Forgive me but this post will probably be a bit of a rant.
I had a call with a founder that I’m mentoring this morning. He’s raising money and got a term sheet from an investor (yeah!), but the investor suggested his founder and co-founder shouldn’t be paid. The investor argued that the founders were “working for equity” and that their investment should not go to the founding team.
That, ladies and gentlemen, is utter nonsense. Now, if this was an isolated incident, you could write it off as a clueless investor. However, as the fundraising climate is changing, 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’re raising money.
The goal of raising money is to go faster and de-risk your business in stages. In the pre-seed stage, there is a lot of risk because many things are unknown: Will the product work? Can you find clients? Will they pay for the product? Etc.
However, there is another risk for the company: at an early stage, the founders cannot afford to lose focus. I should have a big red button on my desk that makes a Voice of God yell “FOCUS!” to the startup founders I advise. This is the #1 challenge for most startups.
It makes sense: opportunities are everywhere and entrepreneurial people are, well, entrepreneurial. 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 meet your mortgage, rent, car payment or next shipment of Huel. As the founder, it is your duty to focus on building the startup to be as successful as possible as quickly as possible.
As an investor in these new companies, it is his You must help the startup get to that point in the shortest possible time. Telling founders not to accept a salary is wonderfully self-defeating on so many levels.
One caveat: That doesn’t mean founders should be paid well above market rates. That said, it’s also not helpful if you’re 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 bad days. On some of those days, throwing in the towel and accepting the paycheck can seem very tempting.
Pay yourself what you need, and make enough that it’s easy for you to say, “Well, I could make more on 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 that amount and set some milestones that will allow you to get your salary closer to your market rate. If those milestones are tied to income or other financial goals, so much the better.
Try this for size: “I’m raising $3 million right now, and once the funding closes, I’ll pay myself a salary of $130,000. Once we hit $300,000 ARR three months in a row, I’ll pay myself a $30,000 bonus and increase my salary to $150,000 per year. Once we hit $1 million ARR three months in a row, I’ll pay myself a $50,000 bonus and increase my salary to $250,000 per year.”
Here are four more reasons why you should tell that investor to roll your term sheet as tightly as possible and file it deep in the filing cabinet that doesn’t see the sunlight.
You are not working for equity, you are giving up equity.
Investors who try to tell you that you are working for stocks are being a little rude.
Yes, as a founder, you have the benefit of granting shares to the company. But when you founded the company, you and your co-founders, by definition, owned 100%. That percentage of ownership generally goes in only one direction as your business evolves. When it raises funds, it issues more shares and dilutes.
