How Much Should You Pay Yourself as a Small Business Owner?
How to Set Your Salary as a Small Business Owner
The first thing you have to realize is that as a small business owner, drawing a salary is just one of the options when it comes to paying yourself if you choose to structure your small business as a corporation, and some of the other options may be better for you tax-wise.
(If you have structured your small business as a sole proprietorship or partnership, there is no decision to make, really, because your “salary” is what is left over once your business has met all its expenses and is your personal income for tax purposes.
The second thing you need to realize is that there are really no hard and fast rules about how much you pay yourself. Although there is a body of traditional advice that you can draw upon to make a decision that’s best both for your business’s stage of development and your personal situation.
The Traditional Advice for Startups
Is there anyone starting a business who doesn’t know that you’re supposed to start out as leanly as possible? As one writer puts it, “Strike all other discretionary items from your life for a while and get used to just the bare necessities” (Paying Yourself: From Startup and Beyond, Entrepreneur).
The theory is that the more you can cut down on your operational expenses, the better chance your small business has to succeed, partly because your business would need less capital to get up and running and partly because it won’t take much to keep it going.
Therefore, if you’re going to pay yourself anything (if you really, really have to) your salary should be just enough for you to scrape by.
I think this kind of advice is one of the reasons so many people who want to start small businesses don’t. There’s nothing inherently attractive about living in a basement suite subsisting on instant noodles while trying to turn your great idea into something real.
Instead, Show ‘Em the Money
And not paying yourself a salary does nothing for your fledgling business either.
If you write a business plan in the hopes of getting funding for your Canadian small business, either through grants or loans or by persuading investors to invest their money, not including a salary for yourself as one of your expenses in the financial section of your business plan will raise a red flag for anyone looking at your proposal. An owner’s salary is a reasonable and expected expense and if you don’t include it, you’ll be giving an inflated view of your business’s potential profits.
It’s also important to include a salary for yourself in your startup plan because if you don’t, you’ll be leaving out a future expense and not asking for enough funding from your creditors or investors.
Note that you don’t have to use the salary if you don’t want to. You can always defer it (and get it back with interest once the company starts making some money).
Your Salary Should Reflect What You’re Worth
How much, then?
First, figure out what you absolutely need.
Start with your personal expenses. Rent? Utilities? Groceries? Car insurance? Make a list and check it twice. You don’t want to miss anything.
Be sure you include semi-annual and annual expenses as well as some kind of rainy day amount.
Tally everything and you’ll have the amount that you absolutely need.
If you are starting a business yourself and have no need of outside funding, use this number as your salary base until your business reaches the break-even point.
However, if you are seeking outside funding, go to the next step right away and figure out what you’re actually worth.
This number will be a combination of:
1) the skills and expertise you bring to the business and;
2) what your peers are paid.
If you don’t know already, find out what people with your skills typically make. Search for average pay in your profession or trade for starters or find out what salaries/ hourly pay are typical for your industry.
As of writing, for instance, a quick Google search tells me that that the average pay for a management consultant in Canada is an annual salary of C$77,375 with an average hourly rate of C$79.00. Salary ranges from C$52,113 to C$123,997.
If I’m a management consultant starting a business, all I need to figure out now is where I fit into the salary range in terms of expertise and experience and how much the local market will bear.
So my next step would be to check out the competition, finding out who they are and how much they charge. Learn more about researching your competitors.
Your accountant can also be a good source; he or she probably works for a fair number of other businesses in the area and may be able to fill you in what they normally see for your industry.
Once you’ve done your research, you’re ready to pick a number.
Paying yourself what you’re worth from the get-go will not only make your start up plan more realistic but give you the incentive to work hard on growing your business.
When Your Business Grows
Once a small business reaches the break-even point, many small business owners are tempted to re-evaluate their salaries. Don’t. Raising your salary now could well tip your new business into the red again.
Instead, wait a year past your break-even point and then re-evaluate it. If you’ve been paying yourself only 70 to 80% of a market value salary, now’s the time to raise it, assuming the business can afford it.
Once a business has become stable, it’s standard practice for owners to pay themselves by taking a percentage of the profits – generally no more than 50%.
This makes sense because it ties your salary to the performance of the company.
Review Your Salary Regularly
Companies aren’t static, so your salary shouldn’t be either. Review it quarterly, relative to your business’s performance. Consult with your accountant to be sure your salary and any bonuses you pay yourself are in keeping with your tax goals. (Learn more about the tax advantages and disadvantages of paying yourself through salary or dividends.)
And remember, “The worst time to take significant amounts of your business is when it’s growing, says Dave Cook, a partner in KPMG’s enterprise group. “Entrepreneurs often fail to realize that a business in its growth stage needs all its cash flow to grow the business” (The Globe and Mail).