Should business owners get a salary? 📊
Read example by a business owner who didn't get a salary...
In the dynamic and ever-evolving realm of entrepreneurship, the question of whether owners should draw a salary from their businesses has been a subject of intense debate. I have witnessed firsthand the contrasting perspectives on this controversial matter.
Surprisingly, a significant number of founders choose to forgo a regular salary, opting instead to reinvest profits into the growth of their ventures. Such was the example of Kathrin, a friend of mine with whom we had a relevant talk a few weeks ago.
However, as you may guess, this practice is not without its pitfalls, and it often raises concerns about its potential to undermine the very businesses they seek to build.
In this article, I will delve into the cons of this contentious issue and explore the potential consequences it can have on their businesses.
The answer is well stated by one of my favourite business authors:
"Business owners should receive a market-based salary rather than relying solely on profits for compensation.”
Greg Crabtree, Simple Numbers, Straight Talk, Big Profits!
Not getting a market-based salary as a business owner can lead to….
1. Fair Compensation: A market-based salary ensures that business owners receive fair compensation for their efforts and contributions to the business. It reflects the value of the owner's time, skills, and expertise, just as it would for any other employee in a similar role.
2. Separation of Roles: By receiving a market-based salary, the business owner distinguishes their role as an employee from their role as an investor or shareholder. This separation is essential for evaluating the business's financial performance objectively.
3. Sustainable Compensation Model: Depending solely on profits for compensation can lead to inconsistent income for the business owner. Market-based salary provides a stable and predictable income, helping the owner to manage personal finances more effectively.
4. Attracting and Retaining Talent: If you do not pay yourself a fair salary, and something unexpected happens that requires you to hire someone else to do your work, there will be no funds available to allocate for the new hire. This scenario can prove detrimental to your business, as it may hinder your ability to attract an executive of the same caliber and remunerate them appropriately.
5. Aligning Incentives: A market-based salary aligns the owner's incentives with the overall success of the business. It ensures that the owner is compensated for their efforts, regardless of the business's profitability in a given period.
6. Financial Clarity: Separating owner compensation from profits provides clarity in financial reporting. It allows the business owner to analyze the business's financial health more accurately and make informed decisions.
7. Accurate Profit Assessment: By ensuring that the owner's salary is market-based, the true profitability of the business can be better assessed. If the owner's salary is not market-based, it may artificially inflate or deflate reported profits.
8. Avoiding Tax Issues: Receiving a market-based salary can help the business owner avoid potential tax-related challenges, ensuring compliance with tax regulations.
Well… it should be clear by now, but let's consider two examples to illustrate the concept of a market-based salary for business owners:
Example 1: Market-Based Salary
Suppose John is the owner of a small manufacturing company. He also serves as the CEO and actively manages the day-to-day operations. John's skills and experience are vital to the company's success, and he could earn a competitive salary if he were working for another company in a similar role.
In this scenario, John decides to pay himself a market-based salary of 80,000 euro per year. This amount reflects the fair compensation he would receive if he were working for another company as a CEO in the same industry.
By paying himself a market-based salary, John ensures that he is fairly compensated for his work and skills, and it also helps him maintain financial stability in his personal life.
Example 2: Not Market-Based Salary (with consideration for the consequences of departure)
Demetra is the owner and manager of a small retail business. She handles various responsibilities, such as managing the day-to-day operations, marketing, and customer service. However, Demetra chooses not to pay herself a market-based salary and relies solely on the profits generated by the business to support herself.
Potential Consequences if Demetra Leaves the Company:
Vacant Key Role: As the owner, Demetra plays a crucial role in managing the business. If she were to leave the company unexpectedly for any reason, her departure would leave a significant gap in the key management position.
Market-Based Salary for New Manager: To attract a qualified candidate for the managerial position, the company would likely need to offer a market-based salary that reflects the responsibilities and expectations of the role. However, Demetra wasn’t receiving a salary so the company doesn’t have projected and allocated a market-fair salary for her role.
By not paying herself a market-based salary, Demetra not only risks her personal financial stability but also faces potential challenges related to the continuity and stability of the business if she were to leave.
Paying herself a fair market-based salary would not only provide Demetra with financial stability but also ensure the business is better prepared to handle changes in leadership and attract suitable replacements if necessary.
In conclusion…
In conclusion, a market-based salary for business owners is not only fair compensation for their contributions but also a strategic decision that accounts for business continuity and long-term success. It ensures the company is well-prepared to handle potential changes in leadership and maintain stability even in the face of unforeseen circumstances.
Let’s interact on the comments: what’s your opinion on that?
PS. I highly recommend you to read Greg Crabtree's book “Simple Numbers, Straight Talk, Big Profits!” - It is what I call literally mindset shaping!
Finally…. don’t forget, sharing is caring, so it’s high time to…