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Your primary objective as a founder is to make you and your shareholders money through a liquidity event (like an acquisition or IPO) rather than through a big juicy salary. Working towards a big exit, however, shouldn’t prevent founders from a salary as compensation for the roles they play within their team.
Working towards an exit shouldn’t prevent founders from a salary. The clearest lens to look at founder compensation through is company stage.
In this post, we’ll tackle when and how much a founder should get paid. This post focuses exclusively on employment income rather than ownership. To help me pull apart this sticky question this week, I called in some backup. Big thanks to Thalmic Labs CEO Stephen Lake and Relay Ventures partner Alex Baker for their invaluable input, which has been incorporated into this post.
Founder compensation can be complicated and depends on a lot of different factors, ranging from what the company can afford to how much the founder needs to live. The clearest lens to look at founder compensation through is company stage. Here, we’re going to go through three stages in the startup life cycle and how a founder might approach compensation at each stage.
Earliest Stage | Pre-MVP
Scale back your personal expenses; only take out of the company what you need to meet your basic needs.
In the very early days of starting up, while you are building out your MVP, cash is king. At this stage a company might be going through an incubator and/or operating off of small revenues, loans, or angel funding. This stage may last anywhere from six to 18 months, depending on how quickly a product finds product-market fit. At this point, without a proven business model, minimizing your burn rate to increase your runway should be your top priority.
You’ll want to determine the lowest amount you can live off of, and how much salary you need to maintain that. Maybe decreasing your burn means moving back in with your parents and listing your apartment on Airbnb. Or, it means downsizing to a more affordable place and giving up the weekly Whole Foods run. Your goal is to take the smallest amount possible out of the company while still ensuring your basic needs are met.
What covers basic needs will vary between founder to founder and company to company, and depends on geography and the age/stage in life of the people involved. Founders in Toronto will see their money go much farther than founders living in San Francisco, where the median rent for a one-bedroom apartment stands at $3,460. Founders with families to support or mortgages to pay may require more to meet their basic needs than founders without those commitments. New grad founders who decide to keep up the dorm lifestyle will have a lower burn rate than founders living in separate home or apartments. A founder with savings may need less than a founder with no savings.
While keeping co-founder compensation as equitable as possible at this stage is advisable from the standpoint of building team morale, you also need to take into account the realities of each individual’s situation and adjust accordingly.
Product in Market | Seed Funded (~$500K – $1.5M in funding)
Founders should get paid enough to live a modest lifestyle without needing to constantly worry about personal finances.
Once a company raises money and is seeing early traction, the conversation around compensation changes. Your salary will start to inch towards market rate. Now it’s not just about maximizing runway (although that’s still important); it’s also about paying you enough that you can focus on the startup.
Investors see lower salaries as a way to keep founders hungry, but paying yourself first will help give you the stamina to grow the business.
Investors see lower salaries as a way to keep founders hungry (hopefully not literally!) and keep their interests aligned as the company marches towards a liquidity event. But smart investors know that you being financially comfortable is in their best interest. A founder that is stressed financially might be more likely to give up in hard times, or feel pressure to accept an early buyout offer rather than holding out for a bigger exit. Paying yourself first will help give you the stamina to grow the business.
Based on my experience, and input from others, I’d say the average starting salary for a seed-funded startup in Toronto today is somewhere in and around $60,000 a year ($60,000 was actually my starting salary after raising money for ShopLocket). In a market like San Francisco, that salary would need to be more than double to provide the same lifestyle. Peter Thiel said back in 2008 that he believed the lower the CEO salary, the more likely the company is to succeed, but then went on to say that average CEO salaries within his portfolio were $100,000 to $125,000. Adjusted for inflation that’s $112,000 to $149,000 today.
As a company progresses and has greater capacity to pay — either through additional funding or revenue growth — founder salaries should continue to climb towards market rate. When you think it’s time for you as the founder to get a raise, ask for one. Your board of directors may not bring up your compensation if you don’t. That said, startups have their ups and downs. Founder salaries can, and should, also be reevaluated with the possibility of going down. Sometimes increasing the company’s runway or applying resources to other areas of the business are better allocations of resources for overall success.
Significant Traction | Series A+
Your salary should be at market rate, with a compensation package that is aligned with the company’s overall compensation strategy.
Once your company has gained significant traction or has raised significant funding (Series A+) your compensation should be at or approaching market value. It’s at this point that you should start thinking in terms of what it would cost to replace you and your co-founders in your roles. As Stephen Lake put it, “If founder x wasn’t in this role, what would we have to pay someone external to fill the role?” Your VCs may have benchmark data (breaking down compensation by stage, number of employees, revenue, etc.) that you can use to help determine market rate, and you can also use compensation calculators and databases available online.
Your compensation package should mirror your company’s overall compensation strategy. Does the average employee work at a below market wage and make up the rest of their compensation in stock options, bonuses, and other incentives? There will always be variance and founders may lean more towards equity compensation over cash, but your goal should be to have your compensation fit within the broader picture.
The above is a good take on how to address paying yourself across different stages. I agree that compensation is stage (and cash situation) dependent. The best founders I have worked with definitely approach their compensation using this as a guide. However, regardless of stage, they also take into account where they can create the most value for themselves at any given time, regardless of stage.
When compensation discussions or reviews come up, the best founders are constantly making tradeoff and cash allocation decisions in their heads. Paramount, of course, is their ability to satisfy their own living requirements. So founders should make sure they bring in enough to minimize home life stress, and not have it add on to startup life stress. From there, the conversation in their head goes something like, “If I pay myself and my co-founders another $25,000 or $35,000 per year, that means we can’t spend as much on Facebook marketing campaigns each month, or we can’t hire a top-notch UX designer to make our product sing, or we will need to cut down on my VP of Sales’ travel budget, or we will have to raise my next round earlier than planned and likely at a lower valuation…”
You get the idea. From there, they start to do mental math in their head and their equity stake enters into the equation. “If I can’t do all those other things, then the value of my equity will go down.”
Maybe you are okay with the value of your equity going down somewhat; maybe you are not. Maybe the answer is somewhere in the middle. Only you can decide. In my experience, the best entrepreneurs often run through this rough math in their heads. And the most successful ones tend to focus on the longer-term value of their equity as opposed to the value of cash in their pockets today.
One other tool in your arsenal is something that is referred to as deferred salary. To illustrate what this means I will use an extreme personal example from my experience with one founder a number of years ago. The founder was a repeat entrepreneur and was well-off enough (but by no means rich) to completely take no salary out of the business over both its seed and Series A rounds. In fact, the founder took no salary at all until the time of exit (which occurred at the equivalent of a Series B stage).
How did he do that? Well, with board approval, he simply was allowed to put off (or “defer”) getting paid by placing the salary he would have gotten over time and turn it into an accruing debt liability for the company. At the time of exit, this liability was actually converted into shares of the company and paid out to the founder in cash. Importantly, this cash was treated as capital gains and not income, thereby minimizing tax payment from the CEO.
The CEO above was one smart cookie, but of course, not everyone is in the financial position to do this. Just recognize it is available to you and in varying degrees. You don’t have to completely forego salary. More often I have seen founders give up a portion of their would-be salary and defer it in order to reduce burn ahead of the next major milestone for the business. This may happen particularly in times of hardship or a “cash crunch” for the company. The deferred amount can be paid out upon a successful Series A or Series B round, or as I showed above, could be deferred altogether until the time of exit.
Of course, this is yet another negotiation with you current investors/board, and you will be somewhat at the mercy of the next set of investors and their desires in the future. So consider and tread carefully.
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