Entrepreneur, trust me on this: Do what I say and not what I did. If you’re working for your own company, your startup, for less than what your market salary rate would be, document it. Please.
Like so many entrepreneurs, I worked without payment a lot in the early days of my company. I also had a stint of almost a year without salary when we needed an extra push during a hard year in 2001, which wasn’t the early days. We already had more than 30 employees and several million dollars in annual sales. But we were also hurting that year and, although we made the rest of the payroll, we didn’t cover me. I didn’t document the sweat equity of the early years well at all, which hurt. With that more recent bout of sweat equity, our very professional controller, who managed the bookkeeping perfectly, recorded everything correctly and avoided the problems.
The problem you face with undocumented sweat equity is what happens if the company grows and prospers. Then assets, expenses and ownership become important elements of tax liabilities and negotiations with new investors and banks. If you have nothing that quantifies those months or years that you worked to build the business without pay it becomes very messy. Of course, if you don’t make it, it doesn’t matter much.
Unpaid wages are hard to put on your books correctly. Although I’m not an accountant and this blog isn’t about accounting or bookkeeping, the problem is that the unpaid wages have to show up as a portion owed to the owner and a portion that will be owed to the government–as employer taxes–when they are finally paid.
If you simply record your unpaid wages as payroll expense and offset those wages as a loan from founders, then the IRS wants to know where the payroll tax money went. Check with your accountant, but I’m pretty sure you can’t deduct unpaid payroll owed to the owners as a deduction that reduces your income for tax purposes.
I was a panelist last night at a new startup organization, Smart-ups, in my hometown of Eugene, Oregon. Somebody asked me about mistakes I’ve made, and I described this one. In this, if you’re making that mistake, you’re not alone. So many of us end up working for our own company without real compensation at one point or another. But please, be aware of the pitfalls. And don’t forget to document.
Tim Berry is the founder and chairman of Palo Alto Software and Bplans.com. Follow him on Twitter @Timberry.
