Let’s talk about a subject matter that for many of our clients, isn’t a challenge they are typically expecting (or even thinking about) early on in the startup process. But this subject matter becomes a huge question and a certain reality — usually sooner — than later.
Paying yourself. To pay yourself during tight circumstances, you will have to have your ducks all in a row.
Once your company reaches a certain point, it’s expected that you are now able to pay yourself. A.K.A., the reason why most of you reading our company blog daily, you want to be an entrepreneur. To do what you love, have full control of your destiny, and perhaps most importantly of all for you, to compensate yourself with what you deserve.
Making a profit is good. That’s why you’re a business. Making money should be expected. You need to make a living.
The questions that our clients most often ask:
How do you go about paying yourself?
What is fair, and what is greedy?
What is enough vs. what is too much?
What amount is taking away from the growth of your company?
Let’s cover the biggest items first. You need to be able to live. Identify what your monthly and yearly expenses are. Only count what your essentials are at first.
This excludes upgrading your daily habits, buying a more expensive home or a better car, etc. Identify this amount for the present moment.
When it comes to the first time you are compensating yourself, identify your current state of affairs, purchasing habits, and daily expenses. This is a great starting point.
Second, see if it aligns with your business profits. By taking this away from your profits, are you still able to cover your company’s daily expenses and upcoming investments? If the answer is yes, you have identified what is considered your bare minimum salary. Congratulations!
Now, one important item to discuss here is the risk of paying yourself now vs. later. A better example of this is the compound interest dilemma.
For example, you decide to put money in mutual funds every month. An extra $50.00 a month will begin adding up over time; a lot more than just $50.00 a month that you’re investing monthly, right? This is thanks to the concept of compound interest and your principal growing consistently.
This compounding interest is the same principle when you are taking money away from your business to compensate yourself.
What you are taking away to pay yourself is the principal that you could had otherwise invested back into your company, and therefore, see the compound interest and dividends from such an investment.
If you are paying yourself 90 percent of your profits, you could be seriously jeopardizing the long-term growth of your company because you are being selfish. You could be preventing yourself in months or years to come, the chance to have made even more profits, revenue and therefore income for you.
Here is a real example. Let’s say you decide to add an additional $5,000.00 a month of income to yourself. That would equal $60,000.00 a year, right? This is from you running the sales of your company since again, you’re still a startup.
Now at the same time, by paying yourself such an amount, you, therefore, didn’t have enough to hire an additional team member to your company. Let’s say this person would had been a sales manager to replace you as a full-time salesperson. This sales manager, if hired for $60,000.00 a year.
This sales manager, if hired for $60,000.00 a year ($5,000.00 a month, remember) would have brought you in ten new sales, translating $250,000.00 in gross revenue, $100,000.00 in profit before tax.
Therefore, if you then paid yourself from such profit from this one hire, you would have been able to compensate yourself even more. You also would have given yourself more time to focus on anything else; running your own company or having more time to relax on the beach.
See in this example how by compensating yourself, you lost such an opportunity for even more growth? This is before calculating even the opportunity cost of having someone handle your sales for you if you were an entrepreneur doing sales yourself.
You end up paying yourself less than you otherwise would have, and as well, you are spending more time working, therefore making your hourly rate less valuable.
Now that we’ve covered the short-term of how to pay yourself, let’s discuss how to manage your personal income further.
You need to diversify your income.
You see, the scariest thing I often see is a successful company today dying out tomorrow.
You need to be cautious about where your income is going to come in the future. You can plan all you want that your company will always remain its current level of success. We have covered this information on our blog. Go back on review those sections on the blog to update and remind yourself.
Keep in mine, you can’t just expect things. The market, clients, your personal health, and competition can and will always change.
So what should you do?
You will always want to seek professional guidance, but I have known enough and picked the brain of enough successful entrepreneurs over the years, I can give you the clearest piece of advice I have been personally given.
Invest a part of your income elsewhere.
You don’t need to be an angel investor.
You don’t need to start picking individual stocks and pretending you’re a day-trader.
Identify low-cost mutual funds, which I personally recommend through Vanguard.
Start investing monthly and put some money away. Then leave the money there and don’t think about it.
Invest in several mutual funds that diversify your risk. For example, 75 percent stocks, 25 percent bonds seems to be a good blend for many people.
On top of that, split up what kind of stocks and bonds.
Small market cap companies.
Large market cap companies.
You don’t need to put a substantial amount of your income away, but even just 10 percent of your total take-home earnings can make a difference.
Long-term, again, following the compound interest example provided above, you can have a serious nest egg.
Here is why such a strategy is recommended.
If the going get’s tough, you’re not pulling extra, unnecessary income away from your business. You have your nest egg to touch first.
This allows you to keep your company moving, growing and for those running it, still being able to get paid fairly.
This gives you a backup plan, already in place, without thinking of much.
Best case scenario, things never get to such a point and you have a nest egg built up from saving 10 percent of your total take home every month, years from now, you can invest that right back into your company.
You are not as limited. You can buy a house with straight cash, withdraw a percentage of your principal monthly for extra income without having to work for it (though a bit technical, the trinity study supports if you withdraw 4 percent, you should in theory, never run out of your investments over a 30 year period… here you can learn more about such an approach).
You can pay for your children’s college tuition and weddings without putting a heavy financial burden on your family. Pretty much, you’ve hacked your way into financial freedom, after already hacking yourself into controlling your own destiny of being an entrepreneur.
Keep in Mind
How to pay yourself.
The questions you need to consider.
How to identify a fair rate to pay yourself.
How to invest and diversify your income.
These aren’t topics that many entrepreneurs think about, especially early-on in building a business, but the more open, honest and understanding you are of such items, the better off you’ll be.
The more prepared you’ll be, and most importantly of all, the more opportunity you’ll have to scale your company, giving the dividends back to you.
The ultimate win-win scenario.