Whats the best way to pay yourself in a self-funded startup?
Is it better to run a payroll, pay all the extra taxes, so the company has more of a structure down the road when trying to do an angel round?
Or leave the company out of it, and just use your savings to live while building out the software?
Or perhaps take a loan from the company, to avoid some taxes early on?
Or become an S-Corp and do a payout through a dividend payment?
Curious to know how other people do it ... Thanks.
5 Answers
It is most common for a self funded startup to remain a sole proprietor until the business is established, substantially profitable and/or incurring significant liability. A good tax accountant will help you know when it makes sense to incorporate.
As a sole proprietor the company is merely a dba so you are not an employee and therefore there is no payroll. Any draws from the company to meet expenses are a matter of cash flow.
Starting out as a sole proprietor is low hassle and low cost. These are two essential things to strive for when you have so many more important things to worry about.
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Keith - I agree although there may be other factors leading you to incorporate/register a company sooner rather than later - for example if you have a cool company name that you want to register before someone else does, and go on to build brand awareness with. It's obviously a trade-off between this and the cost/overhead of operating an actual company. (Personally, I'm currently accepting the overhead, but (until recently) filing dormant accounts to keep the cost to the bare minimum). – Steve Wilkinson 14 years ago
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I don't think this is the case. WE filed for S-corp entity immediately and just live off personal savings. I don't see the benefit in waiting until the last minute. Being prepared made more sense to us. Having things like a bank account, EIN, etc we felt was important when they were needed to avoid delays or embarrassment later. – Tim J 14 years ago
This all depends on if you have partners or not. If it's just you, then doing a sole-propreitor is the way to go (as Keith mentioned).
If you have partners, then I would suggest an LLC. They have some advantages in terms of payouts to the partners that a good tax accountant can explain to you.
I would recommend against taking out a loan from the company. You want to minimize your debt as best you can when looking for angel money (they take offense to "paying" the founder for past work).
Living off your savings works (I did that). Just make sure you get a substantial amount of founders stock once the company is off the ground.
Your question really revolves around 'balancing' your personal needs against the P&L picture that you want to be able to show for the business. For a SP or Partner draw situation, the taxation issues are going to be very similar. Either way the tax liability is going to show on the books.
Be careful with LLC. Many States have the ability to change how they compute your tax rates based on your management practices. If you choose, 'corporate' and act as a 'partnrship' (or vice versa) they can jump up and bite in the tender spot. Make sure you discuss formation and operational polices with both your accountant and a good attorney.
Best practice would be to avoid any more draws from company funds than absolutely necessary and be able to justify the additional expenses if and when you bring in outside investors.
Hope this helps
The choice to incorporate shouldn't depend on whether you have partners or not. It should be based on the level of risk you feel comfortable with and the amount of effort you think is appropriate at this stage in the life of the company.
You can have a one member LLC, so if liability protection is important at this stage, go with the LLC regardless of whether it’s just you or you and 5 others.
This early on I would advise against both taking out a loan from the company and becoming an employee. Both have legal and tax complications you probably don’t want to deal with at this stage. Keep it simple! Use your savings if you can.
Also, ABusinessMentor mentioned corporate taxation versus partnership taxation. I’m not an accountant or tax expert, but in the early stages of an LLC (when you don’t have any profits), it rarely makes sense to opt for corporate taxation. But as he mentioned, that is something you should discuss with an accountant or tax adviser.
This is my 1st time on OnStarups... I was a dba then LLC (then dba) then C-Corp quickly converted to S-corp. My tax guy suggested that I take a payroll so that I personally contribute to Social Security.
Further, given that, I basically cut my "pay" in half and take checks from the company as Shareholder Loan repayment (I invested quite a bit to stay alive from 2008~2011). Now I'm in the other condition of taking a Shareholder Distribution. Since I am 100% shareholder, I get all of the distribution.
IMHO, you would fit nicely in my S-Corp role of taking some payroll (and having continuity and structure) while using your savings as a loan/investment to the company. I didn't pay myself any interest with my loan, as that sounds like more trickerey than I'm interested in.
Definitely talk to your tax people and local business mentor about the shareholder stuff before doing it and don't blindly take my word as advice. While my tax guy was a former auditor, he's also quite behind so I'm switching to another tax preparer...
