How Founder Compensation Changes as a Professional Service Firm Grows Up

How Founder Compensation Changes as a Professional Service Firm Grows Up

As the founder of a boutique professional service firm, you’ve embarked on a unique journey filled with challenges and opportunities. In my book, “The Boutique: How to Start, Scale, and Sell a Professional Service Firm,” I introduced a framework that outlines the three key stages in the lifecycle of a small service firm: Grow, Scale, and Exit. Today, we’ll explore how your compensation as the Founder changes as your firm evolves through these stages.

    1. The Growth Stage: Founders with a Job, Not a Firm

In the early days of your firm, you’re in the Grow stage. During this phase, you’re the primary driver of your firm’s success. You’re not just the founder; you’re also the chief salesperson, project manager, and service provider. In essence, you have a job within your firm.

At this stage, it’s common for founders to pay themselves a salary. Why? Because your primary focus is on selling and delivering work for clients. Your role as an operator is critical, and the salary compensates you for your time and expertise. It ensures your livelihood as you lay the foundation for your firm’s future growth.

The correct amount of salary is best determined by the market. In other words, if you hired someone to perform your duties, what would you have to pay him? The free market determines salary levels. The Founder should pay himself the equivalent.

    1. The Scale Stage: Juggling Two Roles as Founder

As your service firm progresses into the Scale stage, things start to change. You’ve grown beyond being just a service provider; you’re now also an owner who’s actively working on building the firm. This phase is marked by a dual role: operator and owner.

In addition to your salary, you may begin to receive shareholder distributions. These distributions represent the second part of your compensation. While your salary compensates you for your role as an operator, shareholder distributions compensates you for your role as an owner. They reward you for your efforts in growing the firm as a business entity, not just as a practitioner.

The correct amount of distributions is best determined by your working capital needs. Distributions are paid to shareholders out of excess profit. Excess profit is profit more than the working capital needed to run the firm. For example, your working capital requirement might be 6 months of payroll in cash in the bank. Anything cash generated beyond that is considered excess and should be distributed to the Founder in the form of owner distributions.

    1. The Exit Stage: Transitioning to Full Ownership

As your firm matures, it eventually reaches the Exit stage. During this phase, you’ve successfully transitioned from being a hands-on operator to a full-fledged owner. You’ve replaced yourself in the day-to-day operations and are now focusing solely on strategic initiatives that increase the enterprise value of the firm. 

At this point, your compensation structure undergoes a significant change. You no longer pay yourself a salary for your operational role because you’ve delegated those responsibilities to others. Instead, your compensation solely relies on shareholder distributions. This reflects your position as an owner who benefits directly from the firm’s financial success. The salary you once paid yourself can now be redirected to support the new team members who have taken over your operational responsibilities.

And at this stage, the Founder has a critical decision to make. Should he sell the firm, or should he continue to own it? A Founder should sell the firm if there is a buyer willing to pay him a premium for the future distribution stream. The Founder should continue to own the firm if the future distribution stream is larger than what a buyer is willing to pay for it. For example, let’s say your firm is paying you $5 million in annual distributions, and a buyer offers you $20 million to buy your firm. You would accept, or decline, this offer based on whether you feel collecting 4 years of distributions upfront today is a good decision.

Join the Collective 54 Mastermind Community

As you navigate these stages of your service firm’s lifecycle, it’s crucial to have access to a supportive community that understands the unique challenges you face as a founder. That’s why I invite you to consider becoming a member of the Collective 54 Mastermind Community.

In our community, you’ll connect with fellow founders who have walked the same path, gain access to invaluable resources, and receive expert guidance to help you successfully navigate each stage of your firm’s journey. You’ll have the opportunity to learn from experienced professionals and accelerate your firm’s growth and success.

Join us at Collective 54 and take your professional service firm to new heights. Together, we’ll help you master the art of growing, scaling, and ultimately exiting your boutique firm, all while optimizing your compensation along the way.

To learn more about Collective 54 and how we can support you on your journey, visit our website or reach out to our team today. Your fellow founders are waiting to welcome you into our thriving community.