Founders are Working for Equity But Equity Can’t Pay the Mortgage
A common question founders are faced with is how much to pay themselves. On one hand, they need to pay rent and other bills. But the more they pay themselves, the sooner they’ll need to raise more funding. And if they pay themselves too much, it’s a red flag for investors. So what is a suitable salary?
There’s no one right answer to what founders’ salaries should be, but there are many wrong ones that limit the company’s financial runway or turn off potential investors.
It depends on the stage of the company and on the financial situation of the founders. And the current boom in early-stage investing has given founders more leverage — a salary that might have killed a deal a few years ago could be acceptable now.
The Founder Is an Owner and Investor, Not an Employee
Let’s start by looking at why the founders shouldn’t pay themselves a market-based salary, and may get paid less than their employees.
When you work for a big company, you get paid a market-based salary. If you can find a higher-paying job, you move on to your next position. Being a founder of a startup is a different proposition. You’re not working for investors or for your company; you’re working for yourself.
In a venture-backed startup, your one and only goal is to reach an exit (IPO or acquisition) where after years of struggle and hardship, the investment pays out handsomely for both you and your investors. Until that time, investors get nothing — no interest, no dividends, and no ability to cash out.
At its heart, venture investing is simple because the goals of the founders and investors are aligned — to reach the pot of gold at the exit as quickly as possible. At that exit, you’ll reap millions if not hundreds of millions at the same time investors get their reward. This allows investors to hand you a big check and wait patiently for their payout.
But for this venture funding model to work, the converse must also be true — the founders do not get a significant payout until the investors are paid, too.
Besides keeping the founder’s eye on the payoff, salaries are usually the biggest cash burn. Especially prior to Series A, cash is severely limited. A significant salary going to the founders means less money available for everything else that’s needed. This causes a high burn rate and leaves a shorter runway to get to the next round of funding.
Typical Founder Salaries
Until the seed round, most founders don’t take any salary. At this stage, the company has no cash to spare. What money the company does have needs to be used to get the product built and proven. The company needs to operate as efficiently as possible.
However, California law (and probably some other states) require all employees to be paid at least minimum wage, and anyone working at the company, including the owners are considered employees. This is not optional and can’t be disclaimed. If one cofounder is asked to leave (not uncommon), failure to pay minimum wage is a lawsuit the company will lose. Make sure to follow all legal requirements to pay applicable wages and taxes.
Early rounds of investment put some money in the bank. But investors want to see as much of that going into building the business rather than paying the founders. But we understand that even founders have to pay the bills.
After a substantial seed round, a typical founder salary is around $50K — $60K/year, or what is often called “ramen wages.” It’s not intended to do more than allow the founders to pay rent or the mortgage and a daily meal of instant noodles. The amount will vary based on the cost of living in the area and the age of the founder.
After a Series A round, the company should have far more cash available. The business should also be generating substantial revenue on its own.
At this stage, a typical salary is around $100K/year. Still far from market rate for experienced leaders and engineers, but enough to be able to eat decent sushi instead of ramen and not have to share an apartment with three roommates.
As customer revenues increase towards $100 million and an IPO or acquisition becomes possible, salaries will increase up to $250K/yr. But the big payout still awaits with the exit.
There are 3 types of workers in a startup:
- other executives
- regular employees
The founders are basically working for equity and the chance for riches in an exit. Salaries are kept to a minimum to reduce cash burn and focus on the exit.
However, the company needs to hire regular employees and contractors. They may receive a small number of options as an incentive, but the company has to pay market rate to hire the people needed to accomplish specific jobs.
Other executives in a startup typically work for a hybrid of salary and equity. For particular roles like heads of engineering and marketing that should be focused on the long-term success of the venture, it’s better to pay more in equity and less in salary. For roles like CFO that have to be focused on getting the job done right, executives should get market salary with a small number of options. Head of sales focuses on closing sales right away, with compensation primarily based on commissions.
In general, the salaries and equity of the non-founders on the executive team depend on the stage they’re brought in. Earlier hires when the company doesn’t have the ability to pay large salaries are considered more like co-founders.
Whether to pay in salary or equity also depends on how crucial the hire is to the company’s success. Like the founders, who are the most critical employees, other critical executives should be paid as much as possible in equity instead of salary. Make sure they’re incentivized to stay with the startup for the long term and not leave as soon as the company hits a rocky patch and a recruiter calls with a great offer from a competitor.
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