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Figuring out your own salary as a business owner can be tough. It can get more confusing when you factor in the legal requirements of different kinds of business entities.
Should it be flat or based on a percentage? Do you pay yourself more when the business is doing well? What about partnerships and sole proprietors? What if there isn’t consistent cash flow? If you’re not willing to make sacrifices, do you just have to accept that growth will be slow?
How do you handle things when you’re running a solo business what changes when you hire employees? Is there ever a time when it’s right to raise the owner’s salary?
We answer these and more questions in today’s episode.
Highlights, Takeaways, Quick Wins:
- The more money you allocate to your business, the more it can grow.
- Pay yourself what you need to survive. Invest the rest back into the business (especially in the early stages).
- How much ownership you have in a business can be separate from what percent your salary is.
- Separate your business and personal bank accounts.
- Sometimes, you have to do the work with what you have—don’t always get caught up in making things better or growing bigger.
- Lifestyle Creep is letting your lifestyle increase with your pay, but planning for growth isn’t Lifestyle Creep.
- Being transparent with your employees about the financial state of the business can be beneficial.
- Just like with your family, you have to do what it takes to take care of your employees.
- Pay yourself a fixed salary rather than one that is percentage-based or fluctuates with the business income.
- 01:36 Matt: This week, I’ve met random people who can’t understand why I don’t pay myself more of the money that comes through my business. These conversations have started from me telling them about my Lambo Goal. They were wondering how much I keep out of the volume my businesses do considering I work so hard. One guy said, “You must live in a mansion,” and I told him I live on some land with a nice renovated house but it’s not a mansion. He asked, “What do you do with all your money then?”
- 03:43 I put it back into the business because there’s no reason for me to spend it. He was picking on the regular cars I have and telling me to get nicer ones. I told him we only pay ourselves a little bit more than what we need every month to survive. Living that way helps me want to keep improving, even though I have the power to call my accountant to transfer hundreds of dollars. He didn’t understand why we wouldn’t do that.
We don’t have a budget because we’re poor, we do it because we have a goal.
- 05:08 We’ve decided to sacrifice now so later on we can reap the benefits. Sacrificing now speeds up the time for us to get to our goal. They just can’t get past my age, my business structure, only paying myself a little bit, or my Lambo Goal. Sometimes, I wish I could just say, “I work an office job,” because it would prevent an argument. Sometimes it doesn’t become an argument and those are the conversations I love because I get to encourage them. There’s always going to be people that hate their life and want to hate on yours because you’re successful or what you’re doing to be successful.
- 06:56 Sean: Fortunately, those people aren’t our audience members and they’re looking to you to find out how much they should pay themselves as a business owner. It’s tough to figure out how much to pay yourself as a business owner, especially when you’re a solo business owner. Then, bring in all the entities and legal requirements of those and it’s confusing. The majority of people listening seem to be solo entrepreneurs so I wanted to focus on those, but later we’ll talk about what you need to consider as you grow and build a team.
Should I Underpay Myself?
- 08:17 Pablo asks, “Should I give myself a fair salary, or underpay myself and add dividends at the end of a quarter or year?” There’s different requirements for the different entities you can have—Sole Proprietorship, Partnership, LLC, S-Corp, etc. Someone was asking when they should go from Sole Proprietor to an S-Corp and my rule of thumb is when a few thousand dollars in a year is pocket change to you, that’s when you need to start thinking about become a corporation. It’s going to cost you a few thousand dollars to maintain the paperwork and accounting you’re required to do. Once you get to that point, you’re going to save money going to an S-Corp.
- 09:35 Matt: Whenever you get to the point where you’re making enough money to need to protect that money and yourself, then you need to get an LLC. If you’re only making like $10,000 then I wouldn’t go get an LLC.
- 10:02 Sean: An LLC is probably the next thing you want to go to from a Sole Proprietorship. What’s the most common thing people are asking about Sole Proprietorships vs. LLCs?
