Paying Yourself Appropriately

How much should you be paying yourself? This is a question that we get asked quite a bit, and there are many reasons to get this right:

• Making decent money will sometimes drag you through those rougher times when entrepreneurial life is hard. Conversely, underpaying yourself will always mean that you start to ask why you’re doing this. It isn’t always true, but one of the many reasons you left that last firm and started your own was to not bust your butt to make someone else rich. You’re far more likely to get bored when you underpay yourself.
• Paying yourself the right amount helps to balance out all the other metrics that we talk about in our benchmarking service or the Financial Management book that serves as the primary resource to move the industry forward. These including maintaining a predictable 20% net profit, folding unburdened comp (including your own) into 45% of your agency gross income (unburdened = before benefits, bonuses, taxes), etc.
• In most instances, your retirement funding and disability insurance are going to be keyed to your fixed compensation, and you can’t maximize those without appropriate pay.
• Earning enough, and having that reflected in the accrual income statements, will normalize a valuation so that you don’t inadvertently subsidize your EBITDA by underpaying yourself.
• Finally, it’ll be hard to fight for a fair salary during your earnout, after the transaction closes, if you haven’t been earning that amount when you actually had control over your own comp.

So those are the reasons to get this right. Let’s look at what that means.

Normalized Compensation

The theory behind these numbers is that larger firms bring more risk, meaning you should make more, but that above a certain size threshold, the additional income happens via distributions.

So here’s what we suggest:

FTE Employee Band	Principal Salary
1-4	$120,000
5-8	$170,000
9-12	$220,000
12-16	$270,000
17-20	$320,000
21+	$370,000

To interpret this, say that there is one principal and ten other people. In that scenario, the principal should be making $220,000. “FTE” means “full-time equivalent,” where two half-timers would equal one full-timer.

Here’s a quick shortcut to help you quantify the additional risk associated with more employees. Once you are at a that minimum threshold of $120,000, you can just add $12,500 for every FTE employee that you add. That’s even more specific.

Multiple Partners?

What happens when there is more than one principal at a firm? We’ve conducted a lot of research on that front, and the truth is that having a partner might make sense for some reasons, but not financial ones. There’s actually a financial penalty for multiple partners. We cover that in a podcast episode and a deeper article.

To reuse the above example, say that you have two partners and nine other people, for the same total of eleven people. In that case, you’d take the same $220,000, add $120,000 to it, for a total of $340,000, and divide that in half. Each partner would them make $170,000. That illustrates the economic penalty of $50,000 less each, and of course they are splitting the distributions, too.

Two Asterisks

There are two caveats that are important to surface. The first is the interplay between compensation and distributions. In some jurisdictions, you are incentivized to keep your fixed compensation low and route the remainder through distributions. And in other jurisdictions (my state is one of them), it never makes sense to take distributions because there is no income tax.

When you’re incentivized to keep your fixed compensation low, just make sure that the distributions you take are somewhat fixed and predictable to equal whatever your compensation otherwise would be. And then you’d take extra distributions, as appropriate, on top of that to drain your portion of the profit.

The second note is how to adjust these numbers outside the US. We have clients in nearly 50 countries, and we generally think of it like this. In developed countries in western Europe, Canada, and Australia and New Zealand, adjust downward by 20-30%. In developing nations, adjust further downward.

The Big Picture

You’re a private firm, and the pressure on your firm’s performance is indirect.

The other thing that’s different is this: there are typically no outside shareholders to pressure you. You are the sole shareholder, and if you are satisfied, well, who is to complain? Probably only your advisor.

If you were a publicly traded firm, though, there would be a compensation committee, usually comprised of 4-5 people, with at least 2 independent directors, and they would set your pay. And they would probably say you should make more money.

Here’s another way to think about it. The typical CEO’s compensation in a publicly traded company is about 15% fixed base. The other 85% is variable. Your compensation, though is fixed (comp) and variable in two parts: distributions and selling your firm one day. Don’t underpay yourself, especially if it’s only to reduce the appropriate pressure on your firm’s performance.