out fairly strong, John Doe and his co-founder Dustin Artz found themselves at a crossroads. They asked themselves if their salaries, which were split more or less 50/50, were giving the business enough room to grow. The answer was no, ultimately, and in order to serve the business, the pair invested in marketing, hired staff, and ended up paying themselves much less than they’d ever made before. Therefore, understanding how much a new business needs to make the first year is critical to for the business to be viable.
Douglas Wade, Attorney
Paying Yourself: How Much is Enough?
As more and more Americans find themselves abandoning secure jobs to head out into the entrepreneurial frontier, the question of what to pay oneself becomes more and more common and increasingly controversial. Payscale tells us that, on average, U.S. small business owners make about $70,300 annually. But that amount reads differently when you consider that many entrepreneurs do not pay themselves anything during the first few years of running their business, while at the same time, other business owners pay themselves so much that they struggle to grow their businesses. It is clear that paying yourself is a complex task because it raises the question: how do you place a price on a position that expects so much from one person?
Melanie Hopkins is the proud founder of a firm called Finance Friend in New York. Her company assists entrepreneurs in starting and growing their businesses. Her expert opinion is that there truly is no set formula regarding how company owners should pay themselves or how much. There is so much variance among different companies, including industry type, legal structure, and financial goals, that the decision comes down to each specific business. Also, operating costs play a large role in tracking where the money goes. For a job that can require you to do almost everything, from marketing to payroll and even IT, you need to provide yourself with at least modest compensation.
Finding a Figure to Pay Yourself
It will take some research and number-crunching to decide what salary to pay yourself, and you might want to begin by creating or double-checking your personal budget. A great question to begin with, is this: how much do you need to be paid from your business in order to pay your living costs? It is important to be realistic about how much it costs to pay rent, support your family, and live comfortably enough to run a business.
Choosing a Salary for Yourself
There are many ways to figure out how to pay yourself. Some business owners wait until the end of the month and decide how much money they need to pay their personal expenses. However, if a business changes its structure, there are often extra requirements. S corps, for example, require owners to be paid a salary that is comparable to what people in that position make elsewhere. Why? This is because the Internal Revenue Service doesn’t want people to pay themselves a small salary but then take the rest as dividends, which are taxed at a lower rate. Some business owners check Glassdoor, a website where people report their salaries anonymously, in order to derive an estimate.
Knowing When to Give Yourself a Raise
Most business owners start out paying themselves modestly and then hope that they can increase their own compensation over time. However, it can be difficult to continually take money out of a small business that you have worked so hard to build. Sometimes, entrepreneurs are so focused on their business and its performance that they literally forget to pay themselves, which is a problem in itself. It is important for you to remember that, as a business owner, you are integral to the business and should be paid for your overall contribution. Also, increasing your own salary can provide a nice incentive, not to mention a bonus that will make you work even harder to grow your business. You started the company; you put in the hard work; you should be able to enjoy it at some point.
When and How Much to Pay Yourself: More Detail
If you are still wondering when to start paying yourself and unsure of how much, let’s go into a bit more detail. It is true that when you start your own business, money is often tight, and so your salary as an owner becomes one of the last priorities. However, as your company creates income at a steady clip, the idea of compensating yourself becomes more reasonable.
These days, small business owners are enjoying an economy that is beginning to recover from challenges such as the COVID-19 pandemic, and their small businesses are turning a bit more of a profit. When profits increase, optimism comes next, and when business owners feel more secure, they tend to feel better about paying themselves.
Here are three questions that might help you determine if you are able to pay yourself a salary.
- Is my business in the black?
- Does my business create sustained revenue? If so, for how long has it been doing so?
- Can I predict a steady revenue, and is this projected revenue in line with not only my expectations but my costs?
If you can answer these questions positively, then you should be paying yourself. It is also true that when companies make it past “startup mode” and become more firmly established, owners can budget themselves a more lenient salary.
How Much Should Your Salary Be?
The Internal Revenue Service (IRS) suggests that business owners pay themselves what they call a “reasonable salary amount.” But how much is reasonable? Many business owners describe their salaries as modest and affordable. Being fiscally conservative will incur fewer taxes for the business. You can then use the leftover capital to invest back into your business, pay employees, or buy new equipment, whatever is needed.
If you are searching for a specific salary number, experts advise that you first calculate your personal expenses and then decide what you can afford to pay yourself based on how much your company is earning in a fiscal year. An accountant can help with this, and it might be wise to contact the expert that you normally use for your business taxes.
Another approach would be to pay yourself based on the number of your profits. Many small companies have decided to use half of their profits for salaries. However, this depends heavily on how profitable, efficient, and established your business is. Be honest with yourself and your employees about where the business stands, how much you have accomplished, what your revised goals are, and where you see yourself in the future. This sort of honest talk will help everyone to understand their own salaries, from owners to employees.
America’s Small Business Association also publishes a database of income statistics, which is available online. Comparing your own company to other businesses in the same industry and niche, and comparing salaries, can also shed some light on this challenging question.
One last piece of advice: whatever you decide to pay yourself, make sure that the salaries you provide do not take away too much money from the business. If your day-to-day spending and operations become limited, then you will have to restructure.
If you have questions related to your small business, a corporate attorney can help. At Nakase Wade, our business lawyers handle a range of small business issues and offer a free consultation. Contact us today.
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