Startups place an immeasurable amount of stress on a founder’s mental capacity. Especially early in the process, there are a legion moving parts that require an entrepreneurial artfulness to keep the business operating successfully.
The brain drain founders experience in early stage startups often causes minor details — such as how much you should be paying yourself — to be put on the back burner. As a founder, your salary should be scrutinized closely to determine if it is a good fit for you personally and is in line with the goals of your business.
A founder’s pay can also affect other employees and investors, so it should be thought through carefully. Here is why this is important, and some tips for deciding how much you should be making as a startup founder.
Setting the tone
As a startup founder, money is one of your greatest resources. If you set your salary high, you are obviously going to burn money more quickly, but it also sets the wrong tone. We are no longer in the dot com era, and some startups need to realize that a high burn rate is no longer a badge of pride.
Aaron Harris, a partner at Y Combinator, said that it’s about setting the ethos for the company. You want an early stage company to value frugality and wisdom regarding resource allocation. Of course, you also want to build an environment where team members can bring their ideas before you about purchases that might make their job better or improve the company. Money is not a sacred startup totem, but it should be respected.
In order to show their commitment to the company, some founders choose to pay themselves less than their employees. Dino Vendetti, General Partner at Seven Peaks Ventures in Oregon, said that a founder sets the tone for “everything” in the company, and founders should work to build a culture where equity matters.
“As a founder, if you are very conservative in what you are paying yourself, you are setting a standard for better alignment with your investors, and maximizing what all parties/shareholders are getting out of each round of investment, and thus — less dilution for all shareholders,” Vendetti said.
Possibly the most difficult aspect of the salary equation is the metrics by which you will determine what to pay yourself. Each case is different and every founder is in a unique situation, which can often make it difficult.
“If you are a 21-year-old kid just out of college with no real expenses, sharing an apartment with a couple guys or girls, your costs are much less than if you are a founder who’s in his or her 40s, with kids at home, and you need to meaningfully contribute to the household income,” Harris said.
Some basic things to consider are rent, food budget, insurance, and dependents if you have any. In addition, Harris mentions two other questions that should be asked when a founder is thinking through his or her salary.
1. How much do you need to have a life outside of work? Startups often stem from an idea built on a personal passion, so it is easy for founders to get caught up working long days and weekends. It’s important to maintain your identity outside of your startup and spend time with family and friends. Make sure your salary gives you the opportunity to do that.
2. How long do you expect to live on that salary? When it comes to your personal finances, take an account of your savings and your current budget. If you can afford to pay yourself below market for the first year, living partly off of personal savings or by liquidating other investments, that could help free up some capital for your business.
“Be frugal, but be smart,” Harris said. “You don’t want to pay yourself too little that you can’t focus on work because you’re trying to figure out how to put food on the table, and you don’t want to pay yourself anything extravagant. You’re not supposed to be getting fat off the salary such that you’re no longer hungry for the equity.”
Balancing salary and equity
As the founder of an early stage company, your reward is in the equity. Equity is the financial realization of your investment into your dream, being that you own a part of the company and your success is contingent on its success.
Equity allows others to buy into your dream as well, and it is paramount to consider equity distribution before you begin to bring on other team members.
“An important consideration is the equity structure of the company and the founder’s strategy for the team – for example, are if you are someone who plans to keep all of the equity, then you better be prepared to pay higher/market rate salary. Bottom line: Pay = Salary/Equity balance. You need to make sure your key team members are bought in and engaged, committed to the overall business you are trying to build with their help.”
When you hire other people, Harris said, that is the conversation you need to have with them. Most of the time when software engineers go to work for a startup, especially in Silicon Valley, they know that they could be making more money at a bigger company. They are expecting equity, but you still have to sell them on your dream. You have to show prospective employees that it is worth owning a part of your company.
Revisiting your salary
Once you have set a starting salary, you must be willing to revisit and reevaluate your pay as the company grows. When you hit a milestone, raise extra money, or grow your team to a certain size, take another look at your finances.
“Founders actually can be overly frugal for too long, so it’s a good idea to periodically review salaries and also take into account unforeseen circumstances that could impact the business,” Vendetti said.
Vendetti shared a personal experience about one of his portfolio companies in which one of the founders was dealing with personal hardship. At Vendetti’s suggestion, the CEO agreed to increases all of the founders’ salaries by 10-15%. Because of that, some stress was relieved at home and the founder was able to better focus on the business and be more effective.
Salil Deshpande, Managing Director at Bain Capital Ventures, advocates for a minimalist approach for early and seed stage companies, but said that salaries and bonuses should be further discussed when a company has reached its Series A or Series B funding round and shows serious promise.
“For bonuses, I like it if it can be arranged that the entire management team has the same measurable objective (this is often a sales or traction related objective) and has different bonus amounts but a common payout percentage, which is based on what percent achievement there was of the common measurable objective,” Deshpande said.
Startup founders should constantly look at the changes in their company, and evaluate what that means in terms of resource allocation. Always seek to do what’s best for your company in the long run. Sometimes that means cutting back.
Deshpande inherited a board seat at a struggling company a few years ago. The company’s CEO had a high base salary that was no longer appropriate for the performance of the company. Deshpande suggested that they restructure the CEO’s bonus as a carve-out that would be paid upon the exit of the company.
“He was upset at first, but then decided it was a good idea, and agreed, and we replicated this for a couple of the other management team members,” Deshpande said. “This aligned the board and the management team. He did a fabulous job engaging with acquirers and delivered a better than expected exit.”