How to set your salary as a small business owner
There really are no hard and fast rules about how much you should pay yourself, however, there is a body of traditional advice that you can draw upon to make a decision that is best both for your business stage of development and your personal situation.
The traditional advice for start-ups
Most people would have given you the advice to start out as leanly as possible. The theory is that the more you can cut down on your operational expenses, the better chance your small business has to succeed. 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. This kind of advice can be one of the reasons so many people who want to start small businesses don't. There is nothing inherently attractive about living in a hovel subsisting on instant noodles, while trying to turn your great idea into something real.
Instead, show them the money
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 small business (either through grants, loans or by securing investors) not including a salary for yourself as one of your expenses will raise a red flag. An owner’s salary is a reasonable and expected expense, and if it is not included, you will be overestimating your potential profits. It is also important to include a salary for yourself in your start-up plan, otherwise you will be leaving out a future expense and not asking for enough funding from your creditors or investors. Including an amount for salary does not require you to draw the salary if you do not need to. You can always defer it, and get it back with interest once the business starts making some money.
Your salary should reflect what you’re worth
How much are you worth?
First, figure out what you absolutely need. Start with your personal expenses. Be sure you include semi-annual and annual expenses as well as unusual or rainy day amounts. Then add your start up and operating expenses. Start up expenses may include business registration fees, business licensing and permits, starting inventory, rent deposits, down payments on property, down payments on equipment, utility set up fees. Operating expenses may include salaries (yours and staff salaries), rent or mortage payments, telecommunications, utilities, raw materials, storage, distribution, promotion, loan payments, office supplies, maintenance. Six months operating expenses is a good start. Tally everything and you’ll have the amount that you absolutely need. If you are starting a business yourself, and have no need of external funding, use this number as your salary base.
However, if you are seeking external funding, go to the next step and figure out what you’re actually worth.
This number will be a combination of:
- the skills and expertise you bring to the business and;
- 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. Your accountant works with many other businesses and should be able to help with what is normal for your industry.
You need to look at salary ranges for your role and where you fit into the salary range in terms of expertise and experience and how much the local market will bear. So the next step would be to check out the competition, finding out who they are and how much they charge.
Once you’ve done your research, you’re ready set your salary.
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 break-even, many small business owners are tempted to re-evaluate their salaries. We would generally advise against this as 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 reevaluate. If you’ve been paying yourself only 70% - 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%. Your salary is then tied to the performance of the company.
Review your salary regularly
Businesses aren’t static, so your salary shouldn’t be either. You should review it regularly, relative to your business’s performance. As your accountant, we can assist by ensuring your salary and any bonuses you pay yourself are in keeping with your tax goals. We can also discuss the advantages and disadvantages of paying yourself through salary, dividends or a combination of both.