Far too often creatives mistake the money they take from their businesses as being their profits. But your compensation is not your profit, it’s an expense to the company. Profits are what’s left over after you pay yourself and all your other expenses.
When a startup founder goes on Shark Tank, one of the questions they might get asked is whether or not they’ve drawn any money out of the company in salary. This is an important question needed to more accurately value a company. It also informs the investor how some of their investment will be put to use.
On one hand, investors like it when a founder does not take money out of the company. This means that all their investment will go toward production and marketing so that sales and value will grow more quickly. On the other hand, depending on how far along the startup is, if the founder has not drawn a salary, then their overall profit margins are being artificially increased since the overhead cost of the founder’s time and effort are not being counted. Eventually, the founder will need to get paid, or an employee will need to fill the functions being bootstrapped by the founder, which will increase overhead, and cut into margins, thus lowering the valuation.
Startup Founders Bet on a Payday
In the startup world, investors need to ask these questions since they impact the valuation of the equity they’re buying. But either way, it’s not that big a deal since an investor wouldn’t even be interested in the company unless they saw the potential for a 10-100 fold increase in value. In that case, carving out a reasonable salary for a founder, or hiring an employee, is a drop in the bucket, compared to the revenues in view.
When founders forgo drawing money out of their companies, opting instead to reinvest sales back into the business, they’re betting on a future payday, worth much more than what they might have earned in a decent paying job. That’s risky of course, but not unreasonable.
Creatives Aren’t Going to Get a Payday
But when we ask the same questions of founders of creative practices, the answer to how much they compensate themselves is critical, first and foremost because there is no great future payday for a creative entrepreneur. They are not going to get venture capital. Their services can be well rewarded, but not nearly at the scale of an investable startup. Even if they did ever sell their company, it’s not likely to be a big payday.
Creative entrepreneurs, therefore, need to pay themselves a reasonable salary along the way. And they need to be accumulating profits, to build real value into their equity, and take larger distributions from those profits as their success grows.
Undercompensating Distorts Profitability
Unfortunately, in many cases, creatives undercompensate themselves. They adapt to seasons of low revenue by paying themselves less. And even when they are doing well they tend to cap their base pay lower than they should.
This kind of bootstrapping and hustle may be fine for a young freelancer just beginning their career, but far too often they get used to just scraping by, leaving themselves extremely vulnerable to any downturns in their business.
Creatives simply can’t follow the startup model, because there is no future payday. If you forgo money today, it’s not coming back later. You must bake your compensation into your business model from the get-go.
How Low Compensation Lowers Your Valuation
Theoretically, if you were to ever sell your creative practice, whoever buys it ought to ask the same question the Sharks ask. But in their case, they won’t be buying the company in hopes of a 10-100x return, so they’ll want to be sure that your company is inherently profitable. But if you’ve spent your career subsidizing low profits by taking cuts in pay, whatever the differences have been between what you ought to reasonably have been paid and what you actually took, becomes a huge liability to the value of your equity, perhaps bringing it right down to zero, or even negative.
Think about this from the theoretical buyer’s perspective. If you’ve been subsidizing and now the new owner needs to hire someone to fill your role, there would not be enough revenue to replace you. The company’s profits would be eaten up.
How Much Should Creative Entrepreneurs Pay Themselves?
So how much should you pay yourself? There’s no absolute answer to this, and of course compensation scales depending on where in the country (or the world) you live, and whether or not you are running a solo freelance practice or a firm with employees.
However, if you’re self-employed, you’re running a business. And owning your own business requires taking and absorbing risks. So whatever you decide on as a base salary, it should definitely be higher than what you could make working in a comparable role for someone else. A wage that, if someone were to buy your practice, would be more than sufficient to attract another creative to fill your role. If I were to suggest a ballpark target, again outside of those early years of hustling and finding your footing, I would use $100,000 per year as a base target. Anything less than that does not reflect the risks you take running your own business.
Now it might take you a few years to get to that level, but by using that target (as a minimum) if you take less you’ll at least be recognizing that you’re subsidizing the value of your company through low compensation. And you won’t keep deluding yourself about the value of your equity.