- 10:32 Matt: Lets say someone is starting a design business on the side while they still have a day job. They’re starting to make some money at that and they don’t want to pay the personal tax or have their clients make out a checks to their personal name, then the next step up would be to get a DBA. When you start to make more money and have more assets, I would go to an LLC because you not only can do more with it, but you can have a lot more tax savings. It is more expensive because of the legal and accounting aspects of it. You don’t have to have an attorney help you but in most states it’s pretty complicated to get an LLC established without an attorney.
- 11:23 Sean: The nice thing about an LLC is that it’s it’s own entity and you have some protection there, whereas if someone was going to try to sue you as a Sole Proprietor, they can sue you for everything you own. If they sued the company, the max they could get from you is what the company owns. You can start to bring in people and have a payroll with an LLC. In an LLC you have members, not just stock holders.
- 12:04 If you plan to take on venture capital, you won’t be taken as seriously as an LLC because it’s not as formal as an S-Corp. If you’re planning to do that eventually, you should probably just start with an S-Corp. If you’re not planning to take on funding, then you have more flexibility and you can go straight to an LLC. The reason I bring up all this legal stuff is because:
The IRS requires you to earn a “reasonable compensation.”
- 12:45 You have to receive regular paychecks and you have to be on your payroll. Those checks need to include withholdings for social security, medicare, federal income taxes, and, if required, state taxes. If you’re a Sole Proprietor or a Partnership, you can pay yourself whatever you want. It doesn’t matter because it’s all going to be personally taxed anyway. Things to keep in mind regarding reasonable compensation are:
- How much do similar businesses pay for similar services?
- Are the wages equal to the work that’s being performed?
- When you factor in responsibilities, is reasonable?
- Is your pay reasonable when compared with your employees’ salaries?
- 13:39 We’ll be talking about mindset, limiting Lifestyle Creep, and investing in your business, but keep in mind these legal things even if we’re talking about minimizing your salary. Depending on your entity, you can’t just pay yourself pennies, it has to be reasonable.
- 13:58 Matt: Certain LLCs I own, like the bigger S-Corps, require me to pay myself more and I’ll end up gifting it back to the business since I don’t want that money personally.
Should I Give Myself Bonuses?
- 14:16 Sean: While we’re on that note, can you talk about making capital investments in your business? If you put a bunch of money into your business and then later, in addition to your minimal salary, you want to take some money to repair your car or buy something, how would you go about doing that?
- 14:56 Matt: If I was trying to fix my car, I would probably take out a pay advance or take a loan out depending on the amount. If we wanted to go on a cruise or something, I don’t have that kind of money in my personal bank account, but I could pull $5,000 from one of the businesses as a loan. The loan I could pay back in whatever amount of time, but I charge myself interest. Some of my businesses take loans from other business of mine and I charge them interest too. If I took a loan out from one of my businesses for a personal reason, I would have to pay interest. If I took an advance, I wouldn’t have to pay interest.
- 15:57 Sean: What if it’s not a loan or an advance? Say you’ve been taking a minimal salary, you’re working hard, and the business is doing really well. You rightfully earn some of the profits.
- 16:08 Matt: Then you give yourself a promotion and increase your pay.
- 16:18 Sean: That’s an increase in salary like giving yourself a raise, but couldn’t you also take a personal withdrawal from your business? I’m trying to drive at S-Corp distributions. If the company is doing really well, you can send out distributions to multiple people. Essentially, it would be like getting bonuses.
- 17:44 Matt: Have you ever given yourself a bonus? I don’t have that much experience with it because I don’t give myself bonuses.
- 17:48 Sean: Personally, no but I was hoping you could speak to it. I’m the same, I’m paying myself a minimal amount. I don’t get paid the most in my company. I’m not worried about bonuses or distributions, but I might be eventually. You can do that and the nice thing about an S-Corp is it’s only taxed once for you. It’s a pass-through. You have to be careful with the “reasonable compensation” part though.
