Forgive me, but this post will likely be a bit of a rant.
I had a call with a founder I’m advising this morning. He is out 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 be taking a salary. The investor argued that the founders were “working for equity,” and that his investment shouldn’t go to the founding team.
That, ladies and gentlemen, is absolute hogwash. Now, if this were an isolated incident, I might write it off as a clueless investor. As the fundraising climate is shifting, however, I’m hearing more investors suggesting things like “to extend your runway, you should raise from us, but not pay yourself.”
That’s literally why you are raising money
The entire point of raising money is to go faster and to reduce your company’s risk in stages. At the pre-seed stage, there’s a lot of risk because a lot of things are unknown: Will the product work? Can you find customers? Will they pay for the product? And so on.
However, there’s another risk to the company: At an early-stage startup, founders can’t afford to lose focus. I should have a big red button on my desk that makes a Voice of God shout “FOCUS!” at the startup founders I advise. This is the No. 1 challenge for most startups.
It makes sense: Opportunities are everywhere and entrepreneurial folks are, well, entrepreneurial. It makes sense that they’d be tempted to keep their options as open as possible for as long as possible.
But you know what is one of the biggest distractions? Not being able to afford your mortgage, rent, car payment or next shipment of Huel. As a founder, it is your duty to focus on building the startup so it is as successful as it can be as quickly as possible.
As an investor in these startups, it’s your duty to help the startup get to that point in the shortest possible amount of time. Telling founders not to take a salary is wonderfully counterproductive on so many levels.
One caveat: That doesn’t mean founders should pay themselves way above market rates. That said, it also isn’t helpful if you are an experienced developer and you’re getting calls 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 hard and there will be many not-good days. On some of those days, throwing in the towel and taking the paycheck can seem mighty tempting.
Pay yourself what you need and make it enough so you find it easy to say, “Well, I could be making more at Facebook, but I’m working on something I believe in here.” In other words: if your market rate is $250,000 per year and you can make your finances work by paying yourself $150,000, then pay yourself that much and set some milestones that will let you bump your salary closer to your market rate. If those milestones are tied to revenue or other financial goals, all the better.
Try this on for size: “I am raising $3 million right now, and once the financing closes, I will pay myself a salary of $130,000. Once we hit $300,000 ARR three months in a row, I will pay myself a $30,000 bonus and raise my salary to $150,000 per year. Once we hit $1 million ARR three months in a row, I will pay myself a $50,000 bonus and raise my salary to $250,000 per year.”
Here are four more reasons why you should tell that investor to roll up their term sheet as tight as it will go and archive it deeply into the filing cabinet that sees no sunlight.
You’re not working for equity — you are giving up equity
Investors who try to tell you that you are working for equity are being a little rude.
Yes, as a founder, you do have the benefit of vesting equity in the company. But when you founded the company, you and your co-founders, per definition, owned 100%. That ownership percentage typically goes in only one direction as your company evolves. When you raise funding, you issue more shares and dilute yourself.
Yes, that does come with benefits (money being the most obvious one), but it also has downsides: Equity is the most precious resource you have in a startup and it is what turns into money when you exit the company.
I encourage you to reframe your thinking: You’re not working for equity; you’re working your ass off to give up as little equity as you can while you build the company.
It propagates a system of privilege
I could write a 9,000-word rant about why unpaid internships are unfair, stupid and counterproductive. Pretend that you’ve just read that one (and if you don’t know what I’m talking about, read this). An investor who insists that you “work for equity” is essentially telling you that you’re taking an unpaid internship at your own company.
That is problematic for many reasons. For one, not making money is stressful in a world where money buys you frivolous extravagances like food, shelter and health insurance. But there’s another consideration: Think about who can afford to work for free. Where did that privilege come from?
Startups are already not a level playing field, because it takes a huge amount of privilege to be able to start one. But when you raise money, you reach a milestone that should see you getting paid. You don’t have to think for very long to realize that the whole startup ecosystem will be harmed if only those who can afford to work for no pay can start companies.
Startups are about shared risk
As a founder, you are taking a far greater risk than the investors who invest in startups. Why? Because you only have one shot at this; all your energy, resources and time will be poured into a single opportunity for about a decade. The investor is taking a risk too, but they have a portfolio to think about. They are spending the same amount of time and energy, but they take the money they raised from their limited partners and invest it in 20-30 companies. That’s how VC works.
Of course, if a VC firm can convince its entire portfolio of startups to not pay their founders salaries, they’ll get a huge amount of extra bang for their buck. But they are also showing that they are not on the founders’ side. These investors forget that people need money to live, and by exploiting people who are willing — and, as discussed above, able — to work for free, they are drastically lowering a startup’s chances of success. Stressed-out founders make poor decisions and build terrible foundations for companies.
Sharing the risk means investing enough into a startup so that the founders can focus on building their companies without having to worry about affording groceries.
Opportunity cost!
Finally, there’s the opportunity cost of running a startup. Of course you can just not pay yourself, but if you’re smart and driven enough to be an entrepreneur, you probably have a backpack full of skills that are extraordinarily valuable in the workforce. Building a company means that you can’t take that job at Meta, Alphabet, Amazon or your friend’s startup that just raised $30 million.
Make it worth the while by filling that opportunity cost gap as soon as you can. One easy way to do so is to ensure you get paid — enough to live modestly on, at least — while you turn your startup into the next Meta, Alphabet, Amazon or the company that just raised $30 million.