How Much Salary Should a Founder Pay Themselves?

Regardless of whether you have successfully completed the first round of funding, or you are taking the first steps, the question of paying yourself will arise. The timing will vary depending on the type of start-up, business model and financial input.

In the article we will discuss the essential questions and considerations required to judge how much you can realistically look to pay yourself.

Primary considerations

• Your business needs
• Cash flow planning
• The real cost of salaries
• Claiming tax credits
• Fundraising stages
• Problems with high salaries
• Salaries and business value
• Other compensations
• Vesting schedules
• Investor opinions
• Reducing expectations
• Your life situation
• Co-founders with different situations
• Talking to your co-founders

If you are stretched for time, see the summary at the bottom.

Your Business Needs

The first matter of concern as a start-up founder should be the health of the business. For numerous people, it will be the first thing they think of in the morning and the last thing they think of in the evening.

In relation to taking a salary from your company, this needs to be a key consideration. If you are acquiring early stages of funding, then your expenditure rate will be a significant factor in the case of whether you can afford to pay yourself any income.

If you have operated up to this point, using loans or savings to get the business started, then you will already be extremely aware of how much your business costs to run, and have an even better idea of what it will cost to continue to operate and grow. One of the first things you want to observe when determining if you can take a salary, is the company cash flow.

Cash Flow Planning

It is essential you know what your revenue is, what your business expenses are, when they occur and how often they occur. This is generally broken down into elements, (capital, employee, accounting, legal, office and miscellaneous) then displayed in a month per month forecast.

If you have been working and generating an income for more than 6 months, then you will have developed something similar without even realising.

A cash flow file can convey how much money there is available to pay you. To restate, this is not how much to pay yourself, just how much is available.

In most situations, you will not want to use up the last of your money on founder’s salaries.

If you are raising funds and your company bank balance is going to grow, then you can echo this in your cash flow.

Fundraising Stage

If you have no money in the bank or revenue, you will need to raise money in order to take a salary. It is relevant to note, that the deciding factor in raising capital should not lay solely on paying yourself or your co-founders.

It can be an aspect in determining how much to acquire, but it should not be the chief consideration.

The agreement about how much to pay yourself gets less difficult as time goes on. As the company becomes more successful, your salary figure will be discussed at a board level and agreed on by the relevant parties and investors.

Is there a sum of cash that needs to be raised prior to you paying yourself a salary? Seeds Legal conducted a study and their data showed that “the decision to take a salary very much depends on the size of the round”.

Generally, half of founders can take a salary from rounds of £150k or below. However, this increased to 73.1% when the fund raise was higher than £150k.

Therefore, the more you raise, the more likely you are able to take a salary from the company.

The Real Cost of Salaries

If you are considering capital fundraising, you have probably thought about how much you could be paid. You may have calculated (using your new cash flow) that you can recruit two employees alongside having enough money after business expenses to pay yourself and your associate co-founders.

This may be where national insurance, for both yourself and your employees may come as a surprise. First time founders who have never recruited anyone before may be shocked to realise that while personal take home pay is taxable by national insurance, so is the business that is paying you.

Therefore, if you are paying a web developer £50,000 per annum, by considering employer national insurance, you will actually pay £55,709. This is an increase of 11% on what you would expect to pay.

That number decreases and increases accordingly.

Assuming that you decide to pay yourself £20,000 a year then the organisation would have to allot an extra £1,569 (7.8%) deriving in an actual cost of £21,569 per annum.

Many founders will have already calculated this within their cash flow. However, for those who were unaware, it is a factor that should be considered when deciding how much you will pay yourself.

Claiming Tax Credits for Technical/ Science Founders

Assuming you are a technical/scientific start-up founder there is also the possibility of R&D tax credits (research and development). R&D tax credits could offset some of your salary, dependant on what your business produces and does.

For instance, if you are developing a new company that operates machine learning to control financial analysis and make investment decisions for customers through an app, you would meet the benchmark to claim part of the development costs back from the government.

To qualify for R&D you need to indicate that you are:

1. Looking to develop an advancement in science and technology.                                                                      
2. Overcoming a level of scientific technological uncertainty to accomplish this.                                                                       

This does not have to be cutting edge technology or research. For instance, you may be creating a new web-based API for your company, and you may be uncertain as to whether it will scale successfully.

If your start-up is suitable, then you can look to claim back up to 33% of your R&D costs.