You can’t pay yourself $1,000 a year and then take $100,000 in distributions.
How Do I Handle Money as a Sole Entrepreneur?
- 18:39 Legal requirements aside, say you’re the only member in your business. Cory asks, “How do I handle the money I make when I don’t have any employees? As someone who does everything myself, I don’t necessarily have anyone to pay except bills, and so I figure it just goes right back into the business. Should I take a cut of that for myself or just invest it back into my business?”
- 19:06 Matt: Is he using business money to pay his bills?
- 19:10 Sean: It sounds like he has a day job where he’s covering his bills and he’s doing this business on the side. He’s wondering if he should pay himself or keep the business going.
- 19:24 Matt: In the beginning, if you can, let the business take as much as possible to get some traction. If you need the money, then you have to take it. Don’t cripple your business by trying to take 50% or 75%. I’ve seen people dry up their businesses because of Lifestyle Creep expenses. The more money you can leave in the business, the better. If you need funds, then take them because you need them to survive. If you don’t need them and you just want to have some personal fun every now and then or your car breaks down, then you can pull that money. Be cautious though. I joke with my partners that every time we take money out of the businesses, it’s less fuel in the tank. The more fuel it has the further it can go.
The more money you allocate to your business, the more it can grow.
- 20:37 Sean: Eventually you can pay yourself more because of that.
- 20:45 Matt: I tell everyone in my business that we’re in this for the long-haul. If you’re trying to make a ton of money overnight, this isn’t the place to be. We work hard here and we pay ourselves the minimal amount because we’re going long-term. Once we sell all the assets in the next five to ten years, then that’s the payday we’re looking forward to.
- 21:10 Sean: Do your employees get bonuses or raises?
- 21:15 Matt: The employees are a whole different thing. They get bonuses. Partners that own equity in the company do the same thing as me. We all take the minimal amount we need, not want, and the rest stays in the business so it can continue growing.
- 21:50 Sean: Lauren asks a really relevant question here, “My sister and I are partners in our business. We don’t have any other co-owners or employees. It’s just us right now. What are your thoughts on paying each co-owner per duties vs. splitting the income 50/50? It’s currently filed as a Sole Proprietorship, however once our business develops more we’d like to transfer it into an official Partnership.”
- 22:18 Good! When it comes to Partnerships, it’s very important to split ownership 51/49. Ownership is separate than salary. You can still split salary 50/50, but someone always needs a controlling stake. It’s my personal belief that there’s always someone who’s going to take more responsibility, step up, fill in the gaps, show up early, work late, execute harder, or who originally had the idea. There’s always someone and if you don’t know if you’re that person, then it’s the other person.
- 23:10 Matt: I’ve had my share of partners and messed up many times. The hardest thing I’ve experienced with business is partnering up with a family member. They know your strengths and weaknesses so they think they should lead. Are you going to be the one to show up at 5am? Are you going to be the one that takes care of all the administrative duties? Are you going to be the ones to take care of any financial problems, budgets, or projections? If a huge problem comes up, are you going to be the one to decide how to fix it? A lot of my regular partners will give me the extra percent of ownership because they’ll get paid the same amount, but I’ll get the headache.
- 24:41 Sean: The people listening are either nodding their heads and knowing they’re that person or they’re not sure about this advice, which means they’re the other person.
- 24:49 Matt: I tell my partners to be the bigger person and let the other person take lead. If they don’t think they can take lead, then talk about it. Having the 49% isn’t belittling you, it actually brings less stress in your life and more focus. Not only are you helping get everything going every day, you don’t have the stress of the 51% guy. Most of the time the 49% person is the dreamer of the group because they don’t have that weight on their shoulders.
