Kapil Bhutkar

You’re the boss. How much should your new company pay you?
It seems like a silly question, but it’s one that owners of business startups have to answer. How much of a salary should they receive?
Depending on how the business is structured, the answer can be, “What the market will bear,” “Just part of what I’d make otherwise” or even “Nothing at all — at least for now.”

What you’re really worth ?

Basically, the owner of a small business who is also an employee should be compensated by a method similar to that used for anyone else. His (or her) pay should reflect some combination of value to the business, the amount of work performed and what it would cost to hire someone totally independent of the business as a replacement.

Owners need to receive reasonable compensation for tax reasons as well as for common-sense ones. The owner of a C corporation who receives a salary that’s too high for the work performed could find herself in a fight with the Internal Revenue Service if the IRS feels that the high compensation is an attempt to disguise as wages what should be dividends (which are taxed at both the corporate and personal levels).

Conversely, the owner of an S corporation who has a salary that’s too low could find the IRS charging that the unreasonably low salary is an attempt to avoid employment taxes by having the company pass through profits as distributions subject only to a personal income tax.
Nothing, for now

You may be able to calculate what you should get paid, but the truth is that if you’re the sole owner of a business startup, you might not receive any salary initially. “They pay themselves, but instead of actually taking a check, they defer their salaries,” says Barbara Bird, the chair of the management department at the Kogad School of Business at American University.
The deferred salary becomes a liability for the company — one you should get back at some point with interest, once the company starts bringing in some revenue.

Again, the calculation of that deferred salary should be reasonable and based on your experience and the work you’re doing for the business. This is important not just from an accounting perspective but also in terms of having a realistic business model: If you’re not figuring on a reasonable salary for yourself, you’re underestimating the real expenses of the business and exaggerating the profit potential and worth of the venture.
Generally, a business that cannot pay its owner-employee a market salary over the long term is a business that doesn’t have much real value.
Some now, perhaps more later.

Taking some salary, but not as much as your “market value,” is a more likely scenario if you have investors in your business. The reasoning is that part of your compensation is going to be the growth and increased value of the business that you’re going to be able to achieve with the help of your investors’ money. Small businesses with investor backing are also better able to pay salaries from Day One than are single-owner bootstrap ventures.
With investors in the picture, you might still have some income deferred on the company books. However, an entrepreneur may instead receive compensation in the form of stock in the company. That way, overall compensation is tied to the success of the company and the entrepreneur can benefit from that success.

“It’s not at all unusual for an entrepreneur to take a low salary initially,” says Thomas Kinnear, executive director of the Zell Lurie Institute for Entrepreneurial Studies at the University of Michigan Business School. “The rule of thumb that floats around is compensation of maybe 70% or 80% of what you might otherwise get on the open market, although I’ve seen compensation fall to 50% or less of the market rate while businesses work through rough times.”

The compensation issue gets a little more complicated if you have partners. “Usually, particularly with technology startups, you’ve got a team of people instead of just an individual, and you usually have differences in [financial] circumstances among those founders,” says Tom Emerson, director of the Donald H. Jones Center for Entrepreneurship at Carnegie Mellon University in Pittsburgh.

Business planning experts say the time to deal with compensation issues among partners is in the early stages of a business, before any pressures of actually running the enterprise — or any pressures that could threaten the partnership — have time to develop.

Structuring compensation properly at the start can also prevent problems later. “Let’s say you’ve got three people who start a business and one of them is a marketing guy who decides to leave,” Emerson says. “Well, you still have to have a marketing guy. The company needs to be able to pull back some of the equity it was giving that initial guy so it can attract a replacement. So in the initial agreement, you want to have the equity vesting over time, and something that gives the company the ability to get that stock back to attract a replacement if necessary.”

No matter how well you get along with your co-founders, business experts say you should turn to an attorney when formalizing agreements between partners. Hiring a lawyer familiar with startup issues early in the business development process can help you avoid many headaches later.

