Scene from a cocktail party: ?Hi, I?m Paul Downs. Very pleased to meet you. How much money did you make last year??
Sorry, that didn?t actually happen. We?ve all agreed that asking about personal income is rude and that answering such a question would be foolish and unnecessary. But it?s hard to have a meaningful discussion about business without at some point talking about profits.
In my last four posts, I have discussed the various ways I spend money in my business in order to provide some background for this post, which is about the money that is left over, the profit. Yes, I am going to tell you how much I took home from my business. I am offering this information in the same spirit I?ve revealed the rest of the numbers: as a benchmark, a point of reference, that perhaps you can use to evaluate your own business, or your own situation if you are thinking of starting a business. And of course, I appreciate all of the suggestions readers have made about my business.
Let?s start with my salary. In 2002, when I sold half of my business to The Partner, I was taking a salary from the company of $72,000 per year. In the 17 years I had been in business up to that point, I had tried every possible method of paying myself and found that only by putting myself on the payroll would I actually take money out of the business. Waiting around for profits to happen had proved futile ? there weren?t any. Paying myself a commission on the sales I made didn?t work either; it was always too tempting to leave the cash in the business to cover a shortfall.
When I decided to pay myself every two weeks, just like the employees, I actually wrote the checks and took the money. In the rosy early days of our partnership, The Partner and I agreed that I would not give myself any further raises, but that we would split any profits. That wasn?t an unreasonable agreement. He was taking no salary at all, and that arrangement gave me plenty of incentive to make the business grow so that there would be profits to share.
Unfortunately, it didn?t work out that way. Not only did we not make profits, I ended up lending substantial money back to the company every year to cover cash shortfalls ? and so did The Partner. Until August 2008, we contributed equally when cash was short. Between 2003 and 2009 I loaned the company $508,774 and paid myself back $121,676, leaving a debt of $387,098 from the company to me. And as the years rolled on, my salary stayed at $72,000 a year. Eventually, in 2007, I got The Partner to agree to raise it to $80,000 to help me cover the rising cost of taxes on my health policy. During those years, my wife and I got used to a modest lifestyle: thrift shop clothes, public schools, driving vacations to visit family, no new cars. Which was fine, and stood us in good stead when things got tougher.
In November 2008, things fell apart. I cut my employees? salaries by 15 percent and my own by 25 percent, to $60,000 a year. The following year we continued to struggle, and I needed to put money in to pay for a new Web site. I made what turned out to be my last loan to the company in August 2009, for $24,000.
The company?s recovery began in the spring of 2010. I had restored half of my employee?s pay cuts in September 2009, and I raised my own salary back up to a rate of $70,000 a year the following April, when our cash position began to recover. My goal that year was to amass working capital, as we had started the year with enough to operate for just three days. By the end of the year, I was making payroll without much effort, and we had more than $100,000 of cash on hand. The company?s bank balance on the first day of 2011 was $106,777.
In fact, the company made a profit of $92,155 in 2010. Our corporate bylaws require me to distribute a percentage of our profits equal to the highest federal personal tax rate plus an additional 2 percent. In 2010 that was 38 percent. I made the distribution in April 2011.
This would be a good time to talk about who owns the company. It?s an S Corporation. Back at the very beginning, in 1986, I owned it all (not that there was much of anything to own). In 1992 I got my father and brother to put up $40,000 in exchange for 20 percent of the stock, which was a pity investment on their part. (I used the money to print up our first brochures and buy ads in a local magazine).
Nothing changed until 2002, when The Partner structured a deal in which he bought half my stock, and gave my father and brother non-voting shares. So now I owned 42 percent. In 2007, The Partner and I agreed to issue some more shares, which would be given to his daughter in exchange for reduced pay for her services in writing our custom database (which we still use, and is essential to our operations). After that I owned 40 percent. In 2010, my father and brother bought out The Partner. This deal did not affect my ownership stake, but it did leave me with three partners. My father and brother have clearly expressed their desire that I run the company as I see fit, for my own benefit. They leave all decisions about money to me. I have had no communication with my partner?s daughter since late in 2009, other than to send her a check in 2011 for her share of the 2010 profits.
As 2011 started, I was paying myself at a rate of $70,000 a year. That?s not terrible pay by American standards ? above both average and median household income ? but it?s small compensation for the stress of being the boss, and it leaves aside entirely the question of return on the money I have put into the business. Also, I found it shameful. There?s an unspoken assumption that someone like me should be doing well, considering my education and work history. In my whole circle of male acquaintances, I had only one friend who I thought might make less money than I did. Plus, much of my identity was wrapped up in making the company a success. So I took great satisfaction when the company had money in the bank, and was so traumatized by years of running the company on a shoestring that it made me nervous to pay out funds, even to myself. Even in the winter of 2011, when the company started amassing cash, I kept my salary unchanged.
