Angel investing · Startup Funding

How much of an early stage investment money should go to salaries?

Ugur Cirak Will start a startup in Japan

February 27th, 2017

In early stage investments there is always this question of how much you need and where are you gonna spend. If founders show a pie chart with a distribution of investment money mainly to salaries, the deal usually does not go through, then how much of investment money should be allocated for salaries to cofounders or employees?

As a founder, you’re always in fundraising mode (whether active or passive). In this course, we’ll teach you how to successfully raise follow-on capital, establish a valuation for your company, build an investor pipeline for your next round, and more.

Andre Sr. Managing Partner | Business Funding | Speaker | Mentor

February 27th, 2017

Investors are not here to support your lifestyle. Their has to be pain and sacrifice on your side. Your salary should be enough to cover Maslows theory (shelter, food, basic expenses, transportation). Depending on how much you are seeking, maybe 15-20% should be salary.

Eric Platon Maker with background in AI

February 28th, 2017

Investors to early-stage companies often stress that they invest on the team. This means a significant amount is spent on the salaries anyway. Of course the numbers must be "reasonable": As Andre Sr. puts it, they won't pay for the lifestyle, but just enough for "survival".

To dig a bit deeper, early-stage investment money is versatile---as opposed to a typical Series A, for example. The company is probably yet "searching itself" at this early stage [trying to cite Sam Altman here, but I cannot find the link yet].

A company made of "makers" (engineers, etc.) would probably allocate money between salaries (reasonably) and expenses to make things happen. A company made of non-technical people would probably allocate money mostly to salaries, to hire "makers", then to other expenses.

For most early-stage companies, employees are the most expensive asset. Yet it is a central asset without which nothing happens.

Joe Albano, PhD Using the business of entrepreneurialism to turn ideas into products and products into sustainable businesses.

Last updated on March 1st, 2017

Ultimately the goal should be to get key personnel paid at or slightly above market rates for the simple reason that if you don't, there is a reasonable to high likelihood they will leave for "greener pastures".

I'm a bit wary of investors who believe there should be "pain and sacrifice on your side" - that's an indication that you may need a new investor and your investor may need a new career. Well functioning investments are based on mutual contribution to a shared goal. When either side attempts to take advantage of (or feels like they are being advantage of by) the other side, things tend to go bad quickly.

Andy Freeman Product Management and ... - Looking for new opportunities

February 27th, 2017

The short answer is that people who have significant equity usually don't get any salary until the business is generating significant revenue. Those folks can start taking salary before the company is profitable (and after it is generating significant revenue), but only the bare minimum.

Yes, this means that a lot of folks can't afford to be founders.

Andy Freeman Product Management and ... - Looking for new opportunities

February 28th, 2017

> Investors to early-stage companies often stress that they invest on the team. This means a significant amount is spent on the salaries anyway.

"invest in the team" does not mean/imply that. "invest in the team" has nothing to do with whether salaries are paid, how much, and to whom.

"invest in the team" means that investors think that a given group of people is extremely strong. As a result, investors may be willing to accept risks that they wouldn't accept given a lesser team and/or value the company more. Team strength is often how investors decide between competitors.

In fact, a strong team is more likely to have folks who can go without salary and WANT to do so. Why? Strong teams are usually made up of folks who have been successful before and saved money. In addition, they want as much of the money as possible going into making the business a success. Investors like to invest in teams that bet on themselves.

That's not to say that there aren't good people who have no savings or who demand high salaries for other reasons, but those are the exceptions. That said, many investors look for red flags in those cases.

Juan Zarco Managing Director, Silicon Valley Ventures Growth Partners llp

March 1st, 2017

Most investors expect the startup team to get most of their compensation in an ISO program. Of course the salaries must reflect regional compensation level. And most investors assume that the investment be focused on product development and marketing, without which revenues cannot be achieved. Of course, I have seen startup founders do weird things. One in SF bought himself a Ferrari after initial funding. It created such negative buzz the guy sold it back. Then I have seen founders demand that the employees take a pay cut while he pays himself $500k a year and the company never was profitable. Both companies did shut down. It is a balancing act.

Andy Freeman Product Management and ... - Looking for new opportunities

March 1st, 2017

Yes, people can (and should) leave for greener pastures.

Moreover, investors invest in the greenest pastures they can find.

Not only that, investment is "pain and sacrifice" too.

Note that we're discussing founders, that is, folks with a significant equity stake.

Let's compare some different ways to fund a company and see what "founders should not get a salary" means to both founders and investors.

For the purposes of argument, we'll assume four founders, with a fully burdened "higher than market salary" of $100k such that $75k is the effective take-home. (That's a bit high, $70k would be closer after SSI and income tax, but $75k makes the numbers round.)

Let's assume that the business will take a year to get going, that an investor wants 2x in that year and that the company will be 4x as valuable as what is "spent" at the end of that year. If you don't like those assumptions, do the arithmetic with your own assumptions.

Company A:

$500k from investor A1

$100k salary to each founder ($75k after taxes to founder)

Company A has $100k (after founder salaries) to get to $2m (4 x $500k).

Investor A1 wanted 2x, or $1M, so Investor A1 gets 50% which leaves 50%/$1M (total) for the founders.

Company B

$500k from investor B1

$400k from investor B2

$100k salary to each founder ($75k after taxes to founder).

Company B has $500k (after founder salaries) to spend to get to 3.6M (4 * $900k).

Both investors want 2x, and they put in $900k total, so they get 50% which leaves 50%/$1.8M for the founders in equity and $300k of salary.

Company B has to produce 80% more value than company A, but has 5x the "after founder salary" resources to do so.

Company C

$500k from investor C1

each founder lives on $75k in savings (total $300k)

Company C also $500k to spend to get to 3.6M (4 * $900k).

Investor C1 wants $1M (2 x $500k), which is only 28%, which leaves 72%/$2.6M for the founders. Of course, they paid $300k (from savings), so their actual position is worth $2.3M (total).

While Company A has a lower target, I'd argue that Companies B and C have a better chance of hitting their higher target because they have more resources. (If $100k really is higher than market for the founders, companies B & C can afford to hire 4 more people than company A yet those extra people only have to generate $1.6M in value instead of the $2M that the founders have to generate.)

Investor B1 and C1 are equally well off. However, the C founders are much better off than the B founders. The C founders got everything that the B founders got plus they got what investor B2 got but at a lower price. That difference is much larger than the salary that they didn't get. (Yes, they'll pay taxes on the additional gain, but the rate is lower than on salary.)

I'd argue that the C founders are more motivated to succeed than the B founders (because the C founders have more to lose AND more to win). The B1 and C1 investors are likely to take that into account, so C may find it easier to raise money.

Of course, the B2 investors lose out if the founders go with plan C, but ....

In short, if a company actually is a good investment, people are much better off "investing" their salary by living off of savings and taking the additional equity instead of having the company raise additional money to pay said salary.