The issue of whether a startup founder should pay themselves a salary is not straight forward. Many entrepreneurs tend to simplify the issue and pick one of two extremes. They either:
- Get no pay.
- Get paid close to fair market value. They raise enough external funding to reduce the risk and afford to pay themselves.
Clearly it’s more complicated than that and here are a few thoughts:
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. They will not want you to arbitrarily raise your 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. This can be based on things like available cash, tax optimisation (within the law) and fair market value. Most bootstrap startup founders tend to minimise 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 (the founders are shareholders and as such, are impacted by the allocation of salary much like investors would be).
If you plan to raise external financing at some point, you can allocate the business a “fair market value” salary to yourself. And this would simply be treated as a “deferred expense” item in the accounts – basically a liability for the company that will need to be paid off at some point. When 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 event (like when the company is sold).
This often can become 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.
Founder Cash Investment Is Irrelevant
Whether a specific founder invests cash in the company should not impact their salary and compensation – these are two separate issues.
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 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.
Founder Time Is Not Free
Entrepreneurs often make the mistake of assuming that because they’re not paying themselves, their burn rate (amount of money being spent) is low. Your time is worth something. You have an opportunity cost, regardless of what you decide to pay yourself.
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.
My biggest advice to you if you’re trying to figure out compensation for the early team is to try and base your decision on some objective standard and apply that consistently. In these situations, it’s often just as important to be consistent and fair as it is to be “accurate”. It’s also important to be transparent about the risks involved. Startups, and especially bootstrap startups, are not for the faint of heart.
This is an important issue and can lead to much frustration if time is not spent coming up with something that is clear, transparent, equitable and reasonable. If you’re planning on raising money, having a rational approach to founder compensation is a good way to send a positive signal to potential investors.
It may help to have an objective and knowledgeable third-party help work through the structure (particularly when there are multiple founders involved).