Nonetheless, as a founder, it is likely that you will not be able to claim all your income back. This is due to the fact that not all the work you undertake on the project will fall under the R&D perimeters. That said, if your start-up is tech based, there is a possibility that a lot of it will qualify.

You can find out more about R&D tax credit from the HMRC website.

Problems with High Salaries

If you have left a job with a high salary, you may think this will carry on at your start-up. Regardless to how you arrived at the final figure, it is extremely important to recognise the knock-on effects excessive salaries can have.

If you are providing yourself a “market rate” salary, you do not have to pay your employees the same. This is due to them not having the same level of potential equity upside that you do. However, you will adopt some level of resentment if this were to become common knowledge.

Here are some other issues with paying yourself a high salary:

1. Business value – High salaries remove money from your business.
2. Business growth – High salaries can stagnate growth
3. Investor perception – You are burning my money on your salary, why is it not focused on growth?
4. Employee perception – Why am I struggling to make ends meet, whilst the directors are not? What are the founders doing?
5. Team development – There will be less money available to make new hires. Recruitment and selection are expensive.

Reducing Expectations

Founders of start-ups are quite often high achievers. Generally, this results in a pay deduction.

This may be hard to resolve at first, deriving in dissatisfaction at the payslip you receive every month.

However, it is vital to remember that compensation in start-ups is not entirely in salary, you have equity in the company and consequently you are creating value over time.

Salaries and Business Value

Although, your salary may not be high to begin with, it does not mean that it will not increase over time. If the business is making progress, then you should divide at a level of that success rate.

Let’s examine the effect that business valuations have on the founder’s salary.

Seeds Legal determined that for “every £100,000 increase in valuation, a founder’s salary is estimated to increase by £1300 per annum”. Assuming the business continues to grow and prosper, then your salary will follow suit.

It can be seen at a £2,000,000 valuation, a standard founder’s salary was £25,000, increasing to £52,000 and £80,000 at £4,000,000 and £6,000,000 accordingly.

As your business develops, and the possibilities of prosperity and stability increases, then founders can multiply their salary compensation over that time. The development of the business is clearly bound to the founder’s compensation.

Other Compensations

As owners, you and your team will generally have contrasting forms of compensation beyond a salary, above all equity.

Contemplate, for example Y Combinator, one of the leading incubators in the world, they invest £150,000 in every business they acquire to their programme. The upshot of this is two founders, without other factors they will have an equity portion worth nearly £1M each.

Vesting Schedules

Founders’ equity stakes will possess a vesting schedule. The shares you own in the business are generally kept safe in some capacity until a specific time has passed. For instance, if you have a 4-year vesting schedule and you have just proceeded into your 3^rd year at the organisation you would have unlocked just over 50% of your equity.

A vesting schedule does not impact shareholder’s rights to vote director appointments or control. It is merely “locking” away yours and your co-founder’s capability to sell your equity with precise amounts released over time.

Vesting schedules are liked by investors, as they should be by you. This is because they fasten founders into the business. They ensure focus, as a great deal of compensation is tied to the success of the organisation.

It also prevents founders from fleeing early on with a huge amounts of equity, making the company un-investable for impending funding rounds.

The vesting cliff (as they are occasionally listed as) is a set time, whereby a founder will not obtain any equity if they should resign from the company before a set period.

Generally, more likely in year one, vesting shares frequently happen on a monthly, quarterly or annual basis.

It is in yours and the investor’s hands to agree on how often this occurs. In general, this information is found in the term sheet that was produced by an investor.

In conclusion, a vesting schedule may block you from selling your shares later on down the line as you may not have complete access. Furthermore, it will also likely prevent you from having any stake in the business if you should depart before the time period ends.

It also means any financial reward placed on the business’s future success without you will be capped.

However, looking at the bigger picture, a vesting schedule should not be a major concern. As a start-up founder you are generally in this for the long term, and if the business is successful, you will more often than not see out the vesting period.

A vesting schedule is typically structured to prevent “bad behaviour” although if you were in a position to have the business acquired, you would not be penalised.

Additionally, you would still receive the full percentage of the scale, as dictated by your total vested equity share.

Investor Opinion

Whether you have had the correct amount of luck and skill to have developed a business that is revenue generating and profitable from the onset. Or if the business has never had to take outside investment, then you will be raising funds from investors. So how do the start-up investors feel about founders’ salaries?

