How do founders get paid?
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Answers by Brett Fox, Abhijeet Kashyap, Paul Davies, Corrin Lakeland, Hasnain Abbas Dilawar, and Jonathan Neumann.
Updated Thursday
There is a friend of mine, Mark, who started a company about four years ago. Mark raised angel funding to start his company.
The company has grown at a nice clip, and has a real chance at long-term success. At the same time, Mark and his partner have taken a salary of $0 for the first four years.
Every time I have lunch with Mark I tell him that he should take a salary. Even if the salary is $1,000 per month, he should start taking a salary.
Mark’s reaction is always the same. “I know we should start taking salaries, but I can’t convince my partner.”
I admire Mark for continuing to draw down his savings because he believes so much in the company. But I still wish they would pay themselves first.
Why is paying yourself something so important?
Paying yourself a small salary creates fiscal discipline.
You need to get to a living wage as quickly as possible. You may not get there in year one, but paying yourself a small salary starts the process.
Then each year increase your salary until you are finally at a living wage. Then you don’t have to worry about paying your bills.
Paying yourself a salary prevents you from treating the company like your personal piggy bank.
Let me give you the flip side of the story about Mark. There was an entrepreneur named “James” that I worked with.
James started by paying himself nothing. The company grew to about $1M/year in revenue.
The company was profitable and had a nice amount of cash. Then James told me that he was going to take cash out of the company to pay back a second mortgage he had taken on his house.
The only problem was there was no loan on the company’s books. James was stealing money from the company to pay off a personal debt.
I urged James to pay himself a salary, so he could pay of the his second mortgage properly. But James wouldn’t listen.
And that ended my relationship with James.
Now clearly not paying yourself a salary doesn’t mean you are going to end up like James. But why put yourself in that position?
Instead start the process of paying yourself a small salary, so you can get to a living wage.
For more, read brettjfox.com.
Answered May 1
The issue of startup founder salaries is a tricky one. Many entrepreneurs tend to simplify this and pick one of two extremes:
Founders get no pay. (“Salaries, we can’t afford no stinkin’ salaries…”)
Founders get paid close to fair market value. (“We raised outside capital so we could reduce our risk, might as well pay ourselves…”)
I believe that the issue is more nuanced than this and depends on a variety of factors. Here are some thoughts on founder compensation:
Investors vs. No Investors: If you’ve raised money from angels or VCs, chances are that your salary will be governed to some degree by your agreement with them. This should not come as a big surprise. Investors want to protect their interest and in order to do so, they need to ensure that management doesn’t arbitrarily raise it’s salaries and extract inappropriate levels of cash from the company.
Co-Founders vs. No Co-Founders: If you’re the only founder in the company (and there are no investors), then chances are you can make the salary decision based on things like available cash, tax optimization (within the law) and fair market value. Most bootstrap startup founders tend to minimize the salary they pay themselves as it is not to their benefit to take large salaries because of tax implications. If there are two or more founders, things get a little trickier because each founder will now be impacted by the salary draw of the other (in essence, the founders are shareholders and as such, are impacted by the allocation of salary much like investors would be). In this case, salaries are likely better determined as a function of fair market value (whereby each founder is working at some fraction of fair market value). Of course, fair market value is not always easy to figure out – but based on roles, responsibilities, geographies and experience there is data out there that can be used to get reasonably close.
Deferred Salary: I often advise startup founders that plan to raise external financing some day to allocate some “fair market value” salary to themselves, but simply treat this as a “deferred expense” item on the accounting books. Basically, this is tracked as a liability for the company. When an outside investment does come in, some portion of this liability may be “paid off” (i.e. cash taken off the table when the investors write the check), or it is maintained as a liability until some future liquidity event (like when the company is sold). This often becomes a negotiation point with investors, but a reasonable argument can often be made for some fraction of the deferred salary to be paid at the time of financing. One possible tactic to use here is to actually make a loan to the company (treated as debt) and pay some salary to yourself from that. The debt can then be carried on the books and paid when cash is available, or converted to preferred equity when the financing occurs. (Note: A deeper discussion of debt, equity, preferred shares, etc. is outside the scope of this article).
Founder Cash Investment Is Irrelevant: In my mind, whether or not a specific founder invests cash in the company should not impact her salary and compensation. These are two separate matters. (Note to self: Write a future article on how founder cash should be handled and how founders shares should be distributed). So, the cash investment should likely be treated as some form of debt or equity and does not entitle the founder investing the money to a higher salary. Further, just because founder X put in some cash (let’s say $500,000) does not mean that salaries should not be paid to founder X, Y or Z. If the cash is in, it should be treated as a resource of the company and appropriate things done with it. Having said that, it’s important to have an agreement as to what can (and can’t) be done with initial seed investments by founders (much like you’d have an agreement with outside investors).