Then, in March 2011, I read ?Profits Aren?t Everything, They?re the Only Thing? by George Cloutier. There?s some questionable advice in the book, but one thing he said rang true to me: pay yourself first. By that he meant, figure out how much profit you want to take from the business, take it out regularly, and cut costs to make the numbers work. Be brutal if you have to: cut wages, fire people, but learn to run a profitable company.
Keep in mind that at this point (and to this day) I was sharing our cash position with my employees in our weekly meeting. I could see that we were going to start to build up a cash reserve, and that I would be under pressure to give it out as either raises or bonuses. I decided that the first thing to do was to raise my own pay to a more appropriate level and see whether the company would still continue to amass cash. In April 2011, I raised my salary to a rate of $140,000 a year, about 1.8 times the next highest paid employee. Sure enough, this flattened the net cash curve, but for the first time this century, I was able to save a good portion of my salary.
In the summer and fall of 2011, our net cash curve stayed essentially flat. My increased pay didn?t have a negative impact, but it did slow the the rise in our cash reserves. Then, last October, I sold a very large job that promised a rich payout if we increased our production and didn?t make mistakes. The catch was that we had to finance it, which would mean diminished cash for the rest of the fall with a big bump at the end of the year. I explained all of this to the employees, and dangled the promise of bonuses for everyone if we could pull it off.
Which we did. The guys performed like heroes, the client was delighted, and the money arrived just after Christmas. As I entered the last week of 2011, I had more than $300,000 in cash on hand, plenty of work lined up for the coming year, and a dilemma: who gets the money? Clearly the workers would get their bonuses, but how much should I pay them? And when I was done with that, would I distribute the rest as profits and share it with my partners, or would I pay it to myself in a bonus?
The advantage of distributing profits is that the company doesn?t have to pay its share of payroll taxes on the amount distributed (this, at least, is my understanding ? feel free to correct me in the comments section if I am wrong). The disadvantage to distributing profits, for me, is that I have to share that money with my partners. For each dollar of profit, which gets split among the four partners, I see only 40 cents. If I paid the cash to myself as a bonus, including it in my salary, it would be more expensive for the company but I would get 100 cents per dollar. (All of this is before paying taxes.)
I discussed the situation with my father and brother, who again told me to do what I wanted. They had no problem with me paying myself all of the potential profit in a bonus and letting the company break even or show a small loss. I did not consult the other partner. My father, brother, and I own all of the voting stock.
There was one reason to let the company show a profit. I would like to land a General Services Administration contract so that we become a preferred partner with the federal government, and part of the evaluation process is for me to show that the company has been profitable and is stable financially. We showed a small loss in 2009 (like a lot of people) and a decent profit in 2010. So I decided, in the end, to pay bonuses that would leave a profit roughly equal to the previous year?s.
That meant a bonus pool, for myself and the employees, of $120,500. The bonuses would be paid out in a special payroll the last week of the year, and they would be distributed, as usual, through Paychex. That way all of the appropriate taxes would be paid correctly.
So I had to make a calculation: who deserves what? How much do I deserve for my performance in 2011 and for my past sacrifices? And how much do my employees deserve? In the end, I paid myself a bonus of $72,000 and distributed the remainder, $47,500, to the workers. Their bonuses amounted to about 7 percent of their pay.
On my W-2 for the year, I ended up with $208,652 in salary. The company ended up with a profit of $94,933. My share of the profit will be $37,973 ? leaving me with a total pay out for 2011 of $246,626. It is an amount of money that I hope will, after I pay the taxes (which will probably amount to $90,000 or so), allow me to continue my modest lifestyle and pay for my children?s educations. I?ll be doing that out of current income, not savings, as I don?t have much put away. My eldest son was just accepted by M.I.T., and my wife is currently in graduate school. (No fancy cars in my future!)
My goal for this year, if the company grosses $2.4 million, is to take home $250,000 or more. At the beginning of the year, I raised my salary to $180,000. If I can land that G.S.A. contract, I will shift more profits to bonuses. Once the company has a backstop of $200,000 in cash, I?ll start paying back debt.
So there you have it. My income, published in the New York Times. I honestly haven?t decided whether it?s a great result, or a crummy one, or somewhere in the middle. But I hope that you find it useful, particularly if you are thinking of leaving a corporate job to start your own business. It took me more than 25 years to get this result. It?s possible that I could have gotten there sooner, but it didn?t happen.
Does anyone else want to talk about how much their businesses gross and how much they take home?
Paul Downs founded Paul Downs Cabinetmakers in 1986. It is based outside of Philadelphia.
Source: http://boss.blogs.nytimes.com/2012/02/01/what-i-take-out-of-the-business/
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