- 26:23 Sean: We’ve been talking about ownership here but as far as the second part of her question goes, you can split pay 50/50 if you want and I would recommend that. We’ve already established one of you is going to work harder and you’re going to get paid the same. You’re probably wondering what the deal is with that. The problem is if you pay yourself 60% and the other person 40% because you’re the leader, that’s what they’re investment will be—how they think and how they work. You’re a team. You need to treat Partnerships like a marriage. If you wouldn’t want to partner up in every sense of the word with this person, then don’t get into business with them.
- 27:41 Make sure they’re going to have the right mindset and they’re going to do what it takes to no matter what to get the work done. Don’t just bring them on as a partner because they’re good at something if they’re a terrible person. It’s going to go bad. Partnerships have such a high chance of going bad because it really is like a marriage. You need to split the compensation 50/50 because you’re both all in and you both need to be in the mindset of sharing, working hard, and not worrying about getting paid more or less. You’re showing up and working hard no matter what.
- 28:29 Matt: Partnership is a big step. A lot of people think the other person will help fulfill the areas in which they’re not as strong, but you should make sure it’s the right person. Most of my arrangements are Partnerships and Sean and I have both had Partnerships go wrong, so we can say they’re hard. You always have to put time and effort into them and you’re going to disagree on a lot of things.
- 29:13 Sean: I like how Aaron put it, “I’m ok not owning 50%, but I’m still going to give 100%.” That’s the kind of attitude you have to have!
Separating Business Money From Personal Money
- 29:39 First of all, you need separate accounts. That might be a no-brainer for some of you, but other people might be trying to mentally allocate money, but you really just have to have separate accounts. I would also recommend having a separate credit card for the business. Not to borrow money or make purchases you can’t afford, but to get all your expenses in one place. Set up something like Freshbooks that will track your expenses and automatically categorize them. If you have your personal accounts and business expenses all mixed together, you’re just making a headache for yourself or you accountant in the future. Separate it in every way you can for your own sanity.
- 30:23 Matt: It’s going to cost you more money and time. It’s a pain in the butt in the beginning when you go to fill up your gas and you’re wondering if it’s personal or for the business, but you’ll get better at allocating. My wife runs errands for me and she tracks her mileage for that, but she shouldn’t track her mileage if she’s going to Toys R Us. Be honest with yourself.
- 31:21 Sean: I look at my living expenses and I pay myself what I need to survive right now. It’s all about the future and my 10-year long-game plan (Related: seanwes podcast e181 How to Establish Yourself as a Teacher in a World of On-Demand Education). My goal right now is to survive and be able to work on the business. To me, it’s not about right now, it’s about a few years from now. I would like to have the freedom to a greater degree to do whatever I want, work on the business, enjoy what I do, and have the resources to do what I want, when I want, where I want.
- 32:29 In order to be able to do that, you have to invest upfront. Some people want to pay themselves an inflated, cushy salary, but I like the hustle and the grind. I want to pay myself enough to cover bills and not stress out, but we don’t really buy things or go out to eat. Anything I buy is a business expense and I’ve slowed that down.
Eventually, you have to do the work with what you have.
Don’t always get caught up in making things better or growing bigger.
- 34:01 Work hard, stay late, and mow some more lawns. You don’t need to get the new fancy mower when what you have still cuts the grass.
- 34:39 Matt: Do you pay yourself just enough because of the Lambo Goal or you want to live a cushy life later on?
- 35:09 Sean: I think we’ve got something special going on here at seanwes. We’re helping people and changing their lives! I think our mindset, our attention to quality, and our passion for helping other people enjoy what they do in life is something everyone deserves and I would like seanwes to have an even bigger impact. A lot of what made my content great in the first place was my perfectionism but then it got to a place where that was crippling everything.
- 36:18 I didn’t want to give up some of the stuff I was doing, but I realized I could have a perfect impression on a very small number of people, or I could have a nearly perfect impression on a thousand times more people than I was reaching. It’s not about the money. The Lambo Goal isn’t about a lifestyle or a car, it’s to show people they can dream big. You don’t have to live for the status quo. You can go for something bigger and accomplish something huge that you never thought you could before. The Lambo is an icon for the vision we have here, which is inspiring people to do what they love and having that thing support them.
