Why Founders Should be Paid a Salary

September 3, 2013

Investors generally give wise advice to entrepreneurs. One piece of less-wise advice I have often heard is that founders should draw no salary.

I believe that you should always pay the founders, and that in the long run, paying founders is better for the investors too. Why?

First is the issue of being fair to the people who are working full-time in the business vs. those who are working part-time or not at all. True, this can partly be taken care of by vesting. However, vesting is based on a best guess taken at the beginning of who will contribute to the business moving forward. Salaries (or consulting contracts) are a way to actually pay the people who really do the work, without having to go “nuclear” by renegotiating vesting for people who do slightly less than the work you expected. Cash for time worked is a rebalancing factor.

Second, there have been some good things written recently about the emotional or psychological cost of entrepreneurship. There is a huge toll not just on the founders and entrepreneurs, but also on the people who support them, including their spouse. Being paid a salary, any salary, makes a significant difference in being able to justify things, especially to your spouse. There is a big psychological difference between “I’m working for free” and “I’m being paid much less than I’m worth but still getting something.”

As a related point, paying the founders salaries can extend the runway of the company. Most founders can last a number of months without drawing any salary. Once you pass that point, the emotional and psychological pressure starts ramping up. Most companies will take longer, and more money, than you expect. If you start off by paying a salary to the founders you always have a fallback position: if money is falling short you can stop paying the founders’ salaries for a few months to get through a tough period. This way you don’t start ramping up the pressure until you have to, and founders can last with a company for multiple years, rather than just one year.

It may also help for intellectual property rights. Employees typically transfer their intellectual property to the company in return for their salary. If people are paid nothing for their work, they may be able to argue that the company doesn’t own the work they did. While I am not a lawyer, having some sort of salary or cash changing hands should make the company’s position much stronger.

How much should founders be paid? They should always be paid significantly less than their market rate—that is to say, you want them to be earning much less than they would in a salaried job. A good starting point is around 30% to 50% of their market rate. You want enough that they can pay rent and eat, but not much more. If they have to dip into savings for a little bit each month so they can keep up their standard of living, that’s probably the right rate. For instance, in a Canadian context, paying a fresh university graduate something like $2,000 per month is fair. For someone mid-career, possibly with children, $5,000 per month may be more appropriate.

Of course, as the company’s revenues grow, salaries can increase. Then you’re paying based on company results. And founders should still never go above 70% of their market rate in terms of salary and bonus. They can make up the balance through dividends.

Image: SmartRecruiters