May 26, 2020 | 5-minute read (809 words)
To become successful, most founders make sacrifices and draw nothing or next to nothing in terms of monetary compensation. Although, it’s normal to forgo a salary during the initial phase to get a new business off the ground, it’s quite reasonable to start paying yourself once your firm reaches the profitability stage, instead of reinvesting every penny earned back into the business. The reason is simple: It’s your dream and you’ve poured your blood, sweat and tears into making it a reality, and you should get to enjoy the fruits of your labor.
But how much should you pay yourself as a founder? This is an age-old predicament that’s common in the entrepreneurial world. Since you're the business owner, you should be free to decide the size of your paycheck. And while the thought of setting your own salary sounds great in theory, in reality it can be quite a tough call to make.
According to Y Combinator, a founder's salary should strike a balance between maximizing their ability to work on the startup and minimizing the business' burn rate. The IRS states that the wages paid to you as an officer of a corporation should generally be commensurate with your duties. So, consider these pointers to arrive at a reasonable compensation for yourself.
Calculate Your Monthly Net Income
Calculating your business’ net income ensures that your business can cover all its expenses. Net income is what’s left after you deduct your business' expenses from your gross revenue. The formula for calculating (monthly) net income is:
Gross Revenue – Expenses = Net Income
Factor in Your Tax Liability
The next step is to figure out how much you will be paying in taxes. This is important because if your business makes a profit, you will be paying taxes. So, how much should you set aside for taxes?
A decent starting point is 30 percent of your net income. If you have partners or are in a higher tax bracket, your tax percentage might be higher. It is advisable to check with your accountant regarding taxes, as they’ll be able to give you a more accurate figure. For this example, we'll use 30 percent as an example, in which case the tax liability would be:
30% x Net Income = Tax Liability (approximate)
Now, deduct this figure from your net income to broadly arrive at the pool of money you can use to pay yourself. Let’s call it “net cash.” So:
Net Income – Monthly Tax Liability = Net Cash
Don’t Forget About Business Debt
It’s now time to take your business debt (if any) into consideration. For that, start with your total monthly debt payments; this will include things like money borrowed from a lender, loans or credit card expenses. Remember that your loan interest is potentially tax-deductible. Now, deduct your monthly debt payments from your net cash to arrive at your “gross pay.” Hence:
Net Cash – Monthly Debt Payments = Gross Pay
Calculate Your Future Business Needs
Before you pay yourself, think of your long-terms goals. Broadly determine how much you’ll be spending on things like new equipment, product development and launches, new hires and so on. Subtract these expenses from the figure from the previous step to get the number you can take home as salary. Therefore:
Gross Pay – Savings for Future Needs = Money You Can Pay Yourself
Ideally, scrutinizing this amount is how you’ll decide what you should be able to pay yourself each month, but if it's not enough to take care of your personal needs, you can play around with the numbers a bit. However, do remember that while business expenses, debt payments and savings for the future can sometimes be finessed, taxes are non-negotiable. Also keep in mind that you don’t have to pay yourself the entire amount — you can determine what you need to live on, and take only that amount if necessary. But this number is a great guide to show you what’s available to you as salary.
Salary or Owner’s Draw Method?
After consulting with your accountant and determining how much salary you should take home, the next step is to figure out the method you’ll use to pay yourself. There are two standard methods that you can use to pay yourself as an entrepreneur, depending on the structure of your company. You could pay yourself a traditional salary or take an owner’s draw from your profits. You can talk to your accounting team to make the decision on which would be most beneficial for you.
Getting paid for your hard work is one of the biggest rewards of starting your own business. Whatever amount and method you decide upon, be sure to do the proper homework so you can afford to pay yourself regularly and consistently.