In the startup world, the general advice is for founders to pay themselves $50k-$100k/year until they get outside funding. Your net worth ends up higher – but only if you hustle and grow the value of your company, since your net work mostly consists of your ownership stake.
When you build a consulting company, there’s an unbelievable amount of unpaid labor to be done: hiring staff, training them, managing them, improving the deliverable product, marketing, sales, contract negotiations, expenses, accounting, taxes, web site maintenance, you name it. It’s all too easy to say, “We should really pay ourselves for doing this unglamorous work.”
But when we started Brent Ozar Unlimited, we didn’t take any salaries at all. We figured that since Jeremiah, Kendra, and I were all consultants, we could make money directly. Each partner got a percentage of the consulting work that they personally did, but the rest of the money stayed in the business.
We figured that if we were going to hire people, we needed to build a little money fort inside the business. In the event that an employee didn’t have revenue associated for a few months, we still wanted to be able to pay their salary. (That goal ended up coming in handy, and I’m really thankful – if it wasn’t for that, we’d have probably had to close the company’s doors.)
When we finally had enough unpaid labor involved (due to growing head counts, taxes in different states, and selling goods online to EU citizens), rather than paying ourselves for it, we hired an admin to offload 40 hours a week of it – but the unpaid work for the partners continued (and continues!) to grow. It’s just a byproduct of running a growing company.
Taxes make this tricky.
Here comes the really challenging part: in a pass-through LLC, the founders get taxed on profits even if the profits stay in the business. To keep things overly simple, let’s say in a one-founder bootstrapped consulting company:
- Brings in $150K of consulting revenue
- The founder only takes out $100K of that, leaving $50K in the business
- At the end of the year, the business had $20K of expenses, and $30K left in checking
- The founder gets taxed on $130K of revenue, even though take-home was only $100K
The more successful you are, and the more you want to sock away in the business’s savings, the more you get penalized on your personal taxes. Businesses are encouraged to cut things as close as possible, keeping as little cash as possible in savings.
SaaS startups don’t have this problem because they don’t make any significant income for years. Their cash comes from investors, so it’s not revenue.
So should consultant founders take a salary?
There’s probably a little survivorship bias here, but in our case, I’m really glad we chose not to take salaries. (And I still don’t take one.) Cash in the business’s checking account doesn’t let me buy that Porsche 911 Targa that I want today, but it fuels the company’s fire to hopefully let me get one years from now.
In your case, talk to a good attorney and a good accountant. When you’re starting a business, ask around in your circles for local folks who specialize in this kind of thing. Attorneys & accountants will usually have a 30-minute call with you for free, and a good one will ask you questions about your goals, your future tactical plans, and what success looks like to you. The questions they ask will enlighten you and help you decide.
$130K of profit, not revenue. If the business makes no money at all the next year and closes the doors, that leftover $30K gets paid to the founder, but shows as a $30K LOSS to the business, which helps the founders personal taxes, which offsets the previous year. Nets out. Or am I misreading 🙂
If your goal is to close the doors and save money on taxes, you’re probably not going to do well as a founder. 😉
lol…just pointing out that you wont get double-dipped on a pass-thru taxation setup 🙂
With 4 partners with various percentages we take a fixed salary and then leave a set percentage of distributions in the company. Our partnership agreement states that we must distribute enough to cover taxes incurred personally. In other words, you couldn’t suffocate a partner by voting to retain 100% of profits in the company which would require tax payments even though no cash is being distributed.
Smaller percentage holders vote for higher salaries, larger ones vote for higher distributions. All the while a war chest grows of already taxed monies to cover one year’s expenses or be used for capital investments. If a partner got sick or came under financial duress they could vote to pull from that war chest. War chest X equity % is an already taxed personal asset.
LLC filing as an S-corp (allowing W2’s) seems like a very sensible and durable approach to running a small business.
Yep, there’s lots of different options – definitely wanted to make it clear in the post that folks need to talk to a lawyer & accountant to see what works best for their goals.
hi thanks for that information