Paying yourself a massive salary may be tempting, but it's probably not the best thing for your business. Here's what to consider when setting your own pay.
Executive compensation has been a hot-button topic for years at public companies. Large corporations will pay compensation consultants millions of dollars a year to help set their pay and they still can't seem to get it right. If that's the case, how is a small business owner like yourself supposed to find the magic formula?
The reality is, many don't even bother trying. A 2009 survey of privately-held businesses by Compensation Resources, a compensation and human resources consultancy in Upper Saddle River, New Jersey, found that 56.6 percent of respondents have a formal compensation philosophy at their company. That means more than 40 percent of companies are winging their pay practices to some degree.
And really, that's okay for small business owners, especially when it comes to their own pay.
As Don Delves, president of compensation consultancy The Delves Group in Chicago, puts it, 'If it's your business, you're going to pay yourself whatever the heck you want.'
Though true, it's unlikely the answer you're looking for if you're reading this guide.
For many small business owners and entrepreneurs, the last people to get paid are typically themselves.
'It's sort of like after you pay everybody else – all your suppliers, employees, all your expenses – you can take what's left over,' says Mark Reilly, a partner at Compensation Consulting Consortium in Chicago. 'Then you have to decide if you want to take less than that and invest some of that back in the business.'
For reasons like that, it's difficult to go on websites like Salary.com and see what someone in your industry and position should be taking home. There are many things to consider when setting your own pay that don't show up in broad data sets. The decision is specific to you and your business. Here's what you should really consider:
How to Determine Your Own Salary: Assess Your Job
The first step you want to take is to size up your own job.
Business owners need to determine what value they're bringing to their company, says Paul Dorf, managing director of Compensation Resources.
'It's not only what the market is paying for the job, but what am I contributing to the company?' he says.
There are all kinds of businesses and business owners. In some instances, the owner of the company may be the chief salesperson. In others, they might hold a more administrative or managerial role. And we've all heard of the absentee owner.
You should consider exactly what you're putting in to the bottom line.
To do that, Dorf says a good question to ask yourself is: 'How would an independent investor look upon what you're taking out versus what you're putting in?'
You should also consider how much you would have to – or would be willing to – pay if you had to hire an outsider to do your job.
Delves, on how he sets his own pay, says: 'The very simple answer is I get what's left over at the end of the day and what we can afford to pay me. The more complicated answer is that I know what I'd make if I worked at a consulting firm as a partner.'
He also considers the fact that he both brings in the business and delivers it, and that he manages his whole business. 'I consider myself a full-service, senior partner, so I want to get paid what a senior partner would get paid,' Delves says.
He recommends dividing profits into buckets. There should be a sales bucket, a bucket for managers, an ownership bucket and a bucket you leave in the company. The more buckets that you have a right to, the more you'll pay yourself.
How to Determine Your Own Salary: Assess Your Business
When thinking about how much you're planning to take for running your business, you also want to consider your company's needs and what plans you have for it.
If your goal is to grow your business, you might forgo some salary in the near-term to increase its value in the future.
'Some of my compensation comes in the growth in the value of the business,' Delves says. 'If I chose to, I could actually take home more cash. That's my choice.'
If you're happy with things as they are, don't be afraid to take out some more.
Additionally, you should consider where your business is in its life cycle. Are you finally on stable footing after years of sacrifice?
'Maybe during the first couple of years you took very little in compensation,' says Reilly. 'And maybe you need to pay back some debts that you've accumulated once things get going and start going well.'
How to Determine Your Own Salary: Using Benchmarks
When setting your salary, it's natural to want to know what the other guy is making, and there are lots of surveys out there to give you a peek into his paycheck. Some are free and some can cost thousands of dollars. As in most things, you get what you pay for. Dorf says any salary guides you get online 'should be taken as an indicator, but not the gospel.'
There are plenty of compensation consultants out there that have access to the really pricey, detailed surveys, but they likely represent an unnecessary expense to most small businesses. Reilly says compensation can start getting a bit messy for entrepreneurs when they hit the $10 million revenue mark, at which point, they 'kind of don't want to do things by the seat of their pants anymore.'
If you're going to benchmark your pay on your own, you'll want to focus on pay in your industry, companies of your size, companies in similar financial condition as yours, and, to a much lesser extent, companies in the same geography.
For your industry, you want to whittle it down as far as you reasonably can. Just because you resell telephone equipment doesn't put you in the telecom industry, per se.
If you're a small, private company, getting a clear look at a peer's pay is difficult. But if you have public competitors, you have access to valuable data, since their proxy statements will offer up extensive pay disclosures.
For size, a general rule of thumb is that you should only look at companies between half your size and double your size in terms of revenue, Dorf says. So if your company brings in $10 million in revenue, limit your focus to companies between $5 million and $20 million in revenue, give or take.
But really, don't take somebody else's word for it when trying to get the lay of the pay land. Delves says:
'I'm speaking here as a business owner and not a compensation consultant. Yeah, the compensation consultant will say you should look at surveys, at similarly situated public companies that you can pull proxy data from. You should look at industry association surveys, local market surveys. Look at all that stuff.
'But as a business owner, I'll tell you that's all nice, but you've really got to call around.'
In short, even though we're talking about numbers, setting your salary isn't a science. Call your friends in the industry and see how their company does things.
Dig Deeper: Pay Scales for 20 Different Job Descriptions
How to Determine Your Own Salary: Other Considerations
If you're looking for a more extensive checklist on best pay practices, Dorf offers up these 14 points used in Internal Revenue Service court cases when examining whether an executive's compensation is reasonable:
Finally, you might consider this from Lena Bottos, a strategic client relationship executive at Salary.com: 'If someone else was to learn how much I'm making, is it fair? Is it fair to my employees? Is it fair to me for what I'm putting in?'
MATT QUINN contributes to the Wall Street Journal's corporate finance blog. He has also written extensively about banking and corporate finance for publications including Inc., American Banker, and Financial Week. He lives in Brooklyn, New York.