How Can I Use My Money Wisely?
- 40:33 Brent asks, “After paying yourself, how should you divide, save, and reinvest your money to better your business and personal life? i.e. putting your earned money to good use.”
- 41:15 Matt: You could do both. Obviously, don’t reward yourself if the business has only been around six months. There’s a statistic that says the first two years is what determines whether the business is going to survive or not, so if it’s been two years, maybe reward yourself. You could upgrade your business equipment and up your salary a little bit.
- 41:52 Sean: It’s hard for me to answer this question because I don’t really have a ton of extra money to reinvest because of the way I set up my salary. Several people asked, “Should I pay myself a fixed salary, or should it be a percentage of earnings?” Eventually if you have a larger business, it could be salary plus dividends, but in the beginning, I would say to pay yourself a fixed salary. You want to get in the mindset of having payroll and expenses going out consistently. There’s no such thing as job security. As an employee, you’re guaranteed a certain amount of money, but as a business owner, you see the income fluctuate.
- 43:04 As a business owner, you need to see the big picture—averaged out over time is it generally going up? Even if it’s going up and down, you still need to build the habit of guaranteeing future employees money when you bring them on. You can’t pay yourself variable amounts because then you won’t be consistent in paying other people. The income at seanwes varies wildly and I have to be able to spread that out and guarantee six employees a fixed salary. Because it’s fixed and I only pay enough to cover us, I don’t have a ton of extra personal money at the end of the month.
- 44:15 Matt: Everyone in all of my businesses has fixed reasonable salaries and everything else gets left with the business.
When Can I Give Myself a Raise?
- 44:37 Sean: Felippe asks, “When do you raise owner salary?” Never! You hire more employees and give them what you would have given yourself. I’m only partially joking. I would raise my salary if the inflation of living expenses went up.
- 45:03 Matt: Or if you need a bigger place. We moved to the land we have because we had a lot of equipment and vehicles that needed to store. We needed space for the business, as well as our personal needs. I wouldn’t consider needing a bigger place to be Lifestyle Creep.
Lifestyle Creep is letting your lifestyle increase with your pay.
- 45:39 Sean: It’s getting a salary increase and spending more money. It’s the same when you own your own business, you start paying yourself more and you allow your lifestyle to creep up to what you’re getting paid. Now, I think something you’re planning is different from Lifestyle Creep.
- 46:18 We’ve been living in an apartment and we’re trying to run a media company out of it. The circuitry here can’t even handle the insanity! We’re outgrowing this space and because of everything else I’ve been focusing on, I’ve been neglecting the physical product aspect of the business. I want to bring it back eventually and we have no room in this apartment for inventory. We really do need a bigger place but we’ve decided not to move until next year for multiple reasons. Planning for growth isn’t Lifestyle Creep.
- 48:05 Matt: No, and part of it is a business expense.
- 48:07 Sean: If you determine that in order for your business to grow, which we’re trying to do, you need to personally increase something, then that’s a legitimate case where you would want to increase your salary.
- 48:49 Matt: The business actually owns the land we live on and we pay a reasonably rated rent to the business. We did have to give ourselves a little bit of a raise because it’s a lot of land.
Should I Hire or Grow Slowly?
- 49:31 Sean: Christopher asks, “Each time I have transitioned back to self-employment I’ve been able to cover my cost of living and make steady investments in terms of gear and training. Hiring employees and building an infrastructure will cost much more, making my margins tighter. Without sacrifices, do you I have to accept a slower rate of growth as opposed to running the business at a loss?”
- 49:57 If you want to grow, you can’t do it alone. I learned this the hard way—you need help and to hire people you need money. You’re going to have to build capital of some sort. Establish a runaway, like “I want to bring on two employees so I can start expanding.” Decide what you’re going to pay them on average and extrapolate out six months or so. It’s just like quitting your job to start a business, you need money saved up to be able to survive while you get the business going. Similarly, you need a runway to be able to cover those employees.
