Some things to pay attention to if you want to secure an outcome that’s fair to you without burning relationships with your investors
You had to hand it to Donald: his timing was impeccable. The startup where he was CEO had grown quickly to over 200 people, and top-line sales were running at four times the level of the year before.
There were some problems, too. The unit economics had worsened; they were losing money on each sale. As a result, the company needed to raise more funding — something that Donald did almost effortlessly, using a mixture of charm and bullying to persuade the investors to reach into their pockets again.
And that’s when Donald struck. No sooner was the money from the bridge round in the bank than Donald went back to his board. “I’ve had a job offer,” he explained. “The strategy consultancy where I used to work would like me back, and they’ve come up with pretty attractive terms. I’d love to stay and help build the business, but the balance of risk and reward needs to be right. If I’m going to stay, I estimate that requires a 50% salary increase.”
I’ve just had a job offer. I’d love to stay and help build the business, but…
The investors were over a barrel. Without anyone committed to running the business as CEO, the cash they’d just put in would be swiftly burned, and there would be little chance of raising a next round. Much though they hated to admit it, keeping Donald was worth more, a lot more, than the extra salary that he was asking.
Donald (not his real name, for reasons you’ll soon realise) had just given a textbook demonstration of three important things CEOs at venture-backed businesses should do when negotiating their salaries with their board. Let’s look at them one by one.
1. Choose the right moment
No matter how you get on with your investors, the negotiation of your salary as CEO is, at least superficially, a zero-sum game: every extra penny in salary is a penny from the investors’ pockets. If the company is loss-making, as most startups are, it also brings forward the date when the company will need to raise new financing. This means it’s important not to raise the question of your compensation just at the moment it happens to occur to you. Much better is to look for the time when you’re in the best position to negotiate.
2. Have a clear BATNA
When two sides in a negotiation can’t come to a deal, it’s often because the two sides don’t have a clear enough view of what each other’s alternatives are if they can’t agree. Your BATNA, according to Roger Fisher and William Ury’s great book Getting to Yes (Amazon US and UK) , is your ‘best alternative to a negotiated agreement’. And the stronger your BATNA, the more attractive it is for you to walk away from the negotiation. If your implied threat is that you might start hunting for a job, then your employer may not be terrified. It may feel that’s a risk worth taking, and postpone discussing your package for a few months. If your plan B is a highly-paid, job you’ve been offered elsewhere starting Monday, then things are different.
3. Demonstrate value
Founders are understandably emotional about their companies. Investors are much less so. Whatever you may feel about the loyalty you’ve shown over the years, the late nights you put in without overtime, the family time or the vacations you missed, venture capitalists and angel investors are rarely minded to reward you for past performance. This is true even if your past compensation for that performance seems clearly unfair to you. Rather, it’s best to make your case in terms of the future, explaining why the increase you’re demanding will deliver value to investors.
When negotiating salary, it’s best to make your case in terms of the future, not the past
That can be an upbeat message — if I stay, we’ll have a billion-dollar exit — but it can also be downbeat. Helping investors avoid a catastrophe is worth something too.
Donald got all of these things right. Yet three weeks later, he’d been unceremoniously fired. Unpicking the story reveals some other issues that he failed to pay attention to.
4. Check that your proposal will seem fair to the other side
There’s a lot of writing out there on the web about rapacious and immoral venture capitalists who maltreat their founders and try to steal their businesses from them. But my experience across many boards and many companies has been that for the most part, VC investors are honest and want to act fairly. What’s more, they want others to treat them fairly too. And if your definition of picking the right moment is to choose the moment when you have your business partners over a barrel, that’s something they will remember, and resent.
You might expect them to act like rational economic agents, and simply calculate the likely outcome to them of plan A, where you stay, versus plan B where you leave, and pick the one with the higher expected value. But most VCs are human beings, too. They will want to signal to other founders that sleazy behaviour isn’t rewarded, and they may simply get emotional too. They may be willing to take some pain in return for punishing you.
That’s exactly what happened in Donald’s case. Because he forgot to apply the reality check of whether his proposal was fair, his board simply held a conference call between them and then decided to offer the job to Jamie, his COO, who was modest, reasonable and honest. Jamie now runs the business, and he’s doing pretty well at it. Donald, by contrast, ran into a problem with that consulting job he presented as his BATNA. He tried a little too hard to talk up the terms of the new job, and the result was that he didn’t get a job there either. When I last checked LinkedIn, he had a startup that had been ‘in stealth mode’ for a suspiciously long time.