Sean Percival, an early-stage investor, who has invested into over 120 companies, thinks that in early stages of a start-up (pre beta, pre revenue) “the founder currently does not take a salary.” However, at a later stage (launched and with revenue), they may pay themselves £21,000 to cover basic needs such as rent.

Christoph Janz, a partner at Point Nine Capital, an early-stage investor and entrepreneur himself, does not believe founders should get huge salaries that make them wealthy. But does believe that as soon as the business can afford it, founders should be paid enough to make ends meet, enabling them to eliminate worry surrounding money.

Peter Thiel, a founder of PayPal and Palantir, feels that “the CEO’s salary sets a cap for everybody else.” If it is set at an increased level, you end up losing a lot more money. It aligns their interest inequity holders. Furthermore, it goes beyond whether the mission of the company is to build something new or just collect pay checks.

Although, there is not a consensus between all investors, a great number would agree that once a specific business target has been reached, a salary is a common thing to take, and should be ample enough to cover necessary expenses and live humbly. As we know this amount will increase as the business develops.

Co-Founder Expectations

It is advised that the discussion of present salary pre- suppositions, conditions and financial position, happens early in the developing stages of the business. This will decrease the issues that may arise if the business is already moving forward.

During these conversations, be honest and open with your co-founders, in regard to your expectations and life situation. It is practically guaranteed that you will all have contrasting ideas about what you would expect as a salary.

Certain individuals who are more seasoned in the entrepreneurial life will be responsible for alleviating apprehension of those who are newer to the scene.

In all conversations, take stock and review it, and discuss again. If you can survive the heavy internal discussions with your co-founders, then you will be prepared when meeting potential investors.

Below we outline the three most common disputes between co-founders:

1. If they desire more money and refuse to take no for an answer – Maybe there are basic issues with the company, and possibly they are not the appropriate co-founder. If they actually refuse to take any less than what they are accustomed to or their demand is unrealistic, then it’s highly credible the start-up life is not suitable for them.
2. Whilst they may believe they warrant more money than you or would prefer a dissimilar compensation scheme – You need to assess the possibility of a non-equity split. Whereby one individual takes more equity and the other takes a higher salary.
3. When they are not earning a salary and think that you should not either – Then this is on you to create the argument for why you believe you need a salary and decide whether at this stage in the business they are right.

Life Situation

The final aspect is you. With regards to people’s needs and individual financial requirements, there is a large variation.

The two most important factors are traditionally location and family. For instance, if you reside in London you are going to be paying a significant amount for accommodation.

If you have a family, your situation may vary more, and the salary needed to stay afloat is higher.

Therefore, in order to assess how much you need to live on you will need to do two things:

1. Firstly, you need to determine what your average spend is per month for at least 6 months.
2. Then you will need to average out yearly, that monthly requirement.

This can be done by using a reverse calculator. If this number looks slightly higher than expected, you will need to assess your fixed and variable costs to decide what the essentials are, then make reductions where necessary.

It is easier said than done when discussing cutting back on personal expenditure. Nevertheless, the key thing to think of, is that a great deal of savings can be made by cutting costs, not removing them. Reducing down expenditure, opposed to removing makes it simpler to adapt and does not feel like such a loss.

Summary

To summarise, here are 6 steps to get an estimated figure on what you should pay yourself as a start-up founder.

1. Produce a cash flow for the company as well as forecasting for future raises and revenue.
2. Analyse the cash flow to decide expenses and burn rate. If there is not enough cash, you will need to raise some or decide not to take a salary.
3. To establish how much to pay yourself, have a good look at your personal expenses (fixed & variable). Discover a balance between just enough to survive and being comfortable.
4. Decide a figure to a salary, not dismissing employer’s national insurance and decide if any tax regulations can be applied (R&D credits).
5. If your business valuation is less than £2,000,000 then the average salary you will be looking to work around is £25,000 per annum. Try to take what you need only. If your business has just raised seed funding, this amount may be less due to there not being enough liquidity in the business.
6. As the business valuation and raises continue forward, you can increase salary with respect to the present valuation and state of the cash flow in the company.

If you would like some advice on preparing your start-up for funding, get in touch with us today.

Our experienced team can help with everything from business development planning to marketing, all the way to financial modelling and funding applications.

We have a large bank of equity investors we work with and have been able to help streamline and revive many failing start-ups.

Call us on 0203 150 0565 or info@thealtitudeagency.com.