What Should I Account for in My Salary?
- 51:36 Pablo asks, “Besides the money I will spend on myself like rent, food, play, what are the other things I should account for as part of my salary—health, taxes, insurances, etc.?” When you’re running your own business, the business can pay for things like health insurance, but either way it’s your own money. You have to figure out if you can get a good arrangement. When you have more than 50 employees, it’s legally required for you to cover health insurance, but in the beginning, it doesn’t necessarily have to.
- 52:22 A salary that includes benefits is probably going to be lower than it would be had it not included benefits. Personally, we were able to get a good personal deal on health insurance through USAA, but not everyone can get that. Since either the business was going to cover it or we were, it made sense for us to get it personally. For employees, we factor into their salaries that they’re going to have to find that.
- 53:09 Matt: Make sure you allocate money for taxes along with health insurance, and we put savings away for certain things. We have a car fund, rainy day fund, and a vacation fund that we save between $20 and $100 into. The front tires nearly blew out on my Smart Car recently, which we had in our car fund because it’s not considered a business expense.
- 54:27 Sean: You can deduct mileage for your personal car, but if you want the car to be owned by the business, I’m pretty sure it needs to be used most of the time for business. Brookes asks, “How should I balance paying myself, buying things for the business, and keeping money in the business if the business is just me?”
- 55:19 Matt: The more money you have in your business, the more opportunities you’ll be able to invest in—equipment, inventory, etc. The more money you have in there, the more flexibility your business has and the stronger it is.
Be Transparent With Your Employees
- 55:59 Cory: Charli asked the seanwes employees in the chat room, “Is it odd to hear your boss talk about all this money stuff?” It isn’t actually. In some ways, it makes me feel better about the situation I’m in. Justin said, “I’ve worked for big companies, small companies, and for myself in the past. This is reality. It happens everywhere, all the time, and most people simply aren’t exposed to it. I would rather know than not. I found that the more open the discussion and the more transparency there is in a company or organization, the healthier it is and the better it works. Keeping things close to the chest, not sharing, and hiding problems result in sub-par solutions being applied and stuff being ignored that become big issues.”
- 57:30 Sean: That’s spot on. I know they listen to what I talk about and I say this is what it takes to run your own business. You can do it yourself or you can work for someone else, but understand what’s going on behind the scenes wherever you work. It might seem like you have job security somewhere, but you only have “job security” until you don’t. I have enough respect for them to say, “This is the real world of business. I’m paying you a consistent amount, but I’m taking care of you like a family.”
- 59:39 The reality is if you get let go from your job or your self-employed business isn’t doing well, you’re going to have to find a way to take care of your family. It’s the same thing being a business owner, I have to find a way.
Just like with your family, you have to do what it takes to take care of your employees.
- 59:43 Terence has a terrible question, “How do you tactfully lay someone off if your solo business isn’t doing well?”
- 1:00:02 Matt: This is the thing about being transparent in your business, your employees always know what’s going on. My employees always want to know if they’re going to have a job next month and I’m honest with them about projects that haven’t gone through and stuff. That way, the employees don’t get comfortable in their job security. It encourages the employees to hustle because I’m doing my best so I can to pay them.
- 1:00:53 Sean: How do you fire anyone? Do it tactfully, give them as much notice as possible, and help them transition to the next thing. Figure out what you can do before it comes to that point. Are you firing them because their position isn’t directly generating revenue and you’re hurting for money?
- 1:01:21 We’re talking about small businesses, not ones with thousands of employees, so maybe go to them and say, “We’re struggling and we want to be able to pay you, but we have to be real about expenses. This is what the plan is to get things back up and running: we have to focus on more of this other thing and less of what you’re working on. Can you help out with this other project that isn’t your normal job? I want to keep you employed and we’re a team.” Get creative!