You invested your money and time to start your own business. After several years of very hard work, it is starting to produce significant profits.
It’s time to start paying yourself. How much should that be?
One point of view is that you should pay yourself 100 percent of the profits. “If we don’ take the money off the table, someone else will,” a former partner of mine used to say. “We earned it. We should keep it.” That was his point of view.
My main client has a very different point of view. He draws a modest salary from his business and puts 90 percent of the profits back into it for future growth.
When I say that his salary is modest, I mean modest. It represents less than one-tenth of 1 percent of the company’s profits. There are a dozen employees who make at least three times more than he does.
Why does he do it? Because he is interested in building long-term family wealth, not in having a high income. And he believes that reinvesting in his company is the best way he can do that.
Two very different points of view.
That’s the dilemma you face as the owner of a newly profitable business. 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?
I’ve done it both ways. And, having seen the pluses and minuses of each, I have come to the following conclusion. You should pay yourself “fairly” but no more than fairly. And reinvest the rest of your profits into the business to pay for expansion.
What is “fair” pay for an entrepreneurial CEO?
First, 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 performance-based incentives — but nothing more.
Then, recognize that there are things you do for your company that go beyond what any hired hand would do. The way you care about your products, for example, and the ideas you have for the continued growth of your business. You should be compensated for that, too
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. (I think a business should pay out a total of around 20 percent to 30 percent of its profits in bonuses. And the person on top should get about half of that.) And reward yourself for the extras you give the business.[Ed. Note: Mark Morgan Ford was the creator of Early To Rise. In 2011, Mark retired from ETR and now writes the Palm Beach Letter. His advice, in our opinion, continues to get better and better with every essay, particularly in the controversial ones we have shared today. We encourage you to read everything you can that has been written by Mark.]