I am providing some consulting to a start-up company. The owners would like to accrue a salary for their time spent developing their product and
When should a start-up business owner begin to pay themselves a salary?
Answers
I also am confused with the term accruing. If the company is unable to pay the owner, it would be unable to pay any third party individual to perform the same tasks. When do you expect to break-even?
What is the point of posting an accrual? If you are looking to sell a share in the company, I do not believe an investor will honor the accrual.
Please add more information. Would love to help if I had more information.
Here's another slightly off-target point, but related. I've seen many SMB owners over-pay themselves (whether in a business plan or reality) causing two major issues:
1. Working Capital starvation
2. Character issues as seen from lending/investing and employee morale viewpoints
There is a psychological value to accrued salary for a founder of a start up. When investors are approached to consider a cash investment, the founder is not always able to respond by making a cash contribution of his own. By showing a fair and calculated value on the time invested by the founder, he can show a degree of commitment to the Company that may inspire the investors to follow.
Thank you for the great feedback. The founders of the start-up are considering putting a payable on the books for the time they have invested in their company at a fair & reasonable rate. They do not intend to pay themselves until the company is generating sufficient cash flow. On a related note, they wonder at what point do they become employees of their company , if they accrue a payable for the salary does that make them an employee. It's organized as a LLC and they are the founding partners.
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I think Nancy sort of answered this, in an LLC, partners (properly called members) don't get a salary, they get a draw and based on the partnership agreement, get a percentage of income or loss.
Now there is no requirement to take a draw from the company, but you are required to pay income
Like Nancy said, talk to your tax professional (which I am not).
I have actually seen this done in several startups. It creates an interesting issue, with accrued compensation being expensed every month and the liability on the balance sheet getting bigger and bigger. It can actually serve to "scare" banks and potential investors because it typically creates a large negative equity balance. Generally speaking, my recommendation is to avoid doing this if at all possible and then make sure that the "founder's stock" or "founder's membership interest" has some type of preferred distribution or liquidation preferences to try and make the unpaid founders whole once the company is profitable.
I understand the thought-process for doing it, especially the desire to make make-up the unpaid compensation once the company is cash-flow positive and profitable. Since it sounds like this is likely taxed as a partnership, eventually paying it out as a guaranteed payment is a pretty clean way to handle it, all things considered.
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