If you’re thinking of starting a business, know that the deck is stacked against you. According to one oft-quoted statistic, the first-year survival rate among small businesses is only 20%.
And that’s on average; it doesn’t take into account the prevailing economic conditions.

The chances of your startup timing being perfect may be slim at best, and you may find yourself confronted with a sluggish economy when you’re ready to go.

While that doesn’t mean you shouldn’t test the entrepreneurial waters, neither does it mean you should operate the way you would in a robust economy.

Here are five keys to launching a small business, and keeping it afloat, in an uncertain economy.

1.  Keep an eye open to opportunity.

If you’ve been bitten by the entrepreneurial bug, but haven’t yet settled on a specific business, pay attention to the impact the economy is having on different sectors. For example, the corporate downsizing that occurred during the 2001 recession and afterward created some market openings. Sharon Miller, chief executive officer of the Renaissance Entrepreneurship Center, a business incubator in San Francisco, says support services formerly performed in-house represent a particularly fertile field as more and more companies farm out functions such as public relations and payroll. To spot opportunities, keep an eye on the business press for reports of downsizing by local companies. Also, be aware of changing consumption patterns. If security threats and other uncertainties mean people aren’t traveling as much, where are they spending their discretionary income? An idea for a new business or two might lie in the answer to that question.

2. Be extra diligent about your due diligence.

You think you’ve got a good idea, but does the marketplace? Uncertain economic times demand that any new enterprise have legs enough to keep going in the face of tight money and sluggish demand. First, do some homework — by all means talk to people already in the field — to determine if there really is demand for what you want to do. Then, figure out if you can do it profitably. Take a hard look at costs of the enterprise and weigh those against the price you think you’ll be able to charge for your product or service. Do your computations add up to positive cash flow and profitability, or will you be operating in the red from the outset? It’s also essential that you be brutally honest about your own shortcomings. You may have the primary skill needed to succeed at the business you’ve chosen, but what about the more generic aspects of running a business? The marketing? The accounting? If you need help, get it.�
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3. Cast a wide financing net.

A slumping economy generally makes it tougher for a small-business startup to qualify for financing, and chances are you won’t be able to get a conventional bank loan for your business. So, time to think outside the box. Stan Mandel, director of Wake Forest University’s Angell Center for Entrepreneurship, suggests these four alternatives:

• Friends and family. If you can’t convince the people who know and love you that you’ve got a great idea, who can you convince?
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• Potential customers. Identify customers who have a real need for the product or service you plan to sell and see if they’re willing to buy in as investors. They may well be interested, depending on how badly they need what you’re selling.
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• Small Business Investment Corporations (SBICs). Some but not all SBICs are willing to become involved with startups in exchange for a piece of the action. These are the equity SBICs (as opposed to lender SBICs), and you can track them down through the U.S. Small Business Administration, with whom they’re affiliated.
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• Angel investors. These are private investors willing to roll the dice with a new business. The best way to learn of angels in your marketplace, Mandel suggests, is by consulting with the attorney or accountant who handles your business affairs.�
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4. Be tight with your money.

Wherever you find your money, uncertain economic times demand that you be careful with it. Cautions Bill Dunkelberg, chief economist of the National Federation of Independent Business: “Don’t spend your money too quickly, and make sure you’ve got a pot of cash in case the slowdown lasts.” And if you’re operating thanks to investors, Mandel says, be sure you have a clear understanding of the milestones they expect the business to reach in the short term, and make certain you have the money on hand to make that happen.�
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5. Operate creatively.

