The small business employee who often gets paid last and least

Many small business owners have trouble determining an appropriate take-home wage as the company expands, and some don’t pay themselves at all. These errors can easily come back to affect the founder and the company.

Understanding how to pay yourself appropriately — even if it’s a small amount that grows over time — is important to the long-term health of the business, according to professionals who advise small businesses. “It doesn’t reflect the true health of your business if you don’t take something,” said Zahir Khoja, CEO of Wave Financial, a company that provides money management tools to small businesses.

The mechanisms are especially important considering that 26% of small business owners do not pay themselves, according to Wave’s 2022 Small Business Survey.

Here are four tips small business owners should consider when determining their home payroll.

Consider your overall financial situation first

There is no one-size-fits-all answer. Founders need to consider factors such as their income and expenses including taxes, how the business is organized, and their personal financial circumstances. They should use this information to make a realistic decision about how much they can pay themselves without starving the business.

This will largely depend on the status of the founder. Is there a working husband? Does the founder have dependent children or other family members to support? What about mortgage, car payments, student debt, credit card debt, business loans, or other big expenses? The founder’s personal savings buffer is another consideration.

Wassim Daher, CEO and co-founder of Pilot, a company that provides finance, accounting and tax services to start-ups and growing companies.

Don’t pay yourself too much

Many founders are afraid of stifling their business by paying themselves too much, but setting too minimal can be a similar problem, as they can easily become consumed with the stress of trying to make ends meet. “If you’re spending a lot of energy on ‘should I take a taxi or a bus?'” Daher said. “

Business owners may think that the money can be better spent on hiring marketing assistance, re-establishing the website, or some other expense that can help the business expand. But don’t fall into this trap, he said. “You need to figure out how to make this sustainable in the long run for you, and that probably requires you to pay yourself more than you think,” Daher said. “You have to pay yourself enough to really cover your costs so you can focus on making your business really successful.”

Keep wages as regular as they are for any employee

A good rule of thumb is for owners to pay themselves for whatever frequency they pay other employees, said Chris Ronzio, the serial entrepreneur who founded Trainual.

He hadn’t done it in about 20 years with his first job and it became difficult to do once the business became more established. He said that gradually increasing your monthly salary as the business grows is more acceptable than doing it as a lump sum. The goal should be to have a survival wage where you can cover your basic expenses. The next step is to reach a market remuneration that is comparable to what others in the industry are achieving. “It’s all about building habits,” he said.

Be sure to reassess throughout the year in case you need to make any changes, said John Buchanan, chief marketing officer of LegalZoom, an online provider of legal documents for small businesses and families. “Clear monitoring of your business goals and commitments, as well as your personal goals and commitments, will help you determine if you need to adjust the amount or how often you pay yourself,” Buchanan said.

Pay the normative business founder

Many founders have difficulty determining fair compensation because they do not understand its value to others in similar roles. To address this issue, last year Pilot began running an annual survey to track what entrepreneurs in similar industries, geography, and funding levels are paying themselves for. Notably, half of American founders pay themselves less than $100,000 annually, according to 2022 Pilot Study.

Venture capital-backed founders are more likely to earn higher salaries. About 50% of “experienced founders” pay themselves between $1 and $100,000 a year. By contrast, Pilot found that more than 60% of venture capital-backed founders pay themselves between $50,000 and $150,000 annually. Consultants, other entrepreneurs, online job sites, and industry trade groups can also be good sources of comparable income data.

Understand the potential tax consequences

Depending on your tax structure, you may run into trouble for not paying yourself enough, so make sure you understand the specific rules regarding the entity you choose. With an S or C corporation, for example, the IRS requires the owner to obtain a “reasonable salary” and pay required taxes that go along with those wages, said Christopher Collier, a partner with Eisner Advisory Group LLC.

Collier said the amount is subjective, but that owners should generally consider what they would pay someone else to perform the same services and have some objective measures to back that up in the event of an audit. If audited, the owner may be subject to additional payroll taxes and penalties as well, if the IRS feels the salary was unreasonable. “It exposes the company to this potential tax trap if people are not aware of this problem,” he said.

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