Are You Paying Yourself Enough?

Finally the time had come for Smart Furniture's lowest-paid employee to get a raise. Stephen A. Culp, 35, founder and CEO, had launched his Chattanooga-based modular furniture company in 2001, and for three years he had made sure that every one of his employees was paid well and on time. Everyone, that is, except for himself. For all his efforts to make his company a success, through the long days and nights, Culp had been working for slave wages, literally. Every month, for going on 36 months, he took home the princely salary of precisely nothing.

As a single guy, he was able to live frugally, drawing down his personal savings to fund the necessities: rent on a small one-bedroom apartment, groceries, electricity. Meanwhile, every penny of Smart Furniture's profit went back into the company. The money he could have paid himself funded the salaries of two employees who had had a hand in the company's sales tripling over the previous three years. "It's a prioritization of cash flow," Culp explains. "If I can survive on cereal and take all the cash that I would have spent on a more extravagant lifestyle and put it back into the company, it increases my chances of success." And what's Culp's definition of success? To see Smart Furniture become the "Dell of furniture."

Still, it's not Culp's plan to live on Fruit Loops forever. In November 2003, when he prepared his financials to seek venture capital, he knew he'd have to put something on the CEO's salary line. The question was, how much? He didn't want to pick a number that was too high -- he'd been told that venture capitalists were turned off by entrepreneurs who look as if they're only out to pad their bank accounts. And he didn't want to pick a number that was too low, either -- his savings weren't going to hold out indefinitely. The question was, what, exactly, would be a fair way to compensate himself for his time, effort, and risk?

That question can be excruciatingly difficult for any entrepreneur, whether the business is starting up, starting to grow, or well established. It's especially timely right now, coming off several years of a difficult economy. And yet, says Mark Edwards, founder and CEO of Compensia, a compensation consultancy based in San Jose, Calif., "the fact is, there is no one answer."

Perhaps it's no wonder that many entrepreneurs say deciding on self-compensation can feel like playing a game of "pick a number, any number." After all, you're constrained only by how much profit your company makes. You can take nothing, or you can take it all -- or anything in between. Don't like the number you decided on today? Change it tomorrow. Or next month. Hey, it's your company. You're the boss.

This wouldn't be quite so difficult if compensation were merely another business decision, says Larina Kase, a Philadelphia-based psychologist who counsels entrepreneurs. But it's so highly charged. "All kinds of emotional issues come with anything having to do with money," she says. "Since there are no clear guidelines on what you should be compensating yourself, it's even worse. Uncertainty makes for a great way for all of these issues to come to a head."

This can lead to entrepreneurs behaving badly -- or at least inconsistently and haphazardly -- when it comes to their own compensation, says Tom Kinnear, executive director of the entrepreneurial studies program at the University of Michigan's business school. "I don't think it's good discipline to take money out of the business randomly," he says. Like a well-run family, he says, a well-run company requires consistent cash flow.

The journey from pick-a-number-any-number to the right number starts with pondering why you started your company in the first place, says Howard Anderson, a professor at the MIT Sloan School and senior managing director at Yankee Tek Ventures, a VC firm in Cambridge, Mass. Your goals for your company, he says, will govern how much you take from it.

For the purposes of self-compensation, Anderson says, there are two broad categories of entrepreneurial ventures. There are those that intend to grow, and grow fast. And then there are "lifestyle firms," those run by a breed of business owner some call "intrapreneurs" -- people who start a business because they like the lifestyle of a small-business owner but aren't trying to be the next Bill Gates. These are business owners like Lynn Lewis-Bjostad, president of Premier Meetings and Event Management, an event-management firm based in Irving, Texas. With two employees today, she hopes to increase sales by a modest 35% to 40% over the next five years, adding perhaps one or two more employees. She has no desire to sell the company -- and no plans ever to step aside as CEO and start another firm.

For Lewis-Bjostad, setting compensation is about making sure the company stays healthy, not about funding rapid growth. If you're such an entrepreneur, there's less reason to limit the amount of profits you take out of the company. "It doesn't matter what you pay yourself," says Anderson, "because everything after expenses is yours." Often, such entrepreneurs will simply add up their monthly personal expenses, add a little more for safety, and call that their salary. That's what Lewis-Bjostad has done, right from the time she started her company in 2002. In good months, she doesn't take any more than her salary from the firm, and in bad months, she doesn't take any less. "The consistency is important to me," she says. "I couldn't live any other way." A key point to keep in mind: Make sure, as you take profit out of the company each month, that you leave yourself a reserve for when times turn bad. It should be enough to cover six months' worth of company expenses.

24% of Inc. 500 CEOs reduced their own compensation in 2002.

Things are different if you're in Anderson's other group of entrepreneurial ventures -- if you've got goals for your company, as Stephen Culp has for Smart Furniture. If you're planning dramatic growth or thinking about selling your company to outside investors at some point, you have to consider not just how your salary affects your personal finances but how it will look to venture capitalists or the other money types who will scour your company's financials. Many entrepreneurs believe that to impress VCs and their ilk, they should keep their total compensation as low as possible. This is part of the reason Culp confined himself to a salary of zero for three years. "I knew from the beginning that we were going to be going for venture capital," he says, "and I wanted to be able to show them from the beginning that I was willing to make sacrifices, that I knew the value of a nickel, and that there is definitely skin in the game."

There's something to this, says the University of Michigan's Kinnear: "Investors want to see deep commitment." And many entrepreneurs do take this advice seriously. For example, Christie Stone, president of Ticobeans, a start-up coffee distributor in New Orleans, pays herself just $19,000 a year (with commission, she should make $35,000 this year). The business isn't profitable yet, and she won't take a penny more than she needs to pay her bills and stay off the street. But even entrepreneurs with established businesses tend to linger too long in this mode. For example, Jeremy Shepherd, owner of PearlParadise.com, a Santa Monica, Calif., company that did $3 million in sales last year, is paying himself a salary of $36,000 -- considerably less than he gives his top-paid employee.