Five Essential Components of an Entrepreneur’s Compensation
Entrepreneurs can take money from their business through two methods: draws or a paycheck. The type of legal entity will determine which method can be used. In either case, entrepreneurs need to be careful not to shortchange themselves when calculating their total compensation package.
It’s easy to think you can do well with a similar hourly rate that you earned as an employee, especially if you’re running a service business. Here’s a quick list of five elements that should be included in the compensation of every entrepreneur:
1. Competitive pay
If you were doing the same work for a company that hired you, what would your pay be? Are you making at least market equivalent or better? You should be earning a reasonable compensation for services rendered. Many times, as entrepreneurs, we tend to focus only on this piece of our compensation, however, and that’s a big mistake. It’s only 75 percent of what total pay needs to be.
2. Return on Investment.
As an entrepreneur, you take extra risk when you own the company and should be compensated accordingly. Your capital is tied up in your business and should be earning a reasonable return in addition to your salary. Often this takes the form on monthly or quarterly profit distributions.
3. Benefits & Expense Reimbursements
Employees get vacations, health insurance, and bonuses; and you should, too. This should be considered part of your compensation package as an entrepreneur.
Also as an owner, the business can pay for several things that employees might have to pay for on their own. Examples include cell phones, mileage reimbursements, business meals, etc. Just be careful not to take it to far- we see business owners try to write off dog sitting expenses as travel, phones for minor children, and even home cable service. Clearly these don’t meet the reasonable and essential tests for deductibility on your tax return.
Although our individual taxes are not deductible as business expenses, we need to ensure there is enough cash available to pay taxes on the profits from the business. It’s a huge chunk too. We work about three and a half months every year, just to pay for our taxes.
5. Retirement plan
When you work for yourself, no one is going to fund your retirement but you. Although the Social Security program helps a lot of seniors, it’s up to you to set additional money aside for retirement.
Compensation should include all of these components. If you cannot afford to pay yourself that much, then your business model may need some adjusting. Perhaps pricing is the issue, or it could be a volume issue.
It’s normal to take a smaller paycheck the first few years as we are building our business. However, if you’re still doing it after several years or having cash flow issues, then something may be wrong.
Make sure your future is bright and financially secure by including all five components in your entrepreneur compensation.
If you would like our help in this area of your business, please reach out and let us know. We would love to be of assistance.