I’ve been working with startups for a long time. Founders often ask me about investors and how to put a financial compensation package together. An investor will pump investment capital into the business if they feel good about the bootstrapping efforts of the founder. The CEO salary is a huge issue when it comes to the health of the company and whether it’s a good choice for an investor.
The issue is, do you bootstrap (meaning you are running as lean as possible) the company and take a low salary? Do you bring in a professional CEO with experience in your industry, which means you’ll have to pay him big bucks and probably options? Or do you give him a huge equity stake for less compensation; essentially whatever he wants?
A budget is not tough to put together, covering ‘all’ your expenses, but people fail to have a realistic ‘burn rate’ (that’s the amount of money they go through every month). Considering executive salaries can take up a large portion of a startup budget, the determination of executive salaries is a very tricky issue and is a major concern for the investor.
What Do Founders Pay Themselves?
Bootstrapping a startup is very interesting to an investor. Investors like to know that you are frugal with their money and have expenses that are easily controlled. Compass collected salary data from 11,160 startups around the world that use its benchmarking tool. In Silicon Valley, 75% of founders pay themselves less than $75,000 per year and 66% pay themselves less than $50,000 per year, according to the data. In fact, Angel Investors expect founders to take small salaries in the $50,000 range while VCs are willing to pay a more competitive salary at $100,000.
In my experience, investors want financial control over expenditures, so salaries need to be lean, and quite often the investor will put one of his trusted employees in the role of Chief Financial Officer to watch funds, especially if the investment is large. It all makes sense.
I remember talking to a young entrepreneur about his investment needs and when he said ‘somewhere’ between $1 million and $2 million. I was aghast. Was it $1 million or $2 million? I needed to see his budget. When I looked at the budget, he had one year of ‘back pay’ listed for three employees, including him (at $150,000 each) as money needing to be paid from the investment. No investor in his right mind would fund this company for many reasons, but this was the killer.
If you can find an investor who will foot the operating budget’s salaries, your salaries should be considerably below fair market. After all, you need every cent to get your dream alive and growing. Most startups will use a formula of 25% to-50% of fair market value jobs as a scale and make it up with their equity as partners in the firm. You can up your salary later because it will be listed as a ‘deferred salary’ on the books and is listed as a liability of the company.
Taking the Long-term with Compensation
You can make or break your company with early demands for cash. If you really believe in your startup, make your salary enough to live on knowing you will make it up when you have a liquidity event down the road in three to five years. After all, you started the company to create something, not to create paychecks for you and your buddies.
The second issue is hiring an already accomplished CEO from your industry to run the business. Remember that the CEO salary will set a cap for everyone in management in the company. Your bootstrapped salary of $50,000 will give you a nice burn rate versus double or triple salaries with a highly paid CEO. If you hire that expensive CEO, include stock options as part of his compensation package but consider how it will affect the other senior people in your startup.
It’s a slippery slope starting a new venture. How do you pay for an expensive engineer who should get $100,000 when you, as the CEO, are making $50,000? How do you match the benefits they are getting from the current job, let alone address the salary issue?
If you supplement cash compensation at any level job with stock, a couple of problems arise. New hires always expect too much and any stock you give away must include a plan for a liquidity event. Any stock you give to executives must have the long-term effect on the company in mind.
Compensation is a Balancing Act
If you give the hired CEO a lower salary with higher equity, you can effectively burn yourself for future financing rounds. VC’s will certainly demand a large percentage of equity for a major cash infusion. Couple this with the CEO equity and it’s more than most founders are willing to give up. It’s a dilemma and certainly a balancing act to make and keep everyone happy. If you go this route, make sure equity is vested and based on performance.
Any stock you do give away must include a plan for an eventual liquidity event, otherwise it is just play money you’re giving away. If you don’t have plans for a merger or acquisition, no plans to do an IPO or want to create a business for your kids, it’s unlikely you will get a sympathetic ear from a CEO looking for options on a private company. It’s a terrible demotivating factor for anyone’s active participation in a startup. Today’s startups include the liquidity event as a natural function of doing business and the only exit strategy.
Running a startup is all about making tough choices and growing a startup can be fun once you get past some of the obvious hurdles like salaries. You have to take into account your vision for the business, your involvement and your reasons for creating the startup when deciding on paying yourself or others to run your company. Plan your options out well and don’t make rash decisions!
If you want to find out more about Startups check out www.GaryBizzo.com
Originally published at www.equities.com.