When is the right time to pay myself a salary?

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:

  1. Get no pay.
  2. 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).

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Deferred Salary

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.

startup entreprenuer

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).

6 things to know before you look for funding

Cash is the lifeblood of any business, and at some point, every company is likely to need funding to help it grow. Whether you’re seeking £1million in venture capital or £1,000 from friends or relatives, you’ll need to nail down a few basics before trying to make your case. Here are six things to you must do before approaching investors for any amount of money.

PRESENT A BUSINESS, NOT AN IDEA

Investors hear ideas on a daily basis. While many sound great, they may not be viable. Even a business plan is not enough to attract an investor. You must be a business with a model that scales and a product or service that has “legs”. Even then, you still should prove you know what you are doing.

MANAGEMENT TEAM

Ensure you have a strong team in place that can help and support the growth of the organisation. The big question for nearly every financial backer is: Can you do this? They’ll want to know that you and your co-founders or management team can execute the ambitious plan you’ve presented and pay back your loan or generate a return for your investors. “Have they done this before and where have they done it?” Make sure you and your key people can talk about what may be ahead for the business, what the later phases of growth might be, what can go wrong, and how you might handle those things.

LEGITIMACY

Prove the concept and establish income streams or at least demonstrate they are there. The most important piece of preparation you can do before seeking funding is to know why your product or service will work. The easiest way to prove this is to already have customers using the product / service who can demonstrate it’s worth. The big reason startups fail is being at the wrong place at the wrong time. People miss out because they think they have the right idea, but do not do the due diligence on the size of market and more importantly the demand for their given product within that market. If you don’t do your homework or understand how your product or service will fit in, then don’t waste your time walking into a VC pitch.

UNDERSTAND THE WEAKNESSES AND GAPS IN THE BUSINESS

Before you ask, you need to know what you are asking for. Are you getting capital for resources, such as equipment and talent? If so, perhaps you just need a partner that has those resources already and is willing to work based on revenue sharing rather than bringing in an investor just for the capital. Do you want an investor that brings the capital but who can also serve as a mentor or connector? How involved do you want the investor to be in your business? Most likely, they will want to have some say in the matter because their money is on the line. Asking these questions and knowing the answers is very important before seeking investment because it will help align the investor with your needs – and raise your chances of success.

KNOW WHAT PRODUCT OR SERVICE TO DEVELOP FIRST

Most entrepreneurs are overflowing with ideas of how to make money. However, sometimes having more than one or two ideas can be dangerous. Focus on the ideas that are likely to deliver the maximum return possible in the shortest period for you and your investor. Keep it simple, thoroughly research the product or service and ensure that there is a good and viable business opportunity in your idea. This is neither the time nor the place to invest time and energy in a vanity project.

UNDERSTAND YOUR AUDIENCE

When is the investor likely to want to exit the business? What does that mean to to you and your long term strategy? Entrepreneurs should do a lot of research and soul searching before deciding what kind of outside money they need and who to approach for it. Match your business strategy and financial needs to the right backers. For example, if you won’t have strong cash flow for quite a while, then a bank loan probably isn’t for you. And, venture capital investors rely entirely on capital gains to make their money, so if you absolutely don’t want to sell your business, then VC may not be an option either. Pre-qualify backers the same way you do potential clients, by learning how they do business and what their criteria are. For example, angel investors typically invest relatively small amounts and always worry that their stake in a company could wind up diluted if big investors come in later. Thus, they may avoid companies that are likely to need much bigger follow-on investments.