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.