Ask an advisor: I'm founding a startup. What should I pay myself?

June 27, 2023 7:01 PM

Business owners face many financial questions that other workers don't have to answer — including what to pay themselves.

Welcome back to "Ask an Advisor," the advice column where real financial professionals answer questions from real people. The topic can be anything in the world of finance, from retirement to taxes to wealth management — or even advice on advising.

In recent years, startups in the United States have been soaring. In 2021, Americans filed a record-breaking 5.4 million applications to start their own businesses, according to the U.S. Chamber of Commerce.

Though many of these entrepreneurs become CEOs, most of them don't earn millions. This year, the average salary of a startup CEO is $142,000, according to Kruze Consulting, a New York-based accounting firm for startups — down from $150,000 in 2022.

This raises a difficult question: How much should these entrepreneurs pay themselves? It's an appealing decision to make, but also a difficult balancing act. Too low a salary — or none at all — can be a hardship. But too high an income could bankrupt the business.

One person struggling with this dilemma is a young tech worker in New York City. Formerly employed by a popular app, now he has his own idea for a startup and is working with two partners to get it up and running.

How much should they earn? On what basis? Or should they even be deciding this yet? The startup starter turned to the experts for guidance. Here's what he wrote:

Dear advisors,

How should the founders of a startup think about setting their own pay? Are there any guidelines for this?

I'm a 36-year-old tech entrepreneur in New York City, and my two colleagues and I are working on starting our own company. It's a business-to-business, software-as-a-service startup that is working on getting revenue, has a product — a new app for journalists — and is potentially venture backable. As the three co-founders, how do we decide what our salaries should be?

Thanks for your help,

Venturing in the Village

And here's what financial advisors wrote back:

Lawyer up

Ron Strobel, a certified financial planner and the founder of

Retire Sensibly

in Meridian, Idaho

My advice to new business owners is that they should never expect to pay themselves within the first few years. If you can pay yourself, great, but be prepared for that initial period to be pretty tight financially. If you make it to the point where you have to calculate your salary, then that is a good problem to have.

An attorney would likely be a good person to consult because they could advise on the ownership structure of the company, which could include the owners' compensation agreements, provisions for buying out any founders who want to leave and so on. It's very important to have those types of arrangements in writing.

Timing is everything

Evan Henderson, a certified financial planner at

Northright Financial

in De Pere, Wisconsin

There might not be one single right answer to this question. It is important to know how long in your business plan you have until you expect to become profitable. You should be prepared to not take a salary for a couple years when getting things started. Once you have grown the business to the point where you can start earning a profit, you can then decide on the right amount to pay yourselves.

Also, take advantage of the tax perks of being a business owner. With three separate owners, it is important to have an open conversation about each other's responsibilities and how the business is split to determine how much you should each be paid — whether that is equally or determined by how much work is being completed or revenue is being brought in.

More than one way to look at it

Noah Damsky, a chartered financial analyst and principal at

Marina Wealth Advisors

in Los Angeles

This is a great question — one I'll answer from two perspectives:

From a financial advisor lens, one question to ask yourself is, why pay yourselves a salary? If there aren't any profits yet, you're just shuffling money from one pocket to the other. Any salary, at this stage, is subtracting from the money you put into the business. It's more important to grow your startup than to pay yourselves with your own money — and then have to pay taxes on those salaries!

If and when you take venture money, it makes more sense to pay yourself a salary. It's a good idea to loop in a tax pro and an estate planning attorney so you can structure your estate to minimize its tax burden when your company increases in value.

Use this opportunity without a salary to be tax smart. Consider Roth conversions while you have less income than you will in the future; pay taxes now at low rates so you don't have to pay them later when you have more income. This can save you six to seven figures in future tax liability.

From a private equity/venture capital investor lens, I'd say pay yourself enough to live modestly, but not excessively. It can be a turn-off to investors if you're trying to pay yourself $500,000 per year while posting your summer vacation photos from an oceanfront hotel in Mykonos. Investors want to know you're all aligned, that you're going to cash in when they cash in — when the company is a great success, not before then.

Don't overdo it

Julia Colantuono, a certified financial planner and the founder of

One Financial Design

in Boston

Think about what a reasonable market rate would be for hiring an employee to do the same work that you will be doing. That's a good starting point because it keeps the business honest in terms of profitability, scalability and tax compliance.

Of course, you as a business owner are taking on more risk than a regular employee would, with the hope being it will pay off in the form of increasing equity as the company grows. Over time, as profits increase, you can plan to regularly distribute profits to each owner as additional income. That way, you can bridge any gap between your salaries and the income needed for your desired lifestyle.

In many cases, it's still wise to keep salaries in that "sweet spot" of not too high or not too low. It mostly depends on what type of legal entity the company will be. For example, if you will be taxed as an S-Corporation, it could be more tax-advantaged to take income as profit distributions, and therefore you wouldn't want the salary too high. However, the IRS would also want to make sure the salaries aren't too low, allowing you to get away with reduced payroll taxes. If you pay yourselves a reasonable market rate for the work you'll be doing, you can then supplement with profit distributions.

With multiple owners, make sure you speak with an attorney and accountant who can give you guidance for your specific situation. When it comes to connecting the dots between business and personal finances, seek a fee-only financial planner like myself who specializes in helping business owners.

Best of luck with your new venture!