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If you’ve just launched your own startup, you’re probably eager to start all the exciting parts of your business journey. Once it’s up and running, and money starts flowing in, an important question to ask yourself is, ‘when can I pay myself?’
Usually, startup founders don’t prioritise paying themselves in their business’ early stages. This is generally due to other responsibilities involved in a business’ journey, but there are other ways you can pay yourself without compromising your startup’s success. After all, you do want to reward yourself for your hard work.
When Should I Start Paying Myself?
When you’re deciding when to pay yourself, you’ll need to ask yourself a few questions: how much money have you raised so far? Are you planning to hire any co-founders? But, before we jump into salaries, it’s important to choose a suitable business structure.
Sole Trader Or Partnership
Your business structure will determine how and when you can pay yourself, and this should be in writing. If you’re after a simple set-up process with minimal fees, your best bet is to adopt a sole trader or partnership structure. It’s likely that you’ll treat yourself as an employee and will be paid as such.
In a partnership structure, it’s important to have a Partnership Agreement that sets out whether you will pay yourselves as employees and what will happen if the business relationship breaks down (we’ve written more about this here).
Company
On the other hand, a company structure has a lower level of risk and you can appoint yourself as director. This will provide more protection from liability, but it can be a bit more complex and demanding to set up. Under this structure, you could be both a director and a shareholder, meaning you’d need a Shareholders Agreement (we’ll cover this shortly).
After you’ve decided on your business structure, the next question is: ‘Am I treating myself as an employee or director?’
Whether you’re an employee or director will determine how you can pay yourself. Let’s have a look at some options.
I’m Treating Myself As An Employee
The most important consideration is whether you will treat yourself as an employee of the startup. If the answer is yes, then you’ll be entitled to minimum wage requirements under the Fair Work Act 2009. This means that you’ll need to pay yourself, just as you would any other employee.
This also means that there are consequences for not paying yourself according to these employee standards.
However, if your startup’s budget is a little tight, you may be able to pay yourself in the form of shares. This is known as a Sweat Equity Arrangement.
What Is A Sweat Equity Arrangement?
When employers cannot afford to pay their employees for their work, they may be able to issue them shares instead. Put simply, it’s how a startup compensates their employees for their labour when cash isn’t exactly an option.
We recommend you speak with a lawyer before implementing a sweat equity agreement, as there may still be issues with minimum wage if this is how you are paying employees.
Sweat Equity Agreements are pretty common in startups because they’re not exactly flowing with profit in the early stages. This way, you can still reward and compensate employees for their efforts through ownership without worrying about not having the money to pay them.
If you’re a founder, but treating yourself as an employee, you may be able to pay yourself in the form of shares.
This arrangement can be pretty complex, so it’s a good idea to have it in writing. The Sweat Equity Agreement should generally cover:
- How much equity the employee will receive
- What the employee specifically needs to do in order to receive equity
- Milestones
- Termination
- Whether there are vesting provisions
We’ve written more about Sweat Equity Agreements here.
I’m Treating Myself As A Director
Rather than receiving a salary as an employee, you could pay yourself as a director: these are called directors’ fees. Put simply, these fees compensate the director for the services they provide to the startup (but these fees are subject to tax and superannuation, like a regular salary).
It’s best to make sure that the specifics of this agreement are covered in a Company Constitution, Founders’ Term Sheet or Shareholders Agreement. Some key terms could include:
- Founders’ duties
- Any travelling costs
- Other expenses involved in directors’ activities
It’s important to note that a Founders’ Term Sheet is not legally binding. It sets out the general agreement before you make a legally binding agreement later down the track.
Can I Also Be A Shareholder?
The answer is yes, you can be both a director and shareholder (ASIC goes through the role of a director here).
This means you would receive dividends as a shareholder in the company.
A Shareholders Agreement for this situation should generally cover:
- Your responsibilities and role
- What shares can be issued
- How shares will be allocated
Can I Redirect My Wage Into The Startup Instead?
Many directors want to ensure that their startup can get the most help possible. Thankfully, there are some options that allow directors to put their money into the startup rather than paying themselves.
- Directors’ Loan: this allows the startup to borrow money from the director’s wages/fees (remember that a company is a separate entity, so they can borrow money and be liable for it).
- Authorised Deduction: under the Fair Work Act, directors can deduct money from their wages to go to the startup instead (but like most official things, this needs to be in writing!)
However, there may come a point where you do want to start paying yourself a market rate salary. In this case, you might need to accept an equity dilution.
How Does Equity Dilution Work?
If you want to start paying yourself a market rate salary, you may need to sacrifice some ownership. You could issue new shares in the company, meaning that your ownership is diluted. An important question to ask is whether you’re willing to sacrifice some ownership for your salary as director.
This is an important decision, and definitely an option you could be looking at further down the track. If you need some help, Sprintlaw has a team of lawyers ready to chat about your options.
Next Steps
The early stages of the startup journey can be risky, but this doesn’t mean you need to commit to the business without receiving anything in return. You have certain options when it comes to paying yourself, but it’s a good idea to get in touch with a lawyer who can help you choose which option is most suitable for your situation.
You can reach out to us at team@sprintlaw.com.au or contact us on 1800 730 617 for an obligation free chat.
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