Even after 10 years, entrepreneur Sean Glasser still finds it hard to set his pay.
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“Ideally, I’d like to make triple what I make, but it’s just not there,” said Glasser, CEO of BLUETRACK, a manufacturer and distributor of stress balls and light up products. “I really have to watch profits weekly and go conservative.”
From canned-tuna diets to a seven-day workweek, entrepreneurs like Glasser consistently sacrifice themselves for the sake of their business. But giving too much, and not taking enough in the form of a salary can lead to a company’s demise.
“An owner is an employee in the business and a shareholder,” said Greg Crabtree, CEO of consulting and accounting firm Crabtree, Rowe and Berger , “You get paid a salary for what you do and you get a return on what you own. Don’t confuse the two.”
Small business owners’ decision to underpay themselves affects both their personal life and financials.
“Business owners get so involved in the business that they lose sight of self, family and livelihood,” warned Lena Bottos, vice president of compensation at human resources management firm Kenexa, “Not every business survives, so if they haven’t paid themselves a salary, they have put themselves in a really bad financial spot.”
That bad financial spot follows the entrepreneur from the home to the office.
“When business owners underpay themselves, they are lying to themselves about the profitability of their business,” warned Crabtree.
When determining their salary and ensuring that profits are really profits, business owners should look at factors like industry, size and location.
“The first thing an entrepreneur wants to do is look at comparables,” advised Bottos, whose company purchased Salary.com. “They should find out who they compare themselves to at other organizations. They may not have the money to pay themselves that [comparable salary], but they still need to know what that is.”
A great place to find this information, according to Bottos, is filings of publicly-traded companies.
How entrepreneurs pay their employees should also be factored into their own pay.
“Business owners should look at the decisions that they have made about how they are going to pay people at their organizations,” said Bottos, “If they choose to pay people at the low percentile of the scale, then they need to take that into consideration when setting their own salary.”
One warning sign that entrepreneurs are paying themselves too little can be when the second in command makes three times what the owner makes. Another much more jarring warning is a visit from the IRS.
“Tax planning and compensation planning should be joined at the hip,” warned David Klasing, founder of the Tax Law Offices of David W. Klasing.
Klasing explained that the decision to operate as an S-Corp, C-Corp, LLC or Partnership will dictate how high or high low an entrepreneur should set compensation without setting off red flags to the IRS or making the business susceptible to double taxation or a high payroll tax liability.
There are also safeguards entrepreneurs can use to compensate for low pay in their early years.
“If you operate an S-Corp, look at deferred compensation plans, which do not recognize income until you take that income in future years,” advised Klasing.
For businesses that operate as C-Corps, Klasing mentioned that tax planning attorneys should be able to advise entrepreneurs on how to substantiate a shortfall in wages in earlier years so that they can be compensated in future years.
Back at BLUETRACK, Glasser seems to have found a magic formula for the time being. “I factor in what is the least I can pay myself that I will still be happy and that the company will be stable,” he said.