Founders Should Pay Themselves As Little As Possible

Founders Should Pay Themselves As Little As Possible

image001A 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.

John Greathouse

John Greathouse is a Partner at Rincon Venture Partners, a venture capital firm investing in early stage, web-based businesses. Previously, John co-founded RevUpNet, a performance-based online marketing agency sold to Coull. During the prior twenty years, he held senior executive positions with several successful startups, spearheading transactions that generated more than $350 million of shareholder value, including an IPO and a multi-hundred-million-dollar acquisition.

John is a CPA and holds an M.B.A. from the Wharton School. He is a member of the University of California at Santa Barbara’s Faculty where he teaches several entrepreneurial courses.

Note: All of my advice in this blog is that of a layman. I am not a lawyer and I never played one on TV. You should always assess the veracity of any third-party advice that might have far-reaching implications (be it legal, accounting, personnel, tax or otherwise) with your trusted professional of choice.

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  • haroutk

    This is more or less pure BS. Let me put it this way. Would you ever ask a VC to be “compensated” as little as possible? No! Because they take all the preferred stock, leverage, mitigate their risk… in other words. they do everything possible to compensate themselves as much as possible, and do so at the cost of the founder. Many times they will even ask the founder to convert their ownership into common stock options and earn it over an extended period. all this while the founder earns sub-standards wages and works grulling hours. All for the hope of making it big one their and having the stock options be worth something. But even if the company succeeds modestly the founder will realize almost no return on their hard word and sacrifice, while the VC will walk away with almost everything.
    I understand the VCs take risk, but so does the founder – but at the end the risk/reward is not portioned fairly. VCs will get the lion’s share of the reward while the founders get the lion’s share of risk.
    Is that fare?

  • haroutk – I agree with you. VC’s should never get “the lion’s share of the reward.” As an operator for over 20-years, my Partner and I at Rincon have a very entrepreneur-centric view of startups.

    My point is that salaries can often be “expensive” to Founders in the long run, because much of the cash goes to taxes and the dilutive impact can translate into millions of dollars of lost value. Sorry that I didn’t make this more clear in my post.

    Thanks for sharing your thoughts.

  • haroutk

    John, point well taken! Every single hire we make this same exact scenario becomes a decision point for me. I try to include stock options, other forms of perks and benefits (i.e. telecommute, flex hours…) as long as i can reduce the cash burn. the good news is we are cashflow-positive company where we don’t have to worry too much about the bucket of money. the bad news is we need to scale. These is where a partnership with a VC would help a lot. But because of my last experience with VCs i feel very gun shy about approaching one. But if you say Rincon Venture Partners is a different animal then we might have to talk 🙂

  • I am sorry that you had a bad VC experience – I had my share as an operator as well. However, the VC landscape is rapidly changing as entrepreneurs are filling the seats formally occupied by investment bankers.

    Seek out a Partner who was previously a successful entrepreneur and you should be in good hands.

    Best of luck to you!

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