Small business owners and entrepreneurs, particularly those who are just starting out, can often find it difficult to figure out exactly how much they should be paying themselves. It’s not an easy decision. Most don’t want to take any money out of the business when it’s still not fully established. On the other hand, they need money to meet personal expenses, and often their business is their only source of income because they went all-in on it.
The average entrepreneur salary in the USA is somewhere between $68,000 and $72,000. It’s far higher than the average income in many industries but there are also many entrepreneurs who don’t pay themselves at all. So, if you’ve started your own business but are sitting on the fence about your salary, then this article is for you. I will walk you through how to calculate a fair wage and the key aspects to consider along the way.
Should You Take a Salary as An Entrepreneur?
Although some people begin working life as entrepreneurs, many start their business on the side. They manage their start-up around a fulltime job, often working on it in the evenings and on weekends. Since their main job pays the bills they might not think about taking a salary from their venture in the beginning. But is this the right approach?
There’s no question that if your business is your main source of income then you need to pay yourself a salary. After all, there are bills to pay and mortgages to keep up with so you need to keep those in check. Even if you’re worried about taking money out of the business, it’s crucial that you put some serious thought into paying yourself an appropriate entrepreneur salary.
You might have heard countless stories about other small business owners not paying themselves at all. Don’t feel bad about paying yourself because the circumstances are different for everyone. You may not take home as much money as you did from your regular salary back when you held down a 9 to 5 job, but living the entrepreneur lifestyle requires some compromises, at least in the beginning before your business takes off.
Calculating Your Entrepreneur Salary
All the big tech CEOs in the United States get paid a dollar as remuneration. Don’t romanticize that idea. You don’t have billions in stock options to cash in and your company isn’t flush with cash to float your business expenses, at least not yet, so take a more balanced approach. You will need to think long and hard to come up with a number that you feel is fair for you and doesn’t negatively impact the growth of the business.
If you do decide to pay yourself, then how much should it be? As much as the business can afford or just enough for you to live on? Unfortunately, there isn’t a hard and fast rule for calculating an appropriate entrepreneur salary. However, there are some factors that you can weigh up that’ll help you land on a reasonable figure.
What is Reasonable Compensation?
This is something that’s going to vary significantly for small business owners. The primary factors that it depends on are your personal expenses and the financial standing of your business. Has it started turning a profit yet?
If so, you could even take as much as 50 percent of the profits if you wanted or needed to, particularly if you plan on leverage financing like the many small business loans available from American Express, for example, for growth instead of reinvesting all of the profits from the business.
It’s obviously not going to be the same for everyone and there will be other considerations as well, including the draw method you choose, but paying yourself a reasonable compensation should never be taken off the table.
The IRS states that all employees should receive ‘reasonable compensation’. This means that your entrepreneur salary should be in line with comparable roles at similar companies. Recruitment websites like Glassdoor can give you an idea of the type of salary paid by other organizations.
There are also tax implications of withdrawing an entrepreneur’s salary compared with reinvesting the money into your business. Since these are complex and differ by a business structure, it’s best to get the advice of a qualified finance professional. You may find that the tax considerations decide your salary for you since the rates go up at specific cut-off points.
This is a crucial element that some small business owners may not be aware of when they’re starting out. You will be required to pay taxes on the money that you pay yourself, it’s treated as personal income, so make sure that you hold on to all documentation and pay the due taxes on time.
You will also need to be mindful of keeping a consistent payout schedule. Random draws from the company could result in a tax audit of your business by the IRS and that can not only be a drain on the cash flow of your business, but it’s also an unnecessary distraction that you can certainly do without.
This can often be a lot to figure out on your own. The best approach here is to consult a qualified tax professional. They’ll be able to help you ensure that you’re fully compliant with the tax liabilities. IRS fines are no joke and it’s always better to spend some money on a professional than paying significantly more in fines if it finds irregularities in the audit.
Cash flow is the lifeblood of any business so it’s important to consider how drawing a salary will affect it. Are you generating a consistent income that allows you to pay yourself a salary? Do your customers pay on time and would you still be able to pay yourself if an invoice becomes overdue? Do your figures based on the worst-case as well as the best case so that you won’t be caught out in a quiet month.
Remember, ensuring the continuity of business is of paramount importance. Do not end up putting yourself in a position where you have to close your business because of cash flow problems. It will serve as a warning to any potential investors even for your future endeavors, as it signals mismanagement.
They wouldn’t take kindly to knowing that a business owner kept paying themselves too much that they ran out of money to pay their employees and had to shut down. Make sure no mistakes are made when you’ve got your salary estimated and are projecting how paying yourself would reflect on the balance sheet of the business.
Salary or Owner’s Draw Method?
Once you’ve determined how much your salary should be, it’s time to think about the method you’ll use to pay it. The salary method will be familiar as it’s similar to how you’ll have been paid if you worked for other companies. You’ll receive funds on a pre-determined schedule based on a fixed amount or the number of hours you’ve worked.
If your company has either a C or S corporation structure then you may be legally obliged to use the salary method, that’s in addition to the withholding requirements for Medicare, Social Security, federal and state income taxes.
The owner’s draw method is where you take a portion of the profits as salary (not to be confused with a proportion of revenue). You’ll need to account for all of your expenditure first so that you know exactly how much money you’ve made after costs.
This means allowing for any and all business expenses, including employee salaries, utilities, rent, supplies, materials, etc before figuring out how much and when you can pay yourself from the amount that’s left. This option is available to most types of business structure.
Paying your own salary is one of the biggest rewards of starting your own business. Whatever amount you decide upon, be sure you’ve done your homework and can afford to pay it consistently (even if your customers don’t always pay on time).
How We Can Help
Strategic Capital offers business loans, merchant cash advances, and invoice factoring services that support organizations across the USA. We don’t require capital which means that your personal and business assets aren’t part of the equation.
If you’re in need of short-term financing, then we can help. Whether it’s to pay for emergency repairs or investing in expansion we offer small business loans without the need for collateral. Best of all, you’ll benefit from competitive repayment terms and low-interest rates, so you have more money to reinvest in your business.
Transparency, innovation, and expertise are the driving factors behind everything we do. With a talented team of advisors, a plethora of funding partners, and the best technology available -we go above and beyond to help our clients receive their capital rapidly with the industry’s most competitive repayment options and interest rates. We want to break speed records, not bank accounts.
Upon submitting your application, it’s reviewed by a dedicated Capital Advisor. We generate the best rates and terms at lightning speed through our funding matrix and robust lender network. Yep… it’s that simple. Learn more about our small business loans here.
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