Why is it a bad idea to underpay yourself?
One of the things that is very common amongst entrepreneurs is that they deliberately choose to underpay themselves. I, myself, have been a culprit of the same. The salary that I was drawing when we started Tekriti (and till a very long time) was not even enough to pay for my personal monthly expenses (Gurgaon is an expensive city). In fact, I had to transfer money from my US accounts a couple of times during that period to cover the deficit. And it was never because we didn’t have enough money in Tekriti’s accounts – we have been very fortunate in that respect, touchwood!
When I think about it, I can’t really come up with a reason why we did that. The only thing I can think of is that it was an ego-booster. I felt good to think that, yes, I am making a sacrifice by underpaying myself when I can easily afford to pay myself my market-value. How lame was that? And may be, self-centric too?
I was talking to few of my friends who have also chosen to become an entrepreneur and I know that they have also made the same ‘mistake’. Let me try to explain why is underpaying yourself such a bad idea.
- You are un-necessarily increasing your profit-margins: When you are starting up, the true ‘market-value’ salaries of founders form a big chunk of your cost numbers and, by choosing to underpay the founders, you are incorrectly inflating your profit-margins. Then as you expand and increase those salaries, the profit margins may dip down a lot and the comparison will only be unfair then. Even if your company is not making profits, you are reducing your loss numbers, which again is not the correct measure.
- Your company’s money is not your money: Seriously! Know it! There is a distinction – your company’s money is not your money. Your company’s money will (should) be used for the growth of the company or kept in the bank for contingency, if you have a surplus. But it is not your money. By the same logic, your money is not your company’s money and there is nothing bad about that. It doesn’t make you any less loyal. I have underpaid myself for a long time and also increased our salaries recently and, believe me, there have been absolutely no change in anything – except the fact that I cannot claim any longer that I draw a very modest salary (‘modest’ still continues to be true
).
- It’s better to re-invest than draw less: A better strategy to drawing less salary and incorrectly inflating the numbers is to draw your market-worth and re-invest the money in the company, if needed. Re-investing money will only increase the valuation of the company since a re-investment of 100 Dollars by the founders is much more valuable than 100 Dollars of extra profit. And you get to eat that much extra at your favorite restaurant or treat yourself with the coveted drinks, if re-investment is not needed.
- Your personal savings are important: Money is an important reason for most (if not all) of us to work. If you have savings that you have made over years, there is a popular school of thought that says that it should not be spent for regular expenditures – and there is collective wisdom of many people behind that statement. And, it’s totally fine to be sensitive about that. So, if I have personal savings, I can utilize it for my education or education of my family members, buy a property or a car – but utilizing it for my regular needs will only hurt in the long run.
As I write this – I only remember my dad saying “Son, why do you people not take enough salaries when you have enough cash in the bank?”. Dad, as always, you are again right. I just refuse to listen to a few things that you say, but I still love you.
I liked the last paragraph of your post very much. It shows your nice emotions towards your dad.
I think, it’s our ego, which doest not allow us to listen to our elders sometimes. We sometimes think their old thoughts may not work in today’s scenario, but we forgot that they are more experienced than us and they have seen more life than us.
I have realized in my life that we must give enough weightage to our elders when they are saying something to us.
I had given this a thought sometimes ago!
The immediate thought that struck my mind while reading this post was a study done by a prof at Harvard on this topic. I remembered reading it a while back. Posting the URL here as it might interest you and other readers.
Founder Discount
I think as a founder, the focus is on taking care of company and employee. In fact, company & employees are treated same ways like parents treat their children. Parents always want their children to enjoy, spend more for their upbringing but rarely do they spend for themselves.
When children make a mark, the success goes to the whole family and parents (read: investment paid off).
However if the children doesn’t succeed, it is the parent who has to take care of shaping the family again. In this scenario, unless parent has enough cash reserve, the family is going to have tough time. Taking the same thought further, I think a founder should draw a salary which is sufficient (not lavish) enough to safeguard their future. After all they are paid for their contributions. No less, No more.
Ashish,
There is also different dimension to this. I am sure this factor would have also influenced your decision to under pay you.
Taxation. More and more we take as pay package our individual tax burden increases and that is one main reason why most of us leave the money back in company’s account where you need not pay tax for atleast 5 years if you are a STPI member.
Also most of the founders share their profits as dividends which attracts less percentage of taxation(12% I suppose it is) when compared to 30% taxation.
Amit – right that we need to listen to our elders. But, at the same time, with due respect to them – you will be more loyal to the commitment that you make when you yourselves are sure about it (even though that may not be right). That is why people say – that there are certain things that you can learn only from your experience and nobody else’s
But, yeah, dad is always right!!
Siddhartha – thought abt what? when?
Nagendra – wow – that’s an amazing article. My thoughts were so much in sync without that research
Santosh – very good analogy. Rightly said, getting paid for the contributions should be ‘No more, No less’. But, still, difficult to follow in practice.
Kumaran – good point. Yes, raising dividends once or twice an annum is a better way since that attracts lesser taxation. But then that is also not as easy to ‘balance’ the lower salaries since there are more share-holders than just the founders. And the board might not always agree to the dividends you want to raise because of variety of reasons (it works initially but it becomes more and more difficult with time). But you made a good comment that if you sum-total the dividends, you do get closer to your ‘market-value’.
I thoght that you should have increased the salary before…got it?