It’s been about 3.5 years since I quit my job to start my business, SBO.
Over the weekend, I was looking back at the financial forecasts and projections we set ourselves right at the beginning of starting the business.
It is diagrammatically shown below.
I LOL at these lofty projections. In classic startup style, they were highly optimistic.
I can say that we’re nowhere near the financial goal we set.
But on the upside, we’re in the best financial position we’ve been in since the start of our business venture. Personally, I’m at a point now where I’m not experiencing soul-crushing anxiety on a daily basis due to financial problems.
My personal finances
Part of the crushing anxiety I faced early in my venture was because of my personal financial situation.
I didn’t draw a salary for the first 14 months of starting my business.
Yes, it sucked. Chances are you also know of that pain.
I had some savings that I set aside to ensure I could continue to cover my Minimal Viable Lifestyle – the bare minimum funds required to live a ‘satisfactory’ personal lifestyle.
But that financial runway was finite (15 months to be precise). And I almost used it all up – an experience I’d rather not have to endure again.
Over time, a growing and financially healthier business has meant my business partner and I have been able to incrementally increase our salaries.
Both in our early 30’s, we’re entering the stage of life where the financial costs of wedding, family house, car and children are looming and need to somehow be funded.
So yes, it has been nice…really nice, to take a little bit extra to start saving for these life expenses.
Mind you, my current salary is still nowhere at the level to compensate for the wage I didn’t draw in the first phase of the business. Nor it does it compare to the salary I could humbly command in the market if I were to get a ‘job’.
But compared to what it was, I’m grateful to be able to take a little more off the table.
Taking too Much
We’re a very young company. And we’re always conscious of ensuring we’re not taking ‘too much’ from the business.
Taking too much to the extent that it suffocates growth.
Don’t be fooled by the image of young, “millionaire” CEOs that post photos of their waterfront home and Range Rover on Instagram.
The beauty of my role as an accountant is that I see the financials – the truth of what happens behind the veil of Instagram accounts and extravagant press releases.
I can tell you that a lot of these CEOs that are ‘crushing it’, own companies which are only one bad debtor away from bankruptcy. Their lavish lifestyle is often borrowed from the bank.
I fear that I may one day end up as one of those guys…but I have a safeguard – my wife who carries a stick to constantly beat down my ego.
My other assurance is that as accountants, we are constantly aware of the conflicting priorities between our role as an ‘employee’ in the business, as well as being an investor/owner.
We are aware of dancing the fine line between taking too much capital from our company to fund our ever-growing lifestyle wants, whilst ensuring we leave enough capital to continue to grow our asset.
The asset being our business which will provide us with real long term wealth – via dividends and growth in equity value.
And a big part of that is understanding the question – how much is too much?
How much do you pay yourself?
I am a numbers guy – so whatever strategic decision we make, we always crunch the numbers via our financial model.
But over the years I’ve learnt that that’s not how everyone makes decisions. And the most subjective decision for founders is – how much can I take from my business?
In this blog I offer a framework of how much you should pay yourself based on each phase of your business journey.
I wrote this guide because I’ve seen companies fall into dire financial straits due to unsustainable salaries drawn by Founders and CEOs.
The Three stages of your business
Every business goes through three growth phases;
- Phase 1 – Startup
- Phase 2 – Scale-up
- Phase 3 – Maturity
Phase 1 – Startup
The startup phase is the stage where you’re just getting your business off the ground.
You have contributed a boatload of your own money into getting the thing started. Now you have to dedicate even more time, patience and energy into growing it. At this stage, it’s likely that you are not paying yourself anything because your business can’t afford to.
But you should pay yourself something. Up to your personal hygiene rate, or what I term, the Minimum Viable Lifestyle.
The Minimal Viable Lifestyle
You may be familiar with the Silicon Valley term Minimal Viable Product (MVP). This phrase was popularized by startup guru Eric Ries in his legendary book The Lean Startup. The MVP thesis is designed around building the cheapest and smallest product possible, with just enough features to satisfy your early customers.
The idea is to work within a cost constraint that achieves the most viable outcome.
