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The typical entrepreneur usually has one of two reasons why he or she decided to start a business. The first is that they want to make a boat load of money. In spite of the realities and statistics on how many new businesses fail in the first few years, those who start businesses are usually a pretty confident bunch who believe they can make more money as their own boss than working for someone else. This leads right into the second reason many small business owners make the jump from employee to employer: They want to be the boss.
In either case, at some point, and hopefully sooner than later, new business owners must begin to pay themselves for their efforts. But when should new business owners pay themselves and how much?
According to several experts, the answer to “when” and “how much” comes down to first determining where the money that will fund the business is going to come from. Will it be revenue that the business itself will generate, or will it be from some outside source such as investors, venture capitalists or lending institutions?
Bryce Hansen, technology commercialization adviser at the Small Business Development Center at the SLCC Miller Campus, says when fundraising from outside sources like VCs, you usually don’t want to pay yourself if you’re raising less than $500,000—at least in the technology sector. “Investors don’t want to see their money funding your lifestyle. They expect you to have personal reserves or resources you can live on,” he says.
It is wise to plan that for the first year or two, you might expect to take no salary from the business. Be prepared to live on savings or other resources—such as what you can sell or borrow. You might consider taking a second mortgage on your home or cashing in a 401(k).
On the other hand, if you are using revenue from the company to grow, you may be able to take a salary sooner. In the early stages of your enterprise, however, it is important to remember that cash is king and needs to be preserved. Cash is vital for growing and subsequently adding value to the business.
“Once the business begins to generate revenue, pay yourself based on the revenues in conjunction with what the business needs to grow,” advises Ron Baron, Salt Lake SCORE mentor and vice president of marketing. “Make sure you reserve enough cash to fund the next step of growth, be it hiring an employee or buying a piece of equipment.”
Jan Newman, currently a senior executive at Vivint Solar, a former partner with Sage Creek Partners, and a founder of KeyLabs, Inc. and Altris, Inc., says a founder should take the minimum needed to pay the bills and feed the family. And expect below-market pay. “If you take too much salary, you cannot expect to grow the business. If you want a big salary and benefits, a startup isn’t the place to be.”
He points to his own experience as an example: “I was 36 years old with five kids and a mortgage when I started one of my companies, so I needed a certain amount of money. I had taken a $100,000 salary cut. At one point, I went to my partner prepared to show all the value I had brought to the business and to ask for a salary increase. He asked if I wanted a loan, was I having trouble paying my bills? The lesson was clear—the value was not in an extra $10,000 in salary but in the equity I had in the company. Make the company valuable. I did, and I made millions instead of thousands.”
The Bottom Line
When you can take a salary often depends on how the business is being funded and whether revenue is being generated.
No matter what stage the business is in, you must balance what you pay yourself against what is needed to grow the business—to take your company to the next stage.
When you do take a salary, it will most likely not be at market value—remember, you own the business and your value is in your equity.