This is almost a corollary to the preceding point. The name of the game is to stretch your operating cash to the maximum extent possible. That requires creativity. Miller recommends doing a “personal/business audit” that spares no expenditure, no matter how seemingly inconsequential, from scrutiny. The idea is to see if there’s “any give in the overhead.” Savings, like the devil, are in the details. “How much do you spend on coffee?” Miller asks. And, “Do you have someone come in to take care of the plants?” If you do, think again. Miller also is an advocate of creative partnerships that allow two or more businesses to share expenses. One firm she is aware of provides office space to an independent sales rep who, to pay the rent, handles the company’s sales chores.�
 

Whatever particulars apply to you and the business you’re trying to start, the common denominator that should inform your every effort is total commitment. Says Mandel: “You have to be ruthless in terms of trying to get your business launched.”

It’s interesting to me that more people ask me for advice about starting a business when the economy is stumbling than when things are humming along.

However, that’s not as counter-intuitive as it may at first seem. Getting laid off — or just the possibility of losing a job — often causes people to focus on how they might create their own enterprise.

So, I find myself talking a lot about the financial decisions people must make before starting their own businesses. Here are five of the biggest:

1. How long can you live on your savings?

This isn’t an issue for people who are able to raise enough money for their startup venture to pay themselves a salary from Day One. But most small-business startups include the disturbing feature of declining personal bank balances in the early going. As long as you’re looking at your expenses and how long you can live on your savings, you should also figure out now what personal costs you can at least temporarily eliminate. It’s usually emotionally easier to review your personal budget and tighten expenses when you’re contemplating a new venture than it is to cut back after you’ve started. The first path tends to feel voluntary; the second feels imposed by an economic struggle.
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2. How deeply in debt are you willing to go?

Business loans can fund expansion, help improve profit ratios, and improve overall cash-on-cash returns. In short, business debt can be good. For the smallest entrepreneurs, however, business debt is often personal debt. Many people start a venture by lending money to their business or by simply deferring any payments for their own labor. As many small-business owners will tell you, lenders may make loans to a business, but the business owner will often be required to personally guarantee the loan. So although the debt is on the business’ books, you’ll ultimately be personally on the hook if the enterprise goes sour.
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3. What are you going to do about health insurance?

In a country with no national system or guarantee of health coverage, this is a big issue. If you currently work for an entity that offers health insurance and is subject to Consolidated Omnibus Budget Reconciliation Act (COBRA) regulations, you can probably temporarily keep your coverage by paying the full premiums on your policy, plus another 2% for administrative costs. It’s possible to keep your coverage under COBRA for up to 18 months. I’ve also seen many people starting new ventures use COBRA as a stopgap, paying the premiums for four or five months until they find a health insurance plan more affordable or more appropriate for their individual needs.
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4. Have you lined up your lines of credit in advance?

The time to get approval for a loan is when you don’t need one. If you have a lot of equity in your home, it’s currently possible to set up a home equity line of credit that will let you borrow money at 1 percentage point over the prime rate or less. Banks and other lenders are, for obvious reasons, more willing to make loans to someone who has had a job with a steady paycheck for several years than to someone who has just quit to enter the wild, wonderful world of self-employment. If you have an excellent credit rating, you can probably get a home equity or other secured loan with a minimal amount of paperwork. Once you’re self-employed, you’ll probably have to provide at least your most recent tax return and other documentation before getting approval.
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5. Are you covered against not being able to run your business?

You may have some disability insurance through your current employer. The problem is, disability insurance (unlike health insurance) usually cannot be kept or transferred to an individual policy when you leave your job. To protect yourself, get your own disability policy while you are still employed. Once you have the policy established and are paying the premiums, you should be able to keep the policy when you go out on your own. (Check with your insurance agent to make sure that any policy will remain in force after you leave a job.) An added bonus: While the hope is that you never need to collect on a disability policy, benefits you receive on a policy you paid for yourself are free of federal income tax. Benefits on a policy paid for by your employer are taxable.

By Joseph Anthony (Microsoft)

One of the toughest things in starting a business is, well, figuring out what it’s going to cost you to start. It’s tough because startup costs are a moving target, easy to underestimate and almost always subject to change.

