When should you start paying yourself as a small business owner?
It’s a common question that business owners grapple with but figuring out how and when to start paying yourself is a challenge that many struggles to answer.
Setting out as a new business owner is a journey of discovery and, often, heartbreak.
Nobody gets into business for themselves to work pro bono. Still, unfortunately, this seems to happen far too often, with business owners feeling obligated to pay down all costs and reinvest any extra into their business before drawing a meaningful wage for themselves.
This shouldn’t be the case.
For business owners, there should only be three answers to the question of when to begin paying yourself. They are:
- As soon as possible
- As soon as the business can afford it
- When your labour is part of the goods or service
In reality, no one answer works for every business.
The timing for paying yourself is different for every single business and business owner. Some businesses may be profitable early on, while others may take years to reach the point of breaking even, let alone profitability.
Not all business owners are actively working in the business. So when should they get paid?
Other business owners may work full time in the business and therefore require an income for living.
Some business owners have the expectation that they won’t get paid for the first 12 months and set aside personal funds to get them through. Others are planning to build up a business and sell it and receive their payment through the sale.
Every business owner will need to take their individual circumstance into account when considering when and how to pay themselves. So it’s important to discuss this decision with a bookkeeper or accountant to make sure nothing is missed in the decision-making process.
There’s often more to it than just the ‘when’. You also need to consider: ‘Why should I pay myself?’ ‘How should I pay myself?’ and ‘What amount should I pay myself’.
Why should you pay yourself?
There are a number of pros and cons to taking into account when working through the logic behind choosing to get paid as a business owner.
There may be many more on both counts, but here are the major considerations for and against so you can work out how best to define your personal situation.
Considerations for paying yourself:
- Paying yourself helps keep the cost of running your business accurate. Business owners often don’t include their labour in costing and may under-price their products or services because they don’t incorporate it into the price.
- The business’s value can increase if it’s shown that the business owner has received a wage.
- You need to get your investment back at some stage and paying yourself is an effective means of doing that.
- Payment can act as a reward for your hard work. It can help to keep your spirits high. To work the hours many business owners do and not get a reward can become demoralising over time. Even if you start with a modest amount of money in the beginning and then increase it as the business grows, this can add to the sense of achievement and pride of owning and working in a business.
- The business gets used to paying for you, so if you want to leave the business, step back or get a replacement, it doesn’t end up becoming a new expense that has to be found.
Considerations against paying yourself:
- If you take money out of the business before it can afford it, you can put the business at risk. A business incurs a large percentage of costs at the startup phase and growth phase and needs to have healthy cash flow at this time. Drawing a wage is drawing from those vital funds.
- Paying yourself incurs an opportunity cost. Money that goes to the owner isn’t being spent on other things that may help grow the business, such as attracting more customers through marketing.
How should you pay yourself?
You should pay yourself in the way that works best for both you and the business.
And there are a variety of ways to pay yourself. You don’t always have to pay the same amount on a regular basis. For example, you could pay in chunks or on an ‘as necessary’ basis.
You could even consider seeing how the business is positioned at the end of the year and draw a lump sum according to the business’s capacity.
Most importantly, speak to your accountant or bookkeeper to discuss what options are best for you.
What amount should you pay yourself?
There are different ways to look at this question.
There are issues of worth, cash flow, replacement value and compensation for risk and investment – all of which can be factored in to what you get paid.
Ultimately, it’s your choice as to the rate, but you’ll want to be very careful that whatever you’re drawing doesn’t hamper the business’s growth or sustainability.
Some things to consider include:
- What your business can afford
- What is a realistic wage (not too low, not too high)
- What you need
- What you’d like
It is essential to consider if the amount you are paying yourself would be enough to get a replacement for you? If not, you might like to increase it.
Are you earning the minimum wage or higher? Have you taken into consideration superannuation? If your wage is low, you might like to ask yourself why? Does it need to be that low?
One of the many reasons people start a business is to increase their earnings. It’s important to reward your efforts and the risks you’ve taken. If you don’t get around to paying yourself, those rewards may pass you by.
So, get some advice and work out a plan for when what and how you’ll start paying yourself.
Whatever happens, don’t leave it too late.
Three pieces of bad advice for startups that you should avoid.
While the vast majority of this advice is well-meaning – and not all advice fits all startups – we talked to three startup founders about advice they’d received that turned out to be complete tosh.
1. On paying for advice
Co-founder of Mentorloop, Lucy Lloyd, told The Pulse that there was no shortage of people willing to give you help and advice – but you should avoid those charging for it like the plague.
“To early-stage founders out there, we’d say: do not pay for advice.
“Not with cash, not with equity. At [that] early stage, you need to have the best understanding of the problem that you’re solving, and the customers that you’re targeting.
“When you’re very early on, nobody can provide quality enough advice to replace that research, and there are plenty of awesome people who will help you without asking for money. “
Lloyd also said founders would be well advised to ignore commonly held wisdom that you should always go back to existing funders before going out for a second round of funding.
This, she said, meant that you were essentially validating the same idea against the same audience. Plus, it’s not always wise to constantly ask for cash.
“Your early investors have backed you at the longest odds, repay that by not reaching into their pocket at every opportunity,” said Lloyd.
2. On how much cash you need to get started
Co-founder of social enterprise YGap, Elliot Costello, said the main bit of bad advice he’d been given (aside from being told that his crazy ideas wouldn’t work) was that a startup needed plenty of capital to grow a business.
“What I see is ‘you need money, you need money, you need money,” he said.
