Our thinking often determines our outcome. As such, poor thinking (or no thinking at all) can result in poor performance. So far, so logical.
Many of the hundreds of business owners I have had the privilege to speak with over the last twenty plus years feel they are underpaid, but why is this? And why do I believe that business owners should be paid three times?
Part of the confusion comes from owners of businesses opting to contribute the smallest amount to our National Insurance, by taking most of their payment as dividends that don’t attract this tax burden. Could the recent Covid-19 pandemic mean that more business owners will realise that the NHS needs our tax? In any case, what I wanted to ensure we covered here is that taking wages as dividends blurs the line between employee wages and company dividends.
I believe that an owner should be paid for turning up to do their day job, then they should be paid for their performance in reaching their new financial goals and finally they should also be paid for the investment they have in their business. To help you understand why this is important and how you would calculate each of these, please read on.
Turn up for work
The Managing Director (or whatever fancy title you choose) is an employed post. You may think you are special, but you could if needed hire in someone who is at least as good as you and probably better. This will become an important fact when you want to move on so don’t mislead yourself that you are unique, special or a one-off. With that bombshell dropped, we can now talk about the fact that the job you expect someone to do has a value. The Managing Director of a business turning £100K or a business turning £100M will be paid a different amount for turning up to work, but the principle is the same.
What would you pay someone to run your business in a mode known as ‘Business as Usual’? Think of this person being a caretaker of what has already been built.
Hitting your numbers
Businesses that are not growing are dying. What does ‘growing’ mean? Well, it’s a combination of revenue, profitability and innovation. The combined result of growing revenue, increasing profitability and continuing to innovate to remain relevant creates a greater net profit figure at the bottom line.
If you had a business that was dropping 10% to the bottom line, what would you be willing to pay your hired Managing Director to take that to 12% or 14%? Think of this as a bonus for achieving. Of course, these goals will need to be reset over time. If 14% has become the normal profit, the new goal for your Managing Director will need to drive the behaviour you want from that role.
How much is your money worth somewhere else?
For the first two payments I asked you to consider what you would pay someone you hired to be the Managing Director. For this final payment, I want you to think about what you would earn from your money if you invested it somewhere else. Let’s explore that idea just a little.
Firstly, you need to value your business. Your sector probably has ready calculators. In the IT MSP sector we typically work on average of 5x the EBITDA (after adjusting for the owners being paid the right amount for their day jobs including any performance bonuses, but excluding owner investment dividends) averaged with 0.6x of the revenue. Of course, what it is really worth is dependent on the business size and there being a willing buyer.
Then secondly, let’s say that if you sold your business today and it is worth £500K. Where could you invest £500K and what would it return. Both pensions and property portfolios average about an 8% return over time, so you should be seeing about £40K per annum for your investment.
How much of your pay today is related to the money you have invested in your business?
When you get paid just once, you start to believe it is all wages and you deserve it. You only really deserve your return on investing your money based on what you could get for it invested elsewhere. For everything else you must be at least as good at your job as the Managing Director you could hire for your available budget.
So, if ever you find yourself thinking you are not paid what you are worth, start by working out which element of your contribution to the business you feel is being undervalued. Don’t hesitate to contact me if you want to run through any of the theory behind this post.