Local Professional

by Grant Wickes

Owner Compensation for Small Business

In the startup years of a small business, the owner is generally concerned with some of the more urgent issues, such as whether he or she can make payroll next week, whether that new customer is going to place an order soon, and whether an employee needs to be formally disciplined. But there’s another critical aspect of your business- you. As owner and manager of your business, your time and investment are valuable and worthy of compensation, even in the startup years. You wear many hats in your business but the two main ones are that of manager and investor. We’ll look at each of these roles separately.

The Small Business Manager

This is the role you are most familiar with. You are in this role when you work IN your business. Some of the main management functions are: business planning, human resource management, supply management and sales. You could hire a manager to perform these functions for you, but most small business owners do it themselves out of financial necessity. Say, for the time being, that you will keep the manager job. How well does it pay? Let’s look at your situation.

Fill in the following information:

(A) Amount of income from your business that you were taxed on last year: _____________

(B) Number of hours you worked in your business last year: ____________

(C) A divided by B = ___________ Are you at least making minimum wage?

If you’re like most owner/managers, you are making between $ 1 and $ 3 per hour. Hardly a sustainable wage! Why is it that small business owners are willing to put up with such a low hourly wage? Because they believe they are building something for the long term. The problem is that 80% of all businesses fail in the first five years, and 80% of the rest fail in the next five.

Odds are, there will be no long term, especially for those businesses that fail to plan well. Time and time again, I see clients in my practice who slave away at their businesses ten and twelve hours (or more!) a day for years without getting paid. Any money they do make gets farmed back into the business to keep it going. The toll that this takes on the business owner’s morale, health and family is astronomical. How long would you work for someone else and not get paid? Not very long.

You must plan for your own compensation. Not enough money in the cash flows for that? That indicates a problem. It means you are under-capitalized. It also means that you are permanently chained to your business. You couldn’t hire a manager for free, so you will have to continue to do it forever. Not very heartening! How do you know how much you’re worth as a manager?

Look around your industry. Look at what your competitors are paying their managers. Look in the Help Wanted section of your local newspaper. What are the salaries being offered to managers in similar roles? Once you have a sense of what you’re worth to your business, put your pay in the cash projections and make it work. If you’re in the start up phase, you may have to borrow from a lending institution in order to cover your salary. The business must be able to cover the principal repayments on the debt as well as the interest. If it can’t, you will need to look at new ways of attracting increased business.

When you have planned out your salary, PAY YOURSELF FIRST! This is critical. Like any other area of your life, if you leave yourself until last to get paid, there’s a good chance you will run out of money before you get around to it. You will make sure all other suppliers get paid because they will pick up the phone and yell if they don’t get paid. You have to treat yourself just like any other supplier- worthy of prompt payment.

The Small Business Investor

You wear another hat in your business. You are an investor in your business. You have most likely invested personal resources (cash, equipment) into the company, and like any other investment, you should receive a financial return. This has nothing to do with the hundreds of hours you spend working. This only relates to the financial resources you have expended.

Let’s say that when you started your company, you took $ 5,000 out of your savings account for start up costs. What else could you have done with that money? Invest it in the stock market Buy a bond Put a downpayment on investment real estate Loan it to another start up company What would have been the benefit of doing those things? If you had invested in the stock market, you might have income on your investment in the form of capital gains or dividends. A bond would have generated interest income.

Real estate will provide capital gains and rental income. A loan to another company would generate interest. In all these cases, you would be making a financial return on your $ 5,000. You didn’t do any of those things however. You invested in your own company. Was it a good investment decision? It is if you are making a return on that investment that is similar to other investments that carry similar levels of risk. For example, when you invest your money in the stock market, you expect to be compensated for the risk that you won’t get your money back out. When you buy a bond, you bear the risk that the underlying bond issuer will not be able to repay the principal or the interest to the bondholders.

The issuer needs to compensate the bondholders for that risk. Investing in your own small business has risks too. In general, you know that the money is illiquid. In other words, you cannot take it back whenever you want. It is needed for the operation of your company for a certain length of time. You also know that the small business failure rate is extremely high. These are risks that should be offset by financial return. So, how much return should you receive on your investment? Probably more than a government guaranteed investment and less than a junk bond. Your accountant will be able to help you navigate through the owner compensation issues and set up a system that gives you the maximum return with the minimum tax consequences.

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