[Cover Story] How much should you pay yourself?

I recently read a guide to how small business owners should determine their own salaries that had me laughing. Actually it was the comments of a couple of compensation experts that got me going.

One expert suggested that owners ask themselves this question: "If someone else was to learn how much I’m making, is it fair? Is it fair to my employees? Is it fair to me for what I’m putting in?"

The other expert said that owners have to determine what value they bring to their companies: "It’s not only what the market is paying for the job but what am I contributing to the company?"

Actually, I think there is a simpler answer. I think business owners should pay themselves whatever is left — whatever is left, that is, after everyone and everything else has been paid and after money for growth and paying down debt has been factored in.

Among the factors that should not be considered when determining what an owner should be paid are how hard the owner works, what responsibilities the owner fulfills at the business, how long the owner has been running the business, what owners of similar businesses make, what the owner’s employees make — and especially not what some outsider might consider to be fair.

Entrepreneurship is not a job. Employees should be paid what they are worth, depending on market conditions. If a company does particularly well, it probably makes sense for the employees to share the benefit through some kind of bonus plan. But if a company is not doing well, the owner may end up making less than some employees, or even losing money. There is no "fair" when it comes to the owner’s salary, just fear that it won’t be there. You make what you earn.

To some extent, the owner’s salary is a false issue. There are all sorts of reasons why an owner might want to take more or less money out of the company in the form of salary. The more complicated and more important question is how much an entrepreneur should make in profit.

Given all of the risks and responsibilities involved with starting and running a business, most entrepreneurs like to be rewarded. I say most because I have come to understand that some people are perfectly happy running a business for minimal returns. To each his own.

Low or nonexistent profits should tell you that something is wrong with a company. Is it efficient? Is the pricing right? Are costs too high? Is there theft? Has the market become saturated? Is it time to move on?

But finding a benchmark for profitability in an industry of privately held companies can be difficult. What is too high a target? What is too low? If you are in a true commodity business, a profit of 2 percent might be all that the market will bear. A commodity business has few branding, quality or service differentiations. As a result, entrepreneurs accept low profits and focus on increasing sales. The problem is that I have seen owners call their businesses commodity businesses even when they really aren’t.

On the other end of the spectrum, the question is, "What is too much profit?" That’s a question I would not lose sleep over. Most small businesses have plenty of competition, so there is a limit to how much profit they can produce. The major factors affecting the profitability of a small company are service, product quality, product uniqueness, competition, buying power, efficiency, marketing costs, written-off assets still being used (lower depreciation) and marketing costs. Another key factor is the use of overhead. Could you handle 20 percent more business without increasing your overhead? Do the math on that. If your fixed overhead costs are 20 percent of sales, a 20 percent increase in sales would increase your bottom line dramatically.

I have been in quite a few business groups with the owners of many different kinds of businesses, and I have seen their numbers. At the high end, I know of a company that has a profit margin of more than 20 percent. I have seen other companies that considered a 5 percent profit to be very good. Where should your company be? Probably somewhere in between.

In the end, you probably will get what you deserve, not in some cosmic sense but in an all-business sense. If you accept low profits, you will almost certainly get them. In the present economy, many of us are not where we would like to be. That is entrepreneurship.

From The New York Times, © 2010 The New York Times. All rights reserved. Used by permission and protected by the copyright laws of the United States. The printing, copying, redistribution or retransmission of the material without express written permission is prohibited.

Jay Goltz owns five small businesses in Chicago. In addition to overseeing those businesses, he writes and speaks about small business, regularly sharing the realities of running a business on his New York Times blog.