How Much Of Your Profits Should Go Into Your Pocket — And How Much Should Go Back Into Your Business

Sooner or later, you will run into the sticky problem of executive compensation: How much should a CEO/owner get paid? You might have to face this question if/when your business gets going. And you might face it if you invest in a business. Fortune Small Business magazine did a story on this subject a while ago, citing the case of two San Diego entrepreneurs who started a high-end home-furnishings business (the Richard Fischer Collection) with the long-term goal of getting wealthy. But getting there has been tricky for them.

Richard Fischer, who used to make a hundred grand as a political analyst, pays himself just $60,000 today. “I’m in the grocery store looking at coupons, ” he tells FSB. How much you pay yourself is a difficult and important question for most owners of start-up businesses. It says a lot about your commitment to your business and involves such difficult areas as employee morale and company culture. And even if your compensation could be hidden from everyone but you, there is still the all-important consideration of how you should be spending your cash.

Every dollar you pay yourself is a dollar you can’t be reinvesting in the growth of your business. I’ve done it both ways and in between. I’ve been in a business in which my partner and I paid ourselves huge salaries and then took out almost every spare penny we could. We were in a business that had no accumulating asset base. Beyond a certain point, it made no sense to reinvest profits. So we took every penny we could off the table and hoped the gravy train would keep on chugging.

That was fun, but most good businesses don’t work that way. More commonly, you face a dilemma. If you take more money now, there may be less value in the business later. Yet, if you take too little, you will feel as if you’re working for peanuts. And what if something goes wrong and all those retained earnings disappear? In most cases, the wisest thing to do is pay yourself fairly but leave plenty of money in the business to pay for expansion. Here’s how I think you ought to go about it.

First, you must figure out what you do and break that down into jobs. If you are the CEO, figure out how much you’d have to pay a CEO to run your company. Give yourself that salary — the same base and the same incentives — but nothing more for being CEO. After doing that, recognize that there are things you are doing for your company that go beyond what any hired hand, however good, would ever do for you. The way you care about your company and the ideas you have for its development, for example. These are assets you can’t evaluate precisely, but they are enormously important.

As Frederick Winslow Taylor, the world’s first full-fledged efficiency expert, said (a century ago), “Men will not do an extraordinary day’s work for an ordinary day’s pay.” Recognize this fact and feel free to pay yourself something extra for what you do. Then, of course, there is the variable compensation — your chance to reward yourself for your role as investor and equity holder. How much you take in during any given year is a complex question. It depends on the cash flow and the lifetime value of your customers. It depends on your growth plans, the regulatory environment, your competition, and your personal plans.

As for shareholder distributions, here’s what I do: As soon as the business becomes profitable, I pay out something — and it could be only 5% of profits — depending on cash flow, growth plans, etc. Usually, I pay out as much as the company can reasonably afford. There is a lot of discussion today about how much CEOs should make. As an owner of a small and growing business, you should ignore it. Most opinions on the matter come from experts who have never owned a business, never been offered a million-dollar-plus salary, and never had the opportunity to choose between reinvesting dollars and keeping them for themselves.

Pay yourself a fair salary — equal to what you’d have to pay someone else to do the same job. Distribute profits as often as you can but never more than is reasonable. And reward yourself for the extras you give the business. Want more specificity? My hunch is that the total performance-based compensation provided by a business should be around 20% to 30% of profits. And I believe that the person (or persons) on top should get about half of it.

One more thing … I think that your base compensation should be — in profitable years — a fraction of your total compensation. So, if you have a $10 million gross, $1 million net (before performance-based incentives) business, you should be paying yourself a base of between $76,000 and $150,000 with a vig of maybe 2% or 3%. That is your CEO compensation. That would amount to between $95,000 and $180,000. If, after paying yourself for your CEO contributions, you decided you could afford to distribute a percentage of the profits, you’d get your share of that too. I’m not an executive-compensation specialist, but this seems right to me. What do you think? Share your thoughts on our Discussion Board (www.earlytorise.com).

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  • Santana Gonsalves

    Great Article