I like the one-sentence startup guide that I was given by Tom Emerson, director of the Donald H. Jones Center for Entrepreneurship at Carnegie Mellon University in Pittsburgh. “Start out with nothing and sell half of it for several million dollars and you’ll be on your way,” he tells me in a phone interview. I imagine he had a big grin on his face as he spoke.

Unfortunately, except for perhaps a brief moment at the height of Internet mania, we all know that model doesn’t fly. The model that does fly involves calculating and recalculating, and being aware of some of the most common early errors.

Here are five rules that can help you start figuring the cost of starting.

1. Have a solid plan — then change it.

Most business startup stories say that you have to have a business plan. And you do. But that’s not the beginning and end of figuring out your startup costs. Jeff Shuman, professor of management and director of entrepreneurial studies at Bentley College, says, “The conventional wisdom is that an entrepreneur sees an opportunity, comes up with a business plan to capitalize on it, determines the capital that needs to be raised, raises the capital and then applies it to building the business described in the business plan.”

There’s one major problem with that model, says Shuman: It all hinges on getting the business right the first time, and that doesn’t often happen. “In reality, it’s likely that some of your initial assumptions are pretty good and others aren’t going to be worth the paper they’re written on,” he says. Shuman and others say that figuring out your startup costs means regularly reviewing your assumptions and changing your initial business model.

Writing a business plan is good because it forces you to write down literally everything you are going to need to start your business — legal help, tax help, office supplies, equipment, postage, office space, employee salaries, insurance and so on. But that initial plan is likely to change repeatedly as you learn new things and incorporate them into the plan.
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2. Be willing to pull back.

It’s tempting to add up everything you need for the full-fledged business you imagine, and decide that that’s what you need to start out. But pulling back and looking for a smaller model can give you a way to get started while also preserving capital.

Shuman uses the example of someone who calculates that the total cost of starting a retail business in a local mall is going to work out to $150 a square foot. “You could start that way and write a business plan based on that amount,” he says. “But maybe you’d be better off putting a pushcart in the mall and testing what the demand is for your products at that location.

“This consumer testing reduces your initial startup costs. The result is that the initial cycle of your business is dedicated not so much to generating profits as to generating information. “With this, you can fund your business on a cycle-by-cycle basis,” Shuman says. “When you go for the second cycle and for expanding your business, the numbers are now based not on focus groups or surveys but on real-world experience.”
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3. Calculate prices, time correctly.

Calculating your initial cash flow is part of figuring out your startup costs. It’s an area where businesses are sometimes less optimistic than they should be. “Small-business owners may under-price their product or service, thinking they have to come in at as low a price point as possible to compete,” says Barbara Bird, chair of the management department at Kogad School of Business at American University. “They don’t necessarily need to do that.”�
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4.  Correctly estimate your startup time.

Yes, when beginning a business, time can literally be money. Let’s say you’re going to have fixed costs such as a monthly lease. If you have to make improvements to a space before you can actually open for business, those fixed costs are going to be additional startup costs until you can actually open for business.

I’ve watched many entrepreneurs draw up a timeline for their ventures and get tripped up on the zoning, safety and inspection requirements imposed by local agencies. For that reason, I think one of the first places a prospective new business owner should go — even before approaching a lender or leasing agent — is to the local government planning or license department. Construction permits and inspections can push a startup’s prospective opening date back by months. If you fail to figure in the cost of this additional time, you could be short of working capital right out of the gate.
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5.  Be realistic about the cost of money.

Many small-business owners self-finance their ventures by running up big balances on their personal credit cards. Others tap the equity in their homes. But self-financing isn’t a practical option for larger ventures.

Carnegie Mellon’s Emerson says that startups should figure in the cost of capital when determining initial expenses and cash flow. “The cost is usually based on what the interest would be that similar cash invested in something with similar risk would command on the market,” Emerson says. “It’s usually a figure that is a few percentage points or more above the prime rate.”