While many entrepreneurs won't go that far, they do keep morale in mind when developing compensation targets. Jack Stack, CEO of SRC Holdings, a manufacturing company in Springfield, Mo., pays himself $300,000 a year -- or 10 times the salary of his average worker. "I never wanted my people to think I was making a killing," says Stack. "There was a trust factor we were building."
But do employees really care what the boss makes? As long as people perceive that they're being compensated fairly and that they have opportunity for advancement, says psychologist Kase, it's probably not as much of an issue as many entrepreneurs believe. First, most employees realize that salary isn't all the owner takes out of the company -- you do own it, after all. Second, people usually compare themselves to their colleagues, to other employees, not to the boss. As long as you're not super-obnoxious about it -- rubbing your employees' noses in your mink-lined chair, for example -- morale should not be much of a factor when you decide on your compensation.
In fact, as Driskill discovered a few years ago, keeping your compensation low to stay on the level with your employees can backfire. Driskill doesn't divulge her salary but it happened to come up once in a casual conversation with a senior executive. When the exec heard how little Driskill was making, "she was just astounded and appalled," Driskill remembers. In a later conversation, other employees expressed concern about the health of the company, given that Driskill was taking so little in salary. "Employees want the boss to be boss," she realized. "This was hard for me to grasp." It was at that point that Driskill decided to bring her compensation up to a more appropriate level. With the help of salary surveys, she raised her compensation to a figure that's still below market value but more reasonable for a company that did $7 million in sales last year.
Your compensation is probably most relevant to your employees when times get tough. Do you cut your own pay first? Or that of your employees? And how do you handle it when times are good? Do you reward yourself first? Or your employees? This part actually matters quite a bit to employee morale, says Kase. Cut pay for your staff and leave your salary intact, and you'll likely stir up resentment. Take a hefty bonus and leave everyone else out, and expect to hear muttering. When the tech market sagged four years ago, Frank Collocia, president of Creative Technologies Group, an IT company in White Plains, N.Y., opted to slice his own salary dramatically -- from $100,000 a year to $25,000 a year -- to avoid laying off a single member of his 18-person staff. "It's why I have very loyal employees," he says.
But Collocia also has a family -- a wife and three children, now ages 5, 6, and 9. When the family shifted to living largely off their savings, it wasn't easy for anyone. "When your business goes down the toilet," he says, "it's gut-wrenching at home." Vacations, trips to theme parks, extra birthday presents, extras of any kind, really, all had to stop. Collocia and his wife held regular family meetings to let the kids know what was going on -- part of their first lessons in being an entrepreneur.
Over the past few years, Collocia's sacrifice -- and that of his family -- has paid off. Business has rebounded to where he's planning to take a bonus at the end of the year. But he's not raising his salary...yet. "The goal is to make the business healthy and build it," he says. "I'll get paid by the company's performance eventually."
And that's something to keep in mind. In the final analysis, says Driskill, whatever you don't take from your company today should eventually come back to you. "Really, when I'm ready to retire, the compensation issue becomes moot," she says, "because theoretically I will sell the company back to my employees. That's the nice thing -- it all becomes your money in the end."
Sidebar: What the IRS Is Looking For
One of the hardest truths for entrepreneurs to grasp is this: You and your business are separate entities, with interests that sometimes compete -- especially when it comes to taxes. This is something that the Internal Revenue Service pays close attention to, says G. Michelle Ferreira, who spent eight years at the IRS litigating the compensation issues of small, closely held companies and is now a tax attorney at the Silicon Valley law firm of Greenberg Traurig. Here are two issues to keep in mind:
Reasonable Compensation This is an issue for companies that offer dividends. Because dividends are taxed twice at the corporate level (both as income and when the corporation distributes them to shareholders) while salaries are a tax deduction (as a business expense), companies have an incentive to distribute profits in the form of salary. The IRS has its eye out for this potential loss of tax revenue, and if a salary seems "really out of whack" with expenses, Ferreira says, the IRS may investigate. If a court decides that the salary you received is actually a "disguised dividend," it will disallow the deduction -- and you will pay, big time. In 2004, a federal court decided that a California leasing company had run afoul of this "reasonable compensation" standard. In 1995, the owner of the business received a salary of $240,435 plus a bonus of $180,435. The company deducted this $420,870 in salary as a reasonable business expense and paid just $2,674 in federal taxes. But the IRS determined by looking at comparable businesses that the owner should have been paid a salary of $76,800. The company had to fork over $300,000 in taxes and penalties.
Self-dealing You should also be careful about running personal expenses through your company. Everyone knows this, of course, but it's worth repeating: Don't try to disguise personal expenses as business expenses. It's called self-dealing, and it's not like jaywalking -- it can really get you in trouble. "I've seen it all," says Ferreira. "I had a case where the entire family's cars were being paid for by the corporation. All their kids' college tuitions were being paid out of the corporation. If it gets really egregious, the IRS will assert a fraud penalty that is 75% of the taxes owed."
