Founder Compensation: Cash, Equity, Liquidity
TL;DR: Before investor money shows up, founders should pay themselves very little, if anything. As the company reaches milestones, including fundraising milestones, founder compensation increases as a % of market comp, although it rarely reaches full ‘market’ until a Series B/C or later. As a general matter, investors want founders (i) focused on the long-term success of the company’s stock and not on a lofty cash compensation arrangement, but (ii) also comfortable enough financially to pay their bills and not be distracted by financial worries.
- Rich v. King: The (Core) Founder’s Dilemma
- Founder Convertible Notes — Put Your Money on the Cap Table
- It All Changes When the Founder Drives a Porsche
As with many things, how different parties assess and calculate appropriate founder compensation is far more of an art than a science. One thing to keep in mind is that all numbers at each stage of companies are heavily influenced by (i) location and cost of living, (ii) industry, and (iii) life circumstances of the founders. Older founders with families tend to have slightly higher salaries than younger single founders. The same goes for founders in more expensive cities, and for founders in industries (like biotech, energy) where the founder team is made up of seasoned executives that have taken very large pay cuts to join the venture.
There are also tax nuances involved that are not the scope of this article. That being said, the below is an outline of the overarching common principles that I’ve observed among companies along the various stages of their life cycle.
Pre-Seed: Cash In, Not Out
Money in should be documented as a Founder Note or SAFE. Paying yourself a salary at this stage makes little sense, unless there’s substantial revenue. If you need to get some money back, a small bonus upon raising a larger ($2MM+) round is sometimes kosher.
If a startup is currently bootstrapped and not running on a sizable amount of customer revenue, paying founder salaries amounts to taking cash from one pocket and placing it in the other, while allowing the IRS to take a percentage of it. It is very rarely rational. Keep what you need to survive in your own bank account, and only fund the company with the rest.
Contributions of capital from founders beyond minimal amounts should usually be documented as a founder convertible note or SAFE (see articles above), with the expectation that it will convert later into preferred stock, providing that founder a “little extra” on the cap table and eventually in a liquidity event. It should not, however, be expected to be paid back.
However, occasionally founders will put in such a large amount of money that they really need to get some of it back much earlier than in an exit. In those instances, discussing a small ‘performance bonus’ with your seed or Series A investors can often work, as long as the amount isn’t too large of a percentage of the overall round. I’ve seen founders get a $50K ‘performance bonus’ upon raising a $2MM+ Series A, with the logic being that they were taking barely subsistence salaries for the past year and need something to help cover deferred expenses. Sometimes it works. Sometimes it doesn’t. Usually founders with personal obligations, like student loans or families to support, are able to make a more credible case for an early cash bonus.
I would also put “Friends and Family” round territory in this category, although it depends. If you’ve raised $250K or less, which is usually what I see for F&F, paying yourself any kind of salary often doesn’t make sense. For larger F&F rounds that are meant to last for over a year, very small founder salaries can work. As a general matter, however, anyone looking to build a company without at a minimum 6–12 months of cash reserves to live off of should re-consider whether they are in the right position to start a company.
Seed/Series A: Enough to pay the bills
Founders get paid ‘subsistence’ salaries; enough to cover expenses, but low enough to where they’re still hungry for growth.
Once investors are on the cap table and/or the company is generating real revenue, discussions about founder salaries start to make more sense. The core principle to understand in this stage is that investors will want to avoid paying founder such high salaries that they’re no longer hungry and are just enjoying the ride. The vast majority of a founder’s long-term payout should come from their equity stake in the company, and investors want founders laser focused on turning that stake (and the investors’ stakes) into cash with a successful liquidity event. That being said, most investors also do not want founders to be so desperate for cash that they are worried about paying their mortgage, or their kids’ schooling, which will be distracting from company matters.
While this is an extremely rough benchmark and there are all kinds of variations, if you assume 100% as being the aggregate cash compensation of a C-level executive in a respectable, matured middle-market company in a startup’s industry and geography, seed-stage founders will often get paid 20–25% of market, and Series A founders bump up to something like 35–50%. So, as an example, if $250K is ‘market’, a seed-stage founder CEO might earn $50–60K a year, and $85K-$125K at Series A; with the universal understanding that industry, cost of living, and the personal circumstances of founders will push it in either direction.
At this stage, any discussions of founder liquidity (taking some money off the table via a secondary sale) will be non-starters, and even send a negative signal to investors that the founder isn’t as bullish as he/she should be on the company’s long-term prospects. If a founder needs more money (often family circumstances), cash comp, like a special bonus, should be the focus.
Series B/C and Beyond: Edging Toward Market, Liquidity
Now we’re running a real enterprise, with the market compensation to prove it.
It’s at true “growth” rounds when cash compensation starts to edge closer to ‘market,’ and when discussions about some small founder liquidity start to make more sense. A ‘growth round’ would generally mean that the company has found strong product-market fit, growth is going strong, and they just need gasoline (cash) to propel the rocket ship. At this stage, founder cash comp would usually be closer to 75–100% of market for the founders’ position in the company, which may still be C-level, but might not be. See: Rich v. King: The (Core) Founder’s Dilemma.
A dynamic that starts to arise at the growth stage of a company is the feeling among a founder team (and, frankly, their spouses and families), that even though the company hasn’t exited yet, they’ve ‘made it.’ They’ve made it through the sleepless nights, the chaotic weekends, and the strained personal lives, and have built something with sustainable, sizable market value… but the ‘big pay day’ may still be years away.
It’s at this stage that a spouse might ask a question like, “So… you’ve been at this 5 years and your company just raised $20MM. Why can we still not afford to buy that house I told you about?” Those types of thoughts, which are often not unreasonable, prompt discussions about founder liquidity; meaning the sale of a portion of a founders’ common stock for cash beyond an amount that would be reasonable as a cash compensation package directly from the company.
Some VCs, when prompted by a founder looking to take a little money off the table, will respond bluntly, “absolutely not.” The logic being the conventional “I want you to be hungry” mindset. Over the past few years a counterpoint to that perspective has emerged that is reflected in It All Changes When the Founder Drive a Porsche and Some Thoughts on Founder Liquidity. The logic goes something like this:
- Once a founder has built demonstrable enterprise value and their equity stake represents a life-changing amount of money, personal psychology and (often) family dynamics can lead them to become impatient toward converting that stake into cash;
- This impatience can lead founders to become overly conservative in company decisions, edging toward smaller, but earlier exits (early acquisition), when a little more patience and longer horizon could achieve a significantly larger outcome (larger acquisition, IPO);
- Therefore, allowing founders a small amount of liquidity in growth stage — enough to bring something significant home to their spouses/families/friends to reflect their achievement and calm the financial impatience, but not enough to take their eyes off the much larger pot at the end of the rainbow — can maximize the value of the company, and the eventual payout to investors, in the long run.
You’ll still often run into both the “keep them hungry” and “let them take a little off the table” mindsets within a single cap table, but I would say the latter view, that some founder liquidity (think 5–10% of their stake) in true growth rounds can push founders to achieve bigger exits, is winning out. It depends a lot on the context, and on the particular investors.
So to summarize, while there are wide variations in the market, some reasonable, rough guidelines for founder comp are:
Pre-Seed / F&F: All equity, minimal or no cash comp, liquidity impossible.
Seed: 20–25% of market cash comp, liquidity impossible.
Series A: 35–50% of market cash comp, don’t ask about liquidity.
Series B-C+: 75–100% of market cash comp, small liquidity possible in right circumstances.
Originally published at Silicon Hills Lawyer.