Starting a business comes with endless decisions. One big one is how to pay yourself. Do you take a salary, or do you rely on distributions? This choice can have a major impact on your business and your personal life.

Why This Decision Matters

How you pay yourself can profoundly affect the trajectory of your business. Not only is it a reflection of your commitment to your business, but it is a decision that also impacts your cash flow, tax obligations, and the perception of investors and employees. A well-considered compensation strategy can help maintain financial stability, encourage investor confidence, and sustain employee morale.

Your financial stability matters. You need to ensure you can pay your bills and maintain a decent quality of life. If you're constantly worried about your personal finances, it’s harder to make clear-headed decisions for your business. A steady salary can provide the peace of mind needed to focus on long-term goals rather than immediate survival.

This choice also impacts investor confidence. Investors look for founders who are committed for the long haul. A reasonable salary shows you are serious about your business, not just in it for a quick windfall. On the other hand, if you’re pulling large distributions early on, it might signal that you’re more interested in personal gain than the company’s future.

For founders, the stakes are high. A regular salary might provide the security needed to focus on growing the business without personal financial stress. Conversely, tying compensation to business success through distributions can incentivize efficient use of resources and improve decision-making. This isn't just a financial decision; it's a strategic one—one that can influence your company's trajectory and culture.

Understanding Salaries vs. Distributions

Before diving into the pros and cons, it’s important to understand the fundamental differences between salaries and distributions.

Salaries

A salary is a fixed, regular payment that you receive as an employee of your company. It is subject to payroll taxes and is considered an operational expense for the business. Salaries provide a predictable income stream, allowing for personal financial planning and stability.

Distributions

Distributions, or dividends, are payments made to business owners from the profits of the company. They are typically taxed at a lower rate than salaries and are not subject to payroll taxes. However, distributions are contingent on the company’s profitability and can vary greatly from one period to the next.

The Case for Salary

A salary offers predictability. Every month, you know exactly how much money will land in your bank account. This steadiness allows you to plan your life with a sense of security. When you know your personal expenses are covered, you can focus more on the business and less on financial worries.

A fair salary shows investors and employees that you are committed to the business and not just looking for a quick payout. It signals that you believe in the company’s long-term potential and are willing to invest in its future.

However, setting your salary is not straightforward. It needs to be enough to live on but not so high that it drains the business of essential resources. This balancing act is crucial, especially in the early stages when cash flow is tight. 

The Case for Distributions

Distributions tie your income directly to the company’s success. This can be a powerful motivator, pushing you to ensure every decision benefits the bottom line. Since distributions are usually taxed at a lower rate than salary, you can also save on taxes, which means more money stays in your pocket.

But this method comes with its own set of challenges. Distributions can be unpredictable, varying with the company's performance. This variability can make personal financial planning difficult, adding stress in an already high-pressure environment. You might find yourself in a tough spot during slow periods, having to dip into savings or forgo income altogether.

Additionally, heavy reliance on distributions can send mixed messages. While it shows confidence in the business’s profitability, it might also suggest to investors and employees that you’re taking out more than you’re putting back in. This can be particularly concerning in the eyes of investors who are wary of founders who might prioritize personal gain over reinvestment in growth.

Finding the Right Balance

For many founders, a hybrid approach is the most viable solution. A modest salary ensures that your basic needs are met, providing stability and reducing personal financial stress. Supplementing this with distributions during profitable periods aligns your interests with the company’s success, fostering a culture of shared prosperity.

This balanced strategy requires constant adjustment. As your business evolves, so too should your compensation strategy. Early on, you might need to lean more heavily on a salary to maintain stability. As the business grows and becomes more profitable, distributions can play a larger role.

Conclusion

Deciding how to pay yourself is a crucial part of running a business. It affects your personal finances, your company’s health, and the confidence of those who invest in or work for your business. This decision is deeply personal and profoundly impactful. It requires careful consideration of your own needs, your company’s financial health, and the perceptions of those around you. By being thoughtful, you can create a compensation package that supports your personal needs and professional goals.

Ultimately, how you choose to pay yourself is a reflection of your values and your vision for the future. It’s a decision that deserves your time, your thought, your care and—more often than not—some external guidance. In the end, it’s not just about money—it’s about building a life, legacy, and business that you can be proud of.