Forgive me, but this post will probably be a bit of a tirade.
I had a call this morning with a founder I recommend. He’s there raising money and he received a term sheet from an investor (yay!), but the investor suggested that the founder and his co-founder shouldn’t take a salary. The investor argued that the founders were “working for equity” and that his investment should not go to the founding team.
That, ladies and gentlemen, is absolute nonsense. If this was an isolated incident I might write it off as an ignorant investor. However, with the fundraising climate changing, I’m hearing more investors suggesting things like “to extend your catwalk, you need to raise money from us, but not pay yourself.”
That’s literally why you’re raising money
The whole point of raising money is to move faster and reduce your company’s risk incrementally. In the pre-seed phase there is a lot of risk because many things are unknown: Will the product work? Can you find customers? Will they pay for the product? And so forth.
However, there’s another risk for the company: In the early stages of startup, founders can’t afford to lose focus. I should have a big red button on my desk that shouts a voice from God “FOCUS!” I advise the startup founders. This is the biggest challenge for most startups.
It makes sense: Opportunities are everywhere and enterprising people are, well, enterprising. It makes sense that they would be tempted to keep their options as open as possible for as long as possible.
But you know what one of the biggest distractions is? Not being able to pay your mortgage, rent, car payment or next shipment of Huel. As a founder, it is your duty to focus on building the startup so that it is as successful as possible as soon as possible.
As an investor in these startups, yes your duty to help the startup reach that point in the shortest possible time. Telling founders not to take a salary is wonderfully counterproductive on so many levels.
A word of warning: That doesn’t mean founders have to pay themselves way above market rates. That said, it’s also not helpful if you’re an experienced developer and you get a call from Facebook recruiters offering you a $250,000 salary. On a good day it’s easy to say no, but guess what? The life of an entrepreneur is tough and there will be many bad days. On some of those days, it can seem tempting to throw in the towel and accept the paycheck.
Pay yourself what you need and make enough of it so that it’s easy to say, “Well, I could be making more on Facebook, but I’m working on something I believe in here.” In other words, if your market rate is $250,000 a year and you can make your finances work by paying yourself $150,000, pay yourself that much and set some milestones that will help you bring your salary closer to your market rate. If those milestones are tied to revenue or other financial goals, all the better.
Try this for size: “I’m raising $3 million now, and once the funding is in place, I’ll pay myself a $130,000 salary. Once we hit $300,000 ARR three months in a row, I’ll pay myself a $30,000 bonus and raise my salary to $150,000 a year. Once we hit the $1 million ARR for three months in a row, I’ll pay myself a $50,000 bonus and increase my salary to $250,000 a year.
Here are four more reasons why you should tell that investor to roll up their term sheet as tight as possible and file it deep in the filing cabinet that doesn’t see sunlight.
You don’t work for equity – you give up equity
Investors trying to tell you that you work for equity is a bit rude.
Yes, as a founder you have the advantage of establishing shares in the company. But when you founded the company, you and your co-founders, by definition, owned 100%. That percentage of ownership usually only goes in one direction as your business evolves. When you raise financing, you issue more shares and you dilute.