By contrast, you’ll increase your investors’ confidence in your professionalism and honesty if you’re frank with them about your personal circumstances. If you’re having trouble meeting rent or mortgage payments, or have an elderly parent or a toddler to support, then that’s highly relevant information to share. Your investors will want you to focus on the business, and if money worries make that impossible, then they should know.
Reflecting on CEO salary negotiations that have had successful outcomes and left both sides feeling content, I’ve identified a few other common themes.
5. Propose a fair mix of jam today and jam tomorrow
Self-evidently, if you found a startup that succeeds, you’re likely to make a great deal of money. The rewards aren’t dissimilar to winning the lottery, except in the case of really successful startups like Amazon or Facebook, whose founders have so much cash that they could give someone else a lottery win every week for a decade.
In thriving startup ecosystems, there are plenty of investors willing to provide the capital to founders who can provide the labour — the ideas, the talent, the hard work. But the ‘sweat equity’ that a founder or CEO lays claim to has to be more than just a gigantic free option. In short, they can’t just get the upside on top of whatever they had in their previous job. It’s not unreasonable for founders to take some salary sacrifice in return for that option.
Twenty years ago, many investors took a tough line: they liked startups where founders started out paying themselves low or minimum wage or, if where founders have money of their own, the proverbial $1 a year. Thankfully, times have changed: VCs now realise that running a startup is a stressful job, and that being paid nothing or near-nothing for doing it can make it even more stressful. That’s why investors who seek long-term value for their companies want founders to be fairly paid. But they still like to see a little sacrifice.
Investors seeking long-term value want founders to be fairly paid. But they still like to see a little sacrifice
Lots of things influence how big that sacrifice should be: how strong the business model is, how big the market, how much the founder was earning before. But nobody wants to back a business whose leaders are being so well paid and having such a good time that they don’t mind much if it doesn’t succeed. They want you to trade, as Lewis Carroll’s White Queen might have put it, some jam today for jam tomorrow.
6. Use comps with care
Consistent with the weight they put on fairness, most VC investors will be influenced by arguments about what’s common elsewhere in your industry. If you can provide evidence that in the town where you work, salaries for similarly successful people who lead similar companies in your space at a similar stage are 30% higher than your own, that will go a long way to getting the outcome you want.
7. Understand the dilution effect
If you raise $2m for a startup and pay yourself $200,000 a year, then self-evidently you’re transferring 10% of the raise straight back to yourself — and doing so in a way that is highly tax-inefficient, since the income taxes and employment taxes you and the company will pay on your salary and cash bonuses are much higher in most jurisdictions than the capital-gains tax you will likely pay on the increase in the value of your shares on a successful exit.
But there’s more important point still. Suppose the company does well enough to raise money 18 months at three times the valuation. Had you been able to scrape by on a $100,000 salary, the money saved could have reduced the number of shares that had to be issued in the first round. And thanks to the 3x step-up in valuation, the equity that would have been left in the company could now have been sold for $300,000.
This is probably the most important point to consider when you’re a early-stage founder. Particularly in the first couple of years, the rate of return you can achieve on an early salary sacrifice could be immense. And an open conversation about this with your investors can be helpful. Not everything about the negotiation needs to be zero-sum.
8. Remember that this is different from team compensation
For most startup founder, your potential reward if the business succeeds is an orders of magnitude bigger than your most senior hires, and two or three orders bigger than the rest of the team. That’s why it’s appropriate, certainly at the early stages, that your compensation should be handled differently from theirs. For a structured approach to managing salary, bonus and options across the company, I recommend Avrom Gilbert’s insightful advice: How to Negotiate Compensation With Your Team — Clue: Don’t.
I’m Tim, and I run a seed fund out of London that invests in SAAS, platforms, marketplaces and tools. I’ve backed 50 companies and sat on 19 boards, and I coach Series A and B CEOs introduced by VC firms in Europe, America and Asia. I founded a startup and took it to an IPO on the NASDAQ, and before that worked for The Economist and the Financial Times.
About this publication
This is one in a series of blog posts covering nine of the most important skills I’ve seen in founders who successfully scale their companies. If you’d like to read more of them, please follow.