Paying Yourself and Incentives in a Small Business

Nov 11, 2022

Owning a small business has a pitfall that where you start and where the company starts are blurred. You take money out whenever you want and treat the company as a personal bank. I think this has caused misaligned incentives and coming to the conclusion that it be avoided.

When you are the owner of a business that business belongs to you and you decide whether to keep it or not as an investment, when you work on the business you allocate capital including hiring and creating dividend, when you work in the business you get paid for the work you do. An entrepreneur needs to think in these three terms.

An ownership of a business does not mean treat the company like a bank. A company should exist as its own independent unit that like any life force is seeking to optimize itself toward a mission while giving a ROI. The owner of the business needs to think of the business in this term. So a flush out of cash leads to the company not performing at its peak. If anything ownership is an external factor.

Working on the company is using the capital within the company for the benefit of growing the company while also benefitting the stakeholders such as the owners. It is for this reason giving employees ownership is seen as a benefit. When working on the company Capital is allocated to where it is needed and excess capital should be returned as a dividend. The important drive here is while working on the company the incentives should be to think like an owner while acting like a worker. So the worker should be paid a compensation appropriate to their work, but their drive should be to increase the growth rate.

Lastly, working in the company is commiserate to being paid for the work performed. Your incentives are to work to get paid.

As a small business entrepreneur or any entrepreneur, for that matter, it seems that the best way to achieve the desired outcome is to go up the chain. When working in the company you get paid for the work performed, when working on the company you get paid for the work performed and once a quarter give a dividend if it is appropriate, as an owner you seek to ensure that the ROI is appropriate and find other investors who’d want to invest or raise capital to put into growing the business.

Each task set is completely independent.