Founder Time Is Not Free: Entrepreneurs often make the mistake of assuming that because they’re not paying themselves, their burn rate (i.e. amount of money being lost) is low. This is simply not accurate. For example, if you’re running a Web 2.0 company and paying just $100/month for the hosted server and working out of your apartment with another $400/month in expenses, your expenses are not just $500/month. Your time is worth something. You have an opportunity cost, regardless of what you decide to pay yourself.
It irritates me when these kinds of founders claim they don’t need to worry about revenues because they can run their companies “for years” because their expenses are so low. But, surprisingly, despite this irritation, my life goes on. (And, not surprisingly, many of these entrepreneurs eventually figure this out and either start making money, raise more money, or shut down).
As far as magnitude goes, I think it is unlikely for a startup founder or executive to make the same amount of money at a startup as she’d be able to get at an established company. The reason is quite simple – there’s likely a significant equity component in the equation. Granted, if you determine the “value” of this equity by discounting appropriately for risk, it may not be that big. But, it’s still more than zero. In my case, I tend to use something like 25-to-50 percent of fair market value to determine salaries (and even then, some of it may be deferred, based on cash-flows). The rest of the FMV is made up with equity. But, my behavior is skewed by the fact that my startups have been “internally funded” and have not had VC investments. For VC-backed companies, I’m guessing the salary would likely be closer to 75 percent of FMV (or higher) based on stage of company.
Of course, one can (and should) wonder why anyone would work for < 50 percent of FMV for a bootstrapped startup. The answer is that many of us actually enjoy the startup lifestyle and the autonomy, learning and energy that goes with it.
Though from a financial perspective, it may not make sense in the short-term, we still continue to do it simply because we like it – despite the long hours and roller-coaster like swings. Note: I’m talking here only about founders and executive management. Others get close to FMV because their equity piece is not that large.
Answered May 1
If you worry about how much as a founder you will be paid you are probably taking your life in the wrong direction by becoming a founder. It’s a brutal truth but one that deserves bruiting abroad.
Investors by and large — in fact everyone that I’ve encountered, but I know that’s hardly everyone — see using their investment in a company for salaries as unacceptable. There’s a lot going for their logic, especially if they are comfortable with salaries being paid out of income. (You can see the logic of not investing in any startup that doesn’t have a revenue stream that could turn into income. Investors don’t expect founders to starve — only not enrich themselves on their money.)
It may be that you will get a salary, but as a founder your focus should be on earning it.
Answered May 1
I wish I knew! 😉
More seriously, founders typically draw a nominal salary that’s enough to live on. Later when the company gets serious investment, this salary will rise somewhat. As the company grows into many millions of dollars in revenue it will end up at market rate.
The reason they’re paid so much less is because the company has many very good uses for every dollar early on. You have to make so many compromises. Paying yourself a large salary would mean even more compromises. The big prize is growing the company’s value so the shares become valuable and you’re not going to achieve that through compromising.
I’m a big fan of the slicing pie model where founders are paid full market salaries but with as much as possible in shares. That model makes it much easier to handle two people with different needs for cash right now, and also to explain to a developer that if they want shares then they have to take a below-market salary.
Eventually the company should make a strong regular profit and start paying dividends (or get sold) and at that point the founders get their real payday. The rest is just having enough to live off in the interim.
My personal situation is a bit different as my company is bootstrapped so I don’t have to justify my drawings to an investor.
Answered May 1
It’s simple. They hold certain percentage of shares of the company and will get the profits according to it. Secondly, if the founder holds a position in the company, like most founders become CEOs or CTOs, they get salary as well as a percentage of profits.
Answered May 1
From the business profits of course. You really don’t have a business if you aren’t making and taking out profits. That’s really the only way to do it. If your investors can’t get on board with you 100 percent in control of the cash flow, taking out and reinvesting as you please, you don’t want those investors. If you need to get bent over by your investors in the business contract because you need their money before you can start making any profits. . . you’re not a founder really. You’re an employee. Avoid that at all costs. If you think you need to go that route for your business strategy, seriously reconsider. If it’s a truly a once-in-a-lifetime-or-rarer idea that could make a killing and not just one that’s essentially a gamble that you came up with in a month of brainstormingIf it’s a truly a once-in-a-lifetime-or-rarer idea that could make a killing and not just one that’s essentially a gamble that you came up with in a month of brainstorming, then you do (need to go that route). Otherwise, if you ain’t got much money to start you should start small. There are plenty of great non-revolutionary ways to make lots of money off of a small sum. Just do a little research. If you want to go big right off the bat and manage to get investors on board with a good contract than that can be good too, if you actually know what
There are plenty of great non-revolutionary ways to make lots of money off of a small sum. Just do a little research. If you want to go big right off the bat and manage to get investors on board with a good contract, then that can be good too if you actually know what you’er doing, that is.
In a business you put up money then do a little work and then come back with more. You pocket that more. Sometimes you expand your business with that profit. That is essentially the same thing as taking the money except it’s just in investment form. But you always make sure you, at the bare minimum, have enough to get by. Simple as that.
This question, “How Do Founders Get Paid?” originally appeared on Quora, the knowledge sharing network where compelling questions are answered by people with unique insights.