A common question asked by business founders and entrepreneurs is how much of the profit generated (after paying all expenses) they should leave in the company – or put another way:
“How much should I pay myself?”
Here are two scenarios:
William pays himself enough to live off, pay the bills and take the family away for a well earned holiday abroad each year. The remainder he leaves in the company to strengthen its balance sheet and reinvest in new products, services and people as the opportunities arise (as well as protecting against a sudden unexpected ‘black swan‘ downturn in the market). William is mindful of the risk that carrying too much cash could interfere with the trading status of his company in the eyes of the tax authorities and this is kept under review by his trusted Wing-Man (his accountant).
Meanwhile, Harry strips the majority of the cash out of his business each year leaving some to protect against downturns. He works with his
accountant Wing-Man to manage the tax efficient extraction of the profits to avoid any unnecessary tax leakage.
Which strategy is right?
It depends on the goals and aspirations of the founders plus the opportunity cost of either extracting or leaving the cash in the company.
As an entrepreneur you are both a wealth creator and an expert capital allocator. So you must have a plan as to the optimum way you can deploy and allocate the wealth you create for maximum future returns.
If you adopted William’s strategy and stripped most of the profits out you had better have a good plan as to how you are going to deploy that cash to get the best return on your capital. For example, are you going to invest in new ventures, back some promising entrepreneurs as a business angel (SEIS might be of interest?) or perhaps invest in property?
Leaving the cash on deposit in your current account is not a good strategy.
On the other hand, if right now you see plenty of opportunities to get a good return on your capital in the business then leave it in there and take some small bets on new products, services or other initiatives and build from there.
Back to the question and answer: it depends.
There is no definitive answer as it depends on a number of factors including:
- your goals
- where your business is up to in its lifecycle
- what opportunities exist inside your business
- what opportunities exist outside your business
Always good to discuss your personal strategy with a trusty Wing-Man….