How Much Should You Pay Yourself?

“”Self-Esteem: An erroneous appraisement”” – Ambrose Bierce, The Devil’s Dictionary

Recently, Fortune Small Business magazine did a story on executive compensation. It cited the case of two San Diego entrepreneurs who started a high-end home-furnishings business (the Richard Fischer Collection) with the long-term goal of getting wealthy.

But getting there has been tricky for them. Richard Fischer, who used to make a hundred grand as a political analyst, pays himself just $60,000 today. “I’m in the grocery store looking at coupons, “ he tells FSB.

How much you pay yourself is a difficult and important question for most start-up business owners. It says a lot about your commitment to your business and involves such sticky areas as employee morale and company culture.

And even if your compensation could be hidden from everyone but you, there is still the all-important consideration of how you should be spending your cash. Every dollar you pay yourself is a dollar you can’t be reinvesting in your business’s growth.

I’ve done it both ways and in between.

I’ve been in a business in which my partner and I took out almost every spare penny we could. We knew what our cash-flow requirements were – and when the bank accounts exceeded them, we pocketed the difference. We did that regardless of our business’s profitability. It was great fun – but greedy fun and maybe not the wisest policy. (I’ll get back to this later.)

More often, I’ve been in businesses in which I took out nothing but expenses while the business was growing. Employees were getting paid. Even my partners were getting paid. But I wasn’t. That didn’t feel nearly as good as the Greedy Game, but it did feel virtuous.

The main business I’m involved in right now employs about 250 people, generates about $100 million in revenues, and puts a marginally respectable number to the bottom line. My base compensation (like that of the company president) is relatively low. Our non-variable compensation is in line with that of senior management – leaving most of our remuneration performance-based.

What Should You Do? There Is No Easy Answer, But Here Are Some Thoughts . . .

In a small business, it is almost inevitable that your employees will eventually discover how much you make. This is not good, because they will probably not understand the value of your investments (in terms of both time and money) and will instead (as naïve journalists do) compute your compensation on an hourly basis – as if you were a wage earner – and come to the conclusion that you are grossly overpaid.

If this happens, ignore it. There is no way you will ever justify yourself. Say nothing . . . and don’t flaunt it.

If you haven’t yet been financially “outed,” take every precaution to make sure you won’t be. Do everything you can to make all compensation issues private – and make your own (and your partners’) compensation the most difficult to ascertain. Limit severely the number of employees who have access to that information. And swear them to secrecy. Also, break your compensation into pieces and try to arrange it so that even your payroll person doesn’t know all of it. (Why should he know about your profit sharing?)

Do everything you can, but expect that, sooner or later, the truth will out (as the bard put it).

Back To The Main Issue: How Much Should You Pay Yourself?

Here’s how I see it.

First, you must figure out what you do and break that down into jobs. If you are the CEO, figure out how much you’d have to pay a CEO to run your company. Give yourself that salary – the same base and the same incentives – but nothing more for being CEO.

After doing that, recognize that there are things you are doing for your company that go beyond what any hired hand, however good, will ever do for you. The way you care about your company and the ideas you have for its development, for example. These are assets you can’t evaluate precisely, but they are enormously important. As Frederick Winslow Taylor, the world’s first full-fledged efficiency expert, said (a century ago), “Men will not do an extraordinary day’s work for an ordinary day’s pay.” Recognize this fact and feel free to pay yourself something extra for what you do.

Then, of course, there is the variable compensation – your chance to reward yourself for your role as investor and equity holder. How much you take in in any given year is a complex question. It depends on the cash flow and the lifetime value of your customers. It depends on your growth plans, the regulatory environment, your competition, and your personal plans.

As for shareholder distributions, here’s what I do: As soon as the business becomes profitable, I pay out something – and it could be only 5% of profits – depending on cash flow, growth plans, etc. Usually I pay out as much as the company can reasonably afford.

There is a lot of discussion today about how much CEOs should make. As an owner of a small and growing business, you should ignore it. Most opinions on the matter come from experts who have never owned a business, never been offered a million-dollar-plus salary, and never had the opportunity to choose between reinvesting dollars and keeping them for themselves.

Pay yourself a fair salary – equal to what you’d have to pay someone else to do the same job. Distribute profits as often as you can but never more than is reasonable. And reward yourself for the extras you give the business.

Want more specificity? My hunch is that the total performance-based compensation of a business should be around 20% to 30% of profits. And I believe that the person (or persons) on top should get about half of it.

One More Thing . . .

I think that your base compensation should be – in profitable years – a fraction of your total compensation.

So, if you have a $40 million gross, $5 million net (before performance-based incentives) business, you should be paying yourself a base of between $150,000 and $350,000 with a vig of maybe 2% or 3%. That is your CEO compensation. That would amount to between $250,000 and $470,000. And that sounds about right. It would probably be in the upper part of that range.

Then you might distribute 10% of the profits . . . which would give you up to another $400,000, depending on how many shares you owned.

And, of course, you would pay yourself for that “something extra.” If you used the 20% figure, you’d have $1 million to cut up. As the sole owner, you’d get half of that — $500,000 – for a grand total of up to $1.4 million.

Feels right to me. What do you think?