How to Properly Pay Yourself as a Founder of a Boutique Professional Service Firm

Founders of boutique professional service firms, such as consulting firms, marketing agencies, and software development firms, often face a common dilemma: how to structure their own compensation. This critical decision can lead to problematic outcomes: not paying oneself, underpaying, or overpaying. The solution lies in understanding and applying a dual-role compensation method that accurately reflects the value a founder brings to their firm.

The Dual-Role Approach to Founder Compensation

As a founder, you occupy two distinct roles within your firm: the operator and the owner. Each role contributes differently to the firm’s success and should be compensated accordingly.

Role 1: The Operator

As the operator, you’re involved in the day-to-day management and operational success of the firm. Compensation for this role should be based on replacement costs. If you were to leave tomorrow, how much would it cost to replace you? This figure can be determined through salary benchmarks available for similar positions in your industry. This ensures that you’re paid fairly for the work you do, separate from the profits the business generates.

Role 2: The Owner

As the owner, your compensation is tied directly to the firm’s profitability and your share of the ownership. This is where owner distributions come into play. For example, if a consulting firm with two co-founders generates $5 million in revenue and $2 million in profit annually, and decides to distribute $1.5 million after setting aside $500,000 in working capital, the distribution to each founder should reflect their ownership percentage. For example, if the split is 75/25 the 75% owner gets $1.125 million and the 25% owner gets $375,000.

Common Mistakes in Founder Compensation

Many founders of boutique service firms struggle with compensation due to a lack of understanding of its importance. Compensation is not just about covering your living expenses but a reflection of the value you bring to the firm. Furthermore, the way a founder is compensated signals whether the firm is a serious business or merely a lifestyle firm. A substantial founder compensation indicates a firm’s profitability and attractiveness to potential buyers, marking it as a “real” firm.

The “headache factor” of running a boutique firm is real. Founders face challenges that employees do not, and this should be reflected in their compensation. High founder compensation is a quality signal of both the founder’s and the firm’s value.

The Importance of Getting Founder Compensation Right

Proper founder compensation is crucial for several reasons. It benchmarks the firm’s status in the industry, affects its sellability, and compensates for the additional challenges of entrepreneurship. Furthermore, it facilitates productive conversations with star employees who may feel they deserve as much compensation as the founder. Understanding that founders are compensated for two roles—operator and owner—clarifies and justifies the pay disparity, encouraging star employees to appreciate the risks and rewards of entrepreneurship. For example, if the star employee wants to be paid like a Founder he can take the risk and start his own firm, and thus, pay himself a risk premium when/if he is successful.

By adopting this dual-role approach to founder compensation, you can ensure that you’re fairly compensated for both the operational and ownership aspects of your role. This method not only helps in setting a fair compensation for yourself but also sets a precedent that can guide your discussions with key employees about their own compensation and career paths.

If you’re a founder looking to navigate the complexities of running and growing a boutique professional service firm, consider joining the Collective 54 mastermind community. Here, you’ll find support, resources, and insights from fellow founders who understand the unique challenges and opportunities of our industry.

Remember, paying yourself correctly is not just about fairness to you as a founder; it’s about setting up your firm for long-term success, attractiveness to potential buyers, and creating a sustainable model that rewards all who contribute to its success.