Most businesses start with a big dream and a ton of excitement.
As an entrepreneur, you feel powerful and ready to give up anything and everything for the success of your business. You are determined. You put in the work with the right energy and unflinching dedication. You hope you can build wealth or establish an enterprise to serve as your legacy.
But even with all the excitement and sacrifices, you need money to eat and survive. So you need to pay yourself. You also need to earn a living.
So how do you pay yourself from your business?
The manner in which small business owners compensate themselves is mainly determined by their business structure. Instead of a wage, the majority of owners receive a draw, a distributive share, or dividends.
For instance, sole proprietors take a draw. This means that instead of a paycheck, they take a certain amount from the business’s profits. The draw can be either monthly or at the end of every financial year.
If you are a small business owner and have been wondering which is the correct way to pay yourself, here is an elaborate guide on how to pay yourself as a small business owner, depending on your business model.
There are three general types of business models in Kenya; sole proprietorship, partnerships, and limited liability companies. Here is the payment structure for each model:
In Kenya, over 70% of small businesses are sole proprietorships. A sole proprietorship is an unincorporated business with one owner. The owner is the sole decision-maker in the business and is liable for all the losses and returns of the business.
As a sole proprietor, you are the sole owner of your business - meaning you and your business are treated as one and the same.
As such, you can withdraw money directly from your business profits to pay yourself. This can be the whole profit amount or a percentage of the profits - it depends on your own discretion since you are your business. This is called an ‘ owner’s draw.’ But remember, you are also 100% liable for any losses the business makes.
Kenya Revenue Authority (KRA) treats a sole proprietor’s profits as your personal income. When you draw, taxes are not taken out at the time, but you are expected to pay taxes on the draws when you file your individual return.
According to Kenya’s Partnership Act, “a partnership is the relationship which exists between two or more persons who carry on business in common with a view to making profit.”
In this business model, the partners are liable for all the losses and returns of the business. The percentage of liability is based on the partnership agreement.
Therefore, you don’t take a salary or a draw in a partnership. Instead, you are entitled to a distributive share (also called a “distribution”). A distribution is a share of the business profits (or losses), and the exact amount is also based on the partnership agreement.
Typically, since partnership income is distributed between partners, KRA will tax the partnership's income on each partner's individual income. Partnerships are not subject to Company Tax.
According to Kenya’s Business Law, a Limited Liability Company is considered a legal entity apart from its owners. Therefore a Limited Liability Company is a separate legal entity to its owners (shareholders) and its directors (management) and is protected by limited liability.
Owners of an LLC are known as members and aren't considered employees, and as such, they can not take a salary. However, if you own a company and you are the only member, you can take a draw.
On the other hand, an LLC with more than one member is treated the same as partners, and members are entitled to distribution - a share of the profits or losses.
Paying yourself as a business owner is different from receiving a salary as an employee. On the other hand, you can’t automatically consider the business profit as your take-home pay. You need to plow back some profit in order for the business to grow.
To determine how much you should pay yourself, ask yourself the following questions:
For example, when determining what would be reasonable, you can’t compare a mid-sized company making over Ksh. 5M and a small wholesale shop making a little over Ksh. 500,000 in profit.
It is essential to consider your business as an entity. No two businesses are equal. How much you can take out as the owner depends on many factors, mainly on the business model, industry, and profit.
Also read: Loans For Start-Ups in Kenya.
No one goes into business hoping it will make money but leave them struggling financially. So you need to pay yourself. You need to pay yourself enough to survive.
You can - and should - also pay yourself in benefits. The same or better that you extend your employees. Those could include health care, retirement plans, cell phones for business use, and other perks.
However, your business is not your piggy bank. In reality, whether it’s a company or a sole proprietorship, your business is its own entity, and you should treat it as such. Avoid by all means mixing company finances with your personal finances.
For example, do not dig into your business bank account to pay for your groceries without any formalities. If you must, ensure that a formal process is followed and everything is kept in record.