A cornerstone of the Build to Own philosophy is that agency owners should be making what they want – and deserve – from their businesses. In my conversations with owners, it inevitably comes up that they take compensation in a variety of different ways.
Figuring out how to maximize your financial benefit while minimizing your tax burden and doing what’s right by the business requires an understanding of the different ways that you can take compensation as an owner.
I have written previously about the need to compensate yourself both for the work that you are doing for the business as well as benefiting financially from the risk that you are taking as an entrepreneur.
Let’s look at some of the most common forms of owner compensation, as well as some that you may not have considered.
Many – if not most – agency owners take at least part of their compensation as draws from the profits that their businesses generate.
In simple terms, these are the checks that owners write to themselves directly from the business bank account.
Draws can sometimes be referred to as dividends, distributions, or profit-sharing, but the overall principle remains the same (though there can be some nuances to consider from an operational and tax perspective).
While this can be the simplest method of taking money from your business, most agencies make these payments in a haphazard fashion with substantial fluctuations.
To the extent you utilize draws, having them occur on a set schedule is generally the best practice and you should have a method for determining the amount – other than simply saying “I think I can take this much out of the bank account now.”
Draws or profit-sharing represent the primary way that you compensate yourself for entrepreneurial risk, so just about every agency should be using them as a tool.
Depending on the structure of your business, it may or may not be advisable to pay yourself as a W-2 employee like the rest of your team.
Taking direct compensation for the work that you do on behalf of the agency on a regular basis is a best practice, whether you go the W-2 route with an actual salary or you mimic that behavior with regular draws or guaranteed payments.
The discipline of paying yourself on a set schedule helps to ensure that you do not feel taken advantage of by your own business, but it also helps to enforce better business decision-making that will enable you to scale and adjust your own role more effectively in the future.
Regardless of the method that you use to take the bulk of your cash compensation from the business, you should consider including yourself in whatever bonus practices that you have established.
This is especially important in a partnership where it can be valuable to recognize the individual contributions of each member, but even if you are the sole owner you should have a structure in place to reward yourself for your own performance.
Keep in mind that bonuses that you pay yourself should be related to your work on behalf of the agency, while your draws would be used to distribute the profits to you as compensation for your entrepreneurial risk-taking.
In addition to the cash that you receive today in the form of draws, salaries, and bonuses, you should consider maximizing your allowable retirement contributions.
Depending upon the business structure that you have elected and other factors, the amount that you can set aside will vary substantially. You will need to consult with your tax professional to determine how – and how much – you should be able to put aside for your retirement.
When you consider your own compensation, you should be factoring in this amount since it has an impact on the business operations as well as your own financial future.
Keep in mind that if you have employees, you will likely need to balance your desire to maximize your own contributions with rules requiring parity in benefits across your team. Your tax and legal advisers can give you the best advice for your own situation.
Life Insurance Policies
None of us like to consider our own demise, but we should be thinking about whether the agency should own a life insurance policy on the owner(s).
This can end up being a real benefit to the owner’s family, and if you structure the ownership correctly then the business should be able to make the payments and take a tax deduction on them.
Life insurance owned by the business is even more important when you have business partners because it not only has the potential to benefit that individual partner’s family, but it can also make the transition process easier for the other partners by providing capital to buy out the deceased member’s equity stake.
You may hear policies like these discussed as “key person” life insurance policies, and they can be a very valuable tool for operating the business as well as effectively increasing the compensation of the owner.
Health Insurance Benefits
Few things cost U.S. business owners more than health insurance – both for themselves and for their teams.
When you are an employee, you need to accept whatever choices your employer has made in terms of the plan(s) offered.
As an owner, a clear benefit is being able to have a decision-making role in the health insurance benefits that your agency will offer. Obviously, there are still a lot of regulatory restrictions and market factors which impact what you may have as options, but you should still view this as a compensation tool for yourself.
As with retirement contributions, you need to keep in mind that whatever you select for yourself will likely need to be offered to the rest of your team, but even with that caveat there are real advantages to be had here if you play your cards right.
While this won’t end up softening the blow of the total cost all that much, it can still provide you with valuable tax deductions and flexibility to make your own choices about health care that you might not be able to if you were an employee of someone else’s business.
As an agency owner, there are lots of legitimate expenses that your business can cover that might help to benefit you personally as a side effect.
As long as you know and abide by all of the appropriate rules, you can have your business buy things like laptops and cell phones. You may be able to coordinate legitimate business trips to offset the cost of trips with your family.
While you need to be thoughtful to avoid getting careless and inviting troubles with the Tax Man, there are some real opportunities to improve your own compensation by ensuring that your business covers expenses that you might just have eaten as an employee in previous jobs.
Related Business Transactions
Some agency owners may own other businesses, sometimes related to the work that the agency itself does.
For example, if you own a software company, your agency might have a need for the products that it creates.
In those cases, you can have one company pay the other – on commercially reasonable terms – for those products or services.
Depending on how the businesses are structured, there could be some immediate compensation benefit.
Even if there isn’t, there may be a longer term benefit to your personal bottom line by helping both businesses to grow in tandem.
A good tax adviser can help you to evaluate all of the deductions that you may be able to take advantage of to reduce your tax burden (and correspondingly increase your take-home compensation).
While some of these deductions are pretty straightforward (like those cited above for business expenses) others can be more complex. For example, you might want to look at the home office deduction or using the Augusta Rule to host meetings in your home. Both of these come with potential strings attached (and can end up being mutually exclusive), so you will want to review your specific situation to understand your options.
This is where it is important to have a tax adviser who knows your own goals, understands your business, and is compatible with your level of risk tolerance.
Many agencies employ family members, including spouses and children.
It’s important for both business and tax reasons that these be real jobs that actually benefit the agency, but it can increase the owner’s effective compensation both by providing valuable tax deductions and by helping to provide for the financial well-being of those employed.
As with most of the suggestions here, it is important to review the tax consequences – both for the business and the individuals involved – to make sure that everything is structured to maximize the benefit and avoid unpleasant surprises come Tax Day.
While most of this article has focused on financial remuneration, you should also consider the time flexibility that your agency ownership grants you as a form of compensation.
Being able to – within reason – set your own schedule, choose your own work, select your colleagues, and live wherever you want all have a real benefit.
For some agency owners, this flexibility may be why they took the leap into entrepreneurship in the first place. Perhaps family circumstances dictated a flexible work schedule and going out on their own was the obvious choice – and then it turned into a “real” business but they don’t want to sacrifice the flexibility.
If you don’t feel like you have this flexibility now, then you should absolutely look into what you need to do in order to gain (or regain) it.
As an entrepreneur, financial compensation is definitely important, but all of the other benefits that surround your choice to take the risk and responsibility of running your own business must be considered, too.