Don't Forget! - Pay Yourself First!

by Dr. Robert Sullivan

Every small business owner and entrepreneur assumes their venture
will succeed. This is a healthy, and necessary, attitude to mimic
for those of you contemplating starting a new business. But the
fact is most successful entrepreneurs have failed twice previously.
The successful entrepreneur views these failures as learning
experiences and an opportunity to succeed next time. But will
there be a next time for you?

Consider this true story. Like so many entrepreneurs, Richard's
first business started with a single customer. He had a regular
job but had been contacted by a company that wanted to purchase
a few hours of his time to assist in solving a problem for which
he had expertise. Richard took on the work. One "little" job
lead to another and soon Richard was spending a significant
portion of his spare time working as a consultant. The extra
money was great. Eventually it became possible to quit his
job and start his own company. Initially all his work came
from the company that had originally hired him.

Richard's business grew to accommodate increasing demands from
his single customer. This growth was made possible by returning
all profit back into his new company - Richard only kept the
bare minimum needed to meet his current expenses. Unfortunately,
after a couple of very successful years, Richard lost this
major and first customer. The loss was devastating and eventually
the company was forced into bankruptcy. Richard lost his company
and had very little to show for his previous hard work!

I guess we could say Richard was a victim of his own success.
Unfortunately, because of the very traits that can make an
entrepreneur successful, he or she will sometimes forget to plan
for possible failure. One of the biggest and potentially most
damaging errors is failing to pay yourself. Many small business
owners figure that later, when the business is making a profit,
they can take a salary. This can be a grave mistake in the event
of a business failure - you may just end up with nothing for
your efforts and, worse, be left in a position where it is not
possible to try again!

It is difficult to find a book in the small business genre that
even mentions paying yourself, let along give some advice about
it. Could it be that all those authors assume it's not worth
mentioning since a business owner does not need to be told to
pay himself?

As our little story above shows, it does happen frequently. Don't
you do it! Do NOT make the mistake of putting every dollar of
profit back into your business.

You may prosper for a number of years and then be suddenly plunged
into bankruptcy through no fault of your own. If this happens,
and you have not planned for the eventuality, you may find
yourself in a very difficult financial position. Remember that
you deserve to be appropriately paid for your efforts. Pay
yourself first.

Most small businesses are not initially profitable and this
must be taken into account in your planning activities. If
your business will be financed by others, ensure that you
have added an appropriate salary for yourself in the business
plan.

If you are financing the business yourself, the situation is
a little different. You probably have assumed you will take
no salary until the business is profitable. But when profit
is available, it's important to immediately start paying
yourself on a regular basis -- just as if you were an employee.

How much should you pay yourself? There is no easy answer or
magic formula and it is difficult to give specific advice but
some general guidelines are worth noting.

If your business is equity financed, your salary should be formally
determined based on a formula agreed to by the equity lenders.
As an example, in a recent startup for which I assisted, the
equity investment was $200,000. The two owners agreed to a
starting salary of $3000/month until the business became
profitable at which time their salaries increased based on a
percentage of gross profits. The initial salary was based on
the current monthly needs of the two partners and was agreed
to by the equity investors.

If your business is debt financed (by yourself or others), your
business or strategic plan should include your own salary and
its basis. Clearly, if you are using your own money to finance
a new business you probably won't initially take a salary. In
this case you should ensure that your savings and any other
sources of income will support you until you become profitable.
However, as soon as the business starts returning a profit,
start paying yourself a reasonable salary.

Strike a balance between growth considerations and your salary.
This will be different for each business but thoughtful planning
will allow you to determine an effective split.

We all plan for success but in the world of small business,
failure is all too possible, and for reasons beyond your control.
So plan for both success and failure. Don't return every
dollar to the business. Keep some for #1, yourself!