The MVP principle can be adapted to disciplines outside of the software and product development world. As an accountant, I like to apply this perspective to my personal finances. I term it the Minimum Viable Lifestyle (MVL).
The idea behind the MVL is to design your lifestyle so that you are living on the lowest viable cost, which still yields the highest impact to your satisfaction. The core principle is that you only spend money on things which have a high personal utility.
The process simply involves an audit of your personal monthly lifestyle expenses, and eliminating the unnecessary or impulse purchases.
The aim is to understand the minimum salary you can live off of and still enjoy a satisfactory lifestyle. You can find a step-by-step guide of how to calculate your MVL in my book Stark Naked Numbers.
From a business accounting perspective, figuring out your MVL provides a guide of what monthly salary you should draw before investing any surplus profit back into the business.
Which brings me to my next point – sticking to a regular wage!
The added benefit of calculating your MVL salary is that it mentally draws a line in the sand. Rather than taking money from the business as you need it, it helps you to stick to a fixed monthly salary. This mentality equips you with the financial discipline that will serve you long into the future.
Phase 2 – Scale up
As your company hits its stride with growth – understanding the value proposition to customers and has nailed a repeatable engine to service those customers, you start to enter the ‘Scale-up’ phase.
Subject to how aggressively you pursue growth in this phase, you will find that cash flow is a lot better than it was in the Startup phase. Your sales cycle becomes more predictable, you may even start to generate profit.
In Scale-up phase, I find a lot of CEOs get very ‘optimistic’ about their growth prospects. The business is heading up and to the right, so you can justify to give yourself a bit of a raise, right?
The trap in this phase is that CEOs don’t have a sound understanding of their Working Capital Cycle.
That is, how efficiently they are converting profit into cash.
These companies risk ‘growing broke’.
In this phase, sure, consider giving yourself a bit of a raise – but be conscious of the impact to your profitability and cash flow, and the extent it constrains your company’s growth.
Phase 3 – Maturity
Eventually, your business will hit a maturity phase. In this phase, your expenses and revenue are more predictable in nature. Growth is not at its once exponential phase and your company is profitable.
In this phase of the business, your company should be in a position to pay yourself a market salary as a CEO.
From my experience, CEO compensation for private businesses sit around $150k – $250k per annum.
Governance around company bank accounts
As the owner and CEO of your business, you will be tempted to pinch money from your company bank account.
You’re probably thinking what’s so wrong with that? After all, you’re the CEO and owner. It’s your money, right?
This is a common misinterpretation. We need to keep in mind that business and personal expenses are separate.
Not only does this create massive tax problems – it sets you up for poor financial habits.
Your company bank account is not a slush fund.
The only cash you should be taking from your business is via your monthly salary. That’s it. Nothing else.
If you want to pay yourself a dividend of ‘surplus profit’ – ask your accountant if you’re allowed to first.
Additional tips on drawing a market value salary
It’s not uncommon for the salaries of founders and CEOs to be based on tax brackets, rather than market value.
Your savvy tax accountant has most likely advised you to pay your ‘salary’ up to a marginal tax rate threshold of 30% (around $80k in Australia), with any additional cash drawings treated as a ‘Director Loans’. The tax treatment on these drawings are dealt with in your company tax return – typically paid as ‘Dividends’.
Whilst there are tax benefits with this advice, the problem is that it can skew your accounting profit and hence your ability to understand your true financial position. This is because the ‘cash drawings’ are capitalised on the balance sheet, which can result in an inflated profit position.
To deal with this, I have a few suggestions:
- Stick to a consistent amount of drawings per month (similar to your wage)
- When accounting for these cash drawings, code these transactions on your Profit and Loss as ‘Dividends’ or ‘Director Drawings’ as a non-operating expense in your Profit and Loss.
- I know this is not technically correct for accounting purposes (your tax accountant will probably get annoyed with you), but it helps you better understand the profitability of your business.
- In other words, these drawings stick out like the proverbial so you’re acutely aware of your spending habits.
In summary, the question of ‘how much do I pay myself’ can be highly subjective. But in principle, it comes down to how much your business can afford – not what you feel you deserve.
If you’re not sure if your business can support your pay rise – ask your accountant first. Or, give us a call and we can help you out.