The downside of having access to capital (and it’s not a bad problem to have) means that t means startups are robbed of the crazy thinking sometimes borne of necessity.
“There have been plenty of companies who have made a go of it without a lot of cash in the bank because it allows innovation and creativity,” said Costello.
“I see a lot of advice around which says that you need a lot of working capital to be successful, but having access to cash can sometimes stifle innovation because you have that fall-back.
“I’ve never seen a non-profit with too much money, and I think if we did have cash we’d probably do it totally differently.”
3. On pitching (too) early and (too) often
Meanwhile, co-founder of Law Squared, Demetrio Zema, said startups were often advised to pitch early in their lives.
“We tend to see ‘pitch for investment early’, which I don’t think is a good idea,” he said.
“It’s about solidifying your team, about your model, being sure you’ve got something that’s workable to go to investors.
“You’re dealing with somebody’s money, so going in with a half-baked idea is reckless.”
He said part of the desire to bag backers as quickly as possible was a desire to go to market as quickly as they could – something Zema also said was bad advice.
“There’s this thing about wanting to go to market quickly, so you can either succeed or fail quickly – but I’m not a huge believer in failing fast,” said Zema.
“I think when you’re playing with somebody else’s cash particularly, you shouldn’t just go to market or chase further investment as quickly as you can.
“You need to validate the idea first. That doesn’t mean you need to have a bunch of customers, but it does mean consulting with independent individuals about what the idea might be and getting a market around that.”
Five tips for developing a business idea into a real venture
Having a solid business idea is a far cry from having a successful business. In this article, Benjamin Kluwgant discusses the best ways to approach turning your concept into a reality.
Have you ever been working your day job and all of a sudden experienced a light bulb moment with a genius business idea?
Well, if you have, you’re certainly not alone. These days, anyone with even the slightest drop of entrepreneurial spirit in their blood tends to come up with an idea every now and again that they consider taking on.
Unfortunately, these ideas don’t often come to fruition due to obstacles such as limited access to funding, lack of know-how or readiness to leave a full-time and secure job. Other times, a simple lack of follow-through can be the culprit. The idea then goes begging and joins millions of others in an ocean of missed opportunities.
In the small percentage of instances that such an idea is taken seriously, moving from the idea phase into creating an actual business is nothing short of an uphill battle with an endless amount of challenges.
But, if the right strategies are used and if the idea is approached with a disciplined attitude, these unavoidable challenges can play a huge part in setting up a long-lasting business with strong foundations.
In order to get some insight from an experienced, early-stage business mentor, I reached out to Alan Tsen, Melbourne general manager of Stone and Chalk and chair of Fintech Australia, asking for his take on how to approach this delicate transition from idea to business.
1. Setting realistic expectations
According to Tsen, before beginning the journey from idea to a full-fledged business, it is important to align your expectations with the reality of the situation: starting a business is far closer to tip-toeing through a minefield than it is to a stroll in the park.
“Building a company is hard,” Tsen told The Pulse. “In fact, in many ways, it’s an impossible task that requires superhuman levels of focus and determination. It’s a grinding process that takes years of relentless work with many pitfalls and landmines.”
2. Stay focused – keep your eye on the prize
Assuming you can come to terms with the ‘mission-impossible’ type of venture that lies ahead, there are a number of important strategies that Tsen outlined that can help make the transition more manageable.
The first strategy is simple: avoid distraction at all costs.
Based on Tsen’s experience in watching early-stage business founders undergo this transition, he said that it’s “easy to get distracted” by the next “shiny thing” that looks like it’ll make your business more successful.
While ‘shiny objects’ are often tempting, they can be very dangerous. In the competitive world of startups and innovation that we live in today, it is of paramount importance to stay focused on building the solution to the problem you originally identified.
According to Tsen, in order to play in the league of “great startups”, the focus needs to be in creating one solution that is “a magnitude of order better” than any other pre-existing solution.
“Being maniacally focused on what your customers need, and solving their problem is the key early on.”
3. Validate and answer hard questions early
It doesn’t matter how good your business idea might be – when you start out, there are always going to be fundamental questions that need to be answered.
Tsen encouraged those starting out with their business ideas to “test the hard ones early” and not to be afraid to face those challenges head on.
“For example,” explained Tsen, “will a customer actually pay you money for the product? Is this product really ten times better? If it isn’t (which is fine early on), what is your proposed pathway to get there?”
Don’t shrug off the fundamentals or assume you ‘just know’ whether or not something will work. If you launch your business without answering those questions first, you’ll end up scrambling for answers when it’s too late.
4. Balance the company vision with customer input
Another strategy Tsen implored people to implement at the early stages of proving a business concept is to effectively balance your mission statement with the input you receive from potential customers.
When you’re in the validation phase, you have no choice but to consider the feedback offered by those within your target market. Often that feedback can lead to distractions which compromise your vision for the business’ direction.
“Have a view and vision for the company and then augment that with what your customers tell you,” said Tsen.
“If you can do that well, you’ll end up in the sweet spot of being both valuable and unique.”
5. Don’t let failure scare you
At the early stage of a business venture, risk of failure is extremely high. Entering the unknown, testing and tweaking your offering and keeping up with industry trends are all things that invite enough challenge to cause even the most ambitious of people to fail harshly.
As we saw from SpaceIL’s failed attempt to land on the moon earlier this year, successful stories are all filled with plenty of turbulent times and failures.
If you can maintain focus, find the courage to answer the hard questions, balance your vision with customer input and be ready to accept failure, there isn’t much that can stop you from building a high-quality business.