How much should I be paying myself as a business owner?

Do you own a small business and wonder how much you should be paying yourself?  It is a very simple question, but the answer can be pretty complex.  Complex because it can depend on so many factors with your business, and also because no 2 people, businesses, or situations are alike.  So it's not as easy to compare your situation with another business owner's, even if they're in the same industry.  Money can be a very emotional and scary issue for some people, and figuring out how much you should be paid can stir up a lot of emotions.  That is why it is important to be objective when determining how much you should pay yourself.  This topic is not about how to pay yourself from the business, whether it's by payroll (salary, wages, S-corporation reasonable salary requirements), distributions, dividends, etc.  This is about how much you should pay yourself and reviewing a criteria of factors to help you figure that out.

The most common problems we see with most small business owners with figuring out how much to pay themselves are:

• Lack of understanding and a clear picture of the financial situation of the business causes them to make bad financial decisions

• Because they have access to the business bank account, they are tempted to pull money out at any time

• Comparing themselves with other people, like family, friends, or colleagues who may have business also, but in a different situation from their own

• Comparing themselves with the past.  This is most common among business owners who leave a high-paying job, only to find themselves several years into the business, frustrated that they are still not making as much as they did in their previous job.

Factors that affect how much you should pay yourself from the business

• Business profits, cash flow, debt, capex, taxes

  • Is there enough profit from the business?

  • Is there enough cash flow from the business?

  • How much tax do I have to pay or reserve for?

  • Do I have to make any major purchases for the business?

  • Do I have any business debts to pay?

  • This is the most crucial and objective measure for figuring out how much the business can truly pay you.  If you have profits, that should create positive cash flow, but profits and positive cash flow create tax obligations, so it's important to work with your accountant to figure out those amounts.  The net remaining positive cash flow (after taxes or tax reserves) can either be used to pay you, capital expenditures, or to pay debt.  Without positive cash flow, you would either be borrowing money to pay yourself or withdrawing it from the business's reserves (if any).  Work with your accountant to really nail down your business profits, cash flow, taxes, capex, and debt to truly figure out how much you can pay yourself.

• Stage of the business

  • What stage is your business in?

    • A business is cyclical, so it's important to figure out which part of the life cycle your business is in.  Harvard Business Review has a great article on The Five Stages of Small Business Growth, and they break out a business’s growth into 5 stages:

    • Existence - This is the early stages of a business, usually referred to as the start-up stage.  It is common for the business owner to pay themselves nothing.  Mainly because there is very little profit; any profits or positive cash flow are reinvested in the business

    • Survival - You're past the early stages, and the company is growing and generating some profits and positive cash flow.  It is common for business owners to start paying themselves a small amount and/or continue investing the money back into the business.

    • Success - You're past the survivable stages, and the company is generating healthy profits and positive cash flow.  It is common for business owners to start paying themselves the amounts they need or want.

    • Take-off - Your business is growing rapidly.  Business owners want to pay themselves much more than they need, but it's important to balance how much the business needs to fuel its growth.

    • Resource maturity - Your business is at a mature stage.  This is the ideal stage where your business and your pay are at their ideal amounts.

• Industry and business structure

  • What industry are you in?

    • If you are in the service industry, like consulting, and can work from home, you could have a very different overhead structure than a retail store.

  • What is your current business model or structure?

    • Your business model is unique and not always comparable to others in your industry.  What makes your business unique plays a part in your business’s finances and how much you are able to pay yourself.

• Personal life situation and goals

  • How much do you need to take home (pay yourself) to survive?

  • How much would you like to pay yourself from the business?

  • How much do you want to invest in the business?

Methods to determine your pay

• There are two common approaches:

  • Percentage of profits

    • A common starting point for small businesses.  After setting aside funds for taxes, reinvestment, and debt payments, a portion of the remaining profits can be allocated to owner pay.

  • Market rate

    • More common for established businesses.  This approach looks at what someone in your role would earn in the open market.

Tips for sustainability

• Really figure out your monthly nut.  It's important to ask yourself: how much do I need to take home to survive?  Be realistic with this and really take the time to figure this out, as this will help you set the right expectations for your business.  But remember to monitor this number as it changes over time.

• Start modest and take it slow. Understand that it takes time to build the business to get to a level where it can afford to pay you the amounts you want.

• Keep business and personal finances separate. Don't mix business and personal expenses in the business, as it can make it very confusing and hard to really figure out how much the business can really pay you.

• Consistency helps.  If you know you need to take home $5k, $10k, or $20k a month, set up a process where the business pays you consistently, like every 2 weeks or every month.

• There may be times when you have to decrease your pay.  Once you figure out your monthly nut, it's important to set expectations that any amounts paid to you in excess of that amount can fluctuate.  Your business can have good months and bad months, which can affect how much it can afford to pay you.

Example:

Here's an example of 3 businesses at different life cycle stages, showing how much each can afford to pay the owner. 

1. Start Up - Business is just starting the business and building the revenues, profits, and cashflow.  All the cashflow from profits are reinvested back into the business and paying off debt.

2. Growing - Business is growing and has revenues, profits, and cashflow.  Cashflow is available to for some owner's pay.

3. Mature - Business is stable and revenue, profits, and cashflow are healthy.  Cashflow is available to for owner's pay.

Scenario	Start Up	Growing	Mature
Revenue	125,000	600,000	3,000,000
Expenses	(60,000)	(360,000)	(2,250,000)
Profit	65,000	240,000	750,000
Cashflow from profits	65,000	240,000	750,000
Taxes (40%)	(26,000)	(96,000)	(300,000)
Debt payments	(30,000)	(20,000)	0
Capex (Reinvestment)	(9,000)	(30,000)	0
Available for Owner's Pay	0	94,000	450,000

In Summary

There is no one-size-fits-all answer to owners' pay. The right amount depends on your business’s financial health, stage of the business, industry, personal life situation, and goals. These are important factors to consider and evaluate frequently, because the business and situations are constantly changing; it's important to keep up with these changes and regularly re-evaluate the financials.  A combination of the factors above is important to examine to see how they all affect your pay.  If you’re unsure where to start, we recommend working with your accountant to evaluate your numbers and develop a structured approach to paying yourself.