A version of this article previously appeared in The Wall Street Journal.
How much should Founders pay themselves and their senior team? During a company’s early stages, before it has achieved profitability, the answer is, “as little as possible.”
Dave Pink, in this popular video, makes it clear that money only modestly motivates knowledge workers. Once people are paid enough to cover their basic necessities, money is “taken off the table” and is no longer very motivational. Thus, Founders should pay themselves and their senior team just enough to make money a non-issue.
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The True “Cost” Of Salaries
At Rincon Venture Partners, we always ask Founders how much they intend to make, once they are funded. Those who do not expect to immediately be paid a market rate for their “services” are the type of entrepreneurs we seek.
Experienced Founders realize that venture funding is “expensive” money and thus they keep their salaries relatively low. They know that every dollar they raise, especially during a venture’s early stages, entails significant dilution. These savvy entrepreneurs also know that significant wealth is created by exits and that W-2 income is for wage-slave suckers.
After taxes are considered, the relative dilutive impact of investor capital used to pay Founders is even more substantial. For instance, at $1 per share, $10,000 “unnecessarily” paid to a Founder equates to 10,000 shares of dilution. These are shares that cannot be granted to future employees or subsequent investors. Yet, because of state and local taxes, the Founder will only pocket about half of the $10,000. Note: the supposition is that the $10,000 is not necessary to retain the Founder.
More importantly, the company has $10,000 less capital with which to create future value. If the company generates a 10X return to its investors, one could argue that an additional $100,000 of wealth could have been created, if the original $10,000 had been poured into operations, rather than put in the Founder’s pocket. This is incremental wealth that would flow to Founders, employees and investors alike.
Food Stamps Are Not An Option
But aren’t salaries part of “operations?” Yes, absolutely. However, when determining the appropriate salary for Founders and their key staff, the question should be, “how much do you need?” not, “how much do you want?” Founders shouldn’t worry about making their rent, but they also shouldn’t be troubled contemplating the new house they plan to buy with their elevated salaries.
Once a startup proves its product / market fit and is on the path to profitability, salaries should be adjusted to approximate market conditions. However, even when a company has matured beyond survival, a significant portion of Founders’ and key executives’ compensation should be based on the company’s overall performance, via an aggressive incentive plan.
During a startup’s early stages, hire five key employees, work them like eight and pay them the equivalent of ten people, based on the revenue they generate. Capital from customers is a lot less expensive than capital from VCs.
Follow my startup-oriented Twitter feed here: @johngreathouse. I promise I will never Tweet about Founders on food stamps orthat killer burrito I just ate.