Understanding the link between a business owner’s salary structure and the business’ life cycle.
An unemployment rate of 29.1% (according to Stats SA) means that approximately one in three people that have actively searched for work have not been able to find employment. The youth unemployment rate for people between the age of 15 and 24 has risen to 58.2% and 36.1% for people between the ages of 25 and 34.
These severe statistics highlight the need for entrepreneurs to not only employ themselves, but to also create jobs for others in an effort to eliminate the social scourge of unemployment. Fortunately, the entrepreneurial spirit of South Africans is alive and well and with the appropriate support from legislation and financial institutions, SMMEs can lead the fight against unemployment.
Being an entrepreneur (owner) may sound like a wonderful opportunity to work for yourself and reap the benefits of your own efforts. In reality it is an undertaking riddled with challenges, start-up capital usually being the most significant along with lack of administrative and productive support.
And then the biggest question of all: “How do I fund my own personal finances when I have invested all of my money and effort into my business?” This is an awkward, but very relevant question. An entrepreneur cannot pursue their business interests if they are unable to meet their own basic needs. One of the most fundamental errors that an aspiring entrepreneur can make is not factoring in their own salary when structuring their business expenses.
So, how should an entrepreneur structure their own salary when starting their business? The key to answering this question is understanding that the business owner’s salary structure and the business’ life cycle are inextricably linked. Table 1 illustrates this link and explains how the business owner’s salary structure will change as the life cycle of the business changes.
The embroynic phase
During the business’ embryonic phase, the risk of failure is high, the work stream is uncertain and usually the entrepreneur is working alone or in a small team. This phase is often characterised by the business needing to retain as much profit as possible for further investment to expand the business. This necessitates that the entrepreneur sets their guaranteed pay as low as possible and shares in the profits only after funding the business to meet its expansion goals through the profits.
The growth phase
The growth phase occurs when the business has become somewhat established and the work stream is more stable and consistent. This allows the entrepreneur to employ additional resources with more certainty that they can afford these resources, and hence lays the platform for expansion. During this phase the entrepreneur can move their guaranteed portion of pay closer to that of a market related salary and maintain their high ratio of variable pay based on the profits of the business after funding business growth.
The mature phase
Once the business has matured and is approaching its peak, the need for the entrepreneur to carry the full burden of running the business begins to diminish and they can begin to treat themselves as an employee (usually in the role of Chief executive Officer). This transition from business owner to “employee” (although still the owner) allows the entrepreneur more freedom within the business, as structures are well-defined and the business no longer solely relies upon them for survival.
The work stream is well established and allows the owner to pay themselves well in terms of their guaranteed portion of pay, although their ratio of sharing in the profits of the business may decrease.
The decline phase
During the decline phase, the entrepreneur is either seeking to sell the business or keep it as a “break-even” or “loss-leader” business, or as a strategic input into another business. The opportunity to share in profits from this company may have declined, but the business may allow the entrepreneur to reach the growth or mature phase of another business of theirs’ which compensates them through that business.
Lastly, some entrepreneurs pay themselves less because of the shares they own in the company. This should not be confused with salary as they own the shares through starting the business, and not by the nature of their employment. This should always be born in mind, as the business does not exist without the entrepreneur, and the entrepreneur (by definition) doesn’t exist without the company.
Bryden Morton, B.Com (Hons) Economics, is Executive Director at 21st Century, a specialist Remuneration, Organisation Development and Change Management consultancy.