What can my company afford to pay me?
What can I afford to pay myself?

As an active owner/operator of your business you must accept the conflict inherent in being both the boss and the employee.

The life blood of a business

Revenue is the life blood of a business. Revenue is the money that flows into the company from all sources and is used to pay for the expenses the company incurs doing its business.

Revenue consists of three sources. These are the proceeds from equity (sale of shares of ownership), and debt (sale of IOUs) offerings. These sources are critical to getting the business up and running.

The third source of revenue is cash/cash equivalents (sales of goods/services produced by the firm). Cash is cash in the bank. A cash equivalent is a very short term debt — an account receivable — owed to the company by a customer. Revenue in the form of cash/cash equivalents represents the only new money that can be used to sustain (pay expenses and debts) or grow (invest in) the company.
Cash flow is the key measure of success for a start-up. If the company is spending more money than it is taking in then it will eventually “bleed to death.” If it is taking in more cash than it needs to operates, then it can grow. The critical point for a start-up is the “break-even” point where costs and earnings balance out for the period.

The Active Owner and Cash Flow

The active owner/operator faces a real challenge especially if the owner is a sole proprietor.

In the role of company owner, you want to insure that the business survives and grows. Survival gives your owner’s equity share value. Growth increases the value of that equity. Therefore as an owner you want to preserve and use cash efficiently to increase your revenue or the ROI for every dollar spent. One way is to minimize your cash expenses. In your role as a creditor, you also want the company to succeed so that it can continue make its interest payments and to pay back the loan principal.

In the role of employee, you want the company to pay you a fair wage/salary for your current time and effort. Just like other employees, you want a wage that reflects what you feel is the value of your efforts for the company.   Thus as the owner and creditor, your salary/wage represents an expense to company which increases the cost of doing business and reduces the profits and eats into capital. But as the employee, it pays your bills and supports your life style.

This paradox is especially challenging for the sole proprietor who, when considering taking a salary or wage, must choose between the short term and long term cost and benefits to himself and to the company.

Salary/wage is a taxable event

As the active investor/owner your decision to take a salary includes subjecting yourself to federal and local personal income tax as well as the employee’s share of FICA (Social Security) taxes. Being a sole proprietor requires you to pay the full self-employment tax — both the worker and employer portions of FICA.

The Questions to ask yourself if you are planning to take a salary:

• Just how much cash do I require to meet my personal obligations and needs?
• Do I need a salary?
• Do I want to pay personal income tax?
• Do I deserve a salary?
• What can I afford to pay myself?
• How much can the company afford to pay me?
• How much value will the company get for that expense?

Conclusion

A Start-up business is a birthing process. You invest your time and talent, heart and soul, into an idea. You develop it into a concept, test it, and make a commitment to yourself, and maybe others, to take the next step. At this point you form a “company” to wrap around the concept thereby creating a new entity (a business) which is part of you but also has a separate life of its own. This entity requires revenue and nurturing if it is to grow and survive. Most start-up businesses that fail do so because they do not understand or plan for the financial responsibilities they are going to face when the founder(s) ask themselves — What am I worth?

[Guest article from Ruchit’s blog, siliconverse. Though some of the content refers to US laws, overall it’s a useful article to understand founder’s compensation model.]

Also see: Stock Compensation in Early Stage Start-ups – How to go about it?

Tags: cash flow management, Entrepreneurship, startup compensation model