Op-Pieces, Startups, Ventures

Find out what you get to earn as a founder with this start-up math

We all know the fair value of a good Developer, Designer or Accountant, but what’s the going rate of a Founder? In Nigeria, founders’ remuneration has always been that little detail that’s not exciting to discuss, but one that always rears its head to cripple negotiations with investors or to shatter the willpower of entrepreneurs. In my limited experience, founders’ salary is always a big bill in the financial model that’s left to judgement, and one that investors love to highlight to achieve some power-distance. I frequently hear entrepreneurs in the course of preparing their financials say: “Yeah, $30,000 per annum is fair”, only to approach investors who always believe, rather condescendingly, that any figure is too high. This quickly degenerates into a personal debate about the founders’ personal-worth, rather than one about their earning power or value to the company. Many investors have based their investment decisions on the negative signalling they perceive from the Founders’ salary determination, and very little more.

 

The Why and When

I’m not from the school of thought that founders should be ascetics, or that deprivation should be the new entrepreneurs’ signature lifestyle. As executives of a business committing time and talent, they need to be compensated at some point with a salary, or with an equity premium if they decide to sacrifice that for the good of the company. Deprivation does not signal good leadership, and it should not be confused with austerity—a quality that entrepreneurs must apply to both life and business. However, it’s only appropriate to take from the business either when the company has closed external capital sufficient to give it at least 12 months of runway, or when the business can afford it on its own. It’s counter-intuitive to take a salary at the pre-seed to seed stage of the company when it needs all the cash it can get.

 

The S-Formula

So, what’s the figure? How much should Founders pay themselves? If only there could be a formula or system, some community-agreed “S-Formula” that entrepreneurs can apply to the determination of their salaries without inviting scoffs and backroom condemnation from investors and fellow entrepreneurs…. As a self-proclaimed Numbers guy, and with some help from the angels at Push and Start, I hope come to up with one, or at least initiate the conversation towards arriving at the almighty S-Formula.

 
Let’s get to the shaky maths.

If previous Earnings (E) > 0, Founder’s Salary (F) = Previous Earnings (E) * Sacrifice Coefficient (S) * Capital Multiple (M)

These are the few variables we must consider, and only one is left to personal judgement, such that a third-party must be able to determine the fair salary for easy juxtaposition with the Founders’ proposition.

Previous earnings (E): If E > 0, it’s reasonable to determine one’s salary in the context of his previous earnings. An entrepreneur earning $18,000 annually before venturing out should reasonably not expect to take out $120,000 annually. His salary should therefore hover comfortably close to the most recent earnings, at least initially. IF E = 0, then an entry-level base must be determined for different levels of capital (Table C).

The final salary’s degree of variation from “E” should be determined by some coefficient. Let’s call that the “Sacrifice coefficient”.

Sacrifice coefficient (S): This is the only figure that’s left to judgement. It simply calculates the degree to which the Founder decides to deviate from his current standard of living. This number ranges from 0-1, with 0 being the extreme case where the founder decides to sacrifice his entire earning power, and with 1 being the scenario where the founder believes he must at least maintain his current standard of living. A figure above 1 does indeed throw a negative signal when capital is low. The table below suggests ideal ‘S’ at different levels of investment capital (C).

tableA

 
Given the above table, a Founder will be expected to receive the salary below (without the Capital Multiple (M) :

tableB

 
NOTE: Select the higher figure where the result in a Range “E” is lower than the result in range “E-1”.

Capital Multiple (M): This is important. A Founder that has successfully raised $10m for a company valued at $50m should be expected to earn more than he would have if he’d raised $250k for a company valued at $1m. In the earlier scenario, he’s running a much bigger company, the scope and implication of his work is much more profound, the market rate for CEOs of $50m companies is easier to estimate, and he needs to be compensated enough to support a lifestyle and the market demands on one running a $50m company. While that is partly captured in the Sacrifice Coefficient, the resulting figure still converges too closely to the previous earnings figure. It’s a little difficult to determine a reasonable multiplier here, and this one is particularly in need of the community’s affirmation.

For Founders with no previous earnings or significant experience to benchmark against, a flat annual entry level rate is suggested in Table C below. Also, as shown, there should be a cap to the number of founders to minimise the financial constraint on the business.

tableC

 
For Founders with some level of experience and a history of earnings, a multiplier (M) is required to at least bring them on par with the base shown in Table C, and to reflect the size of the business as measured by the capital raised/valuation.

tableD

 
In summary, If: Previous Earnings (E) =$20,000, and capital raised = $300,000

Founder’s Salary (F) = E * S * M = $20,000 *1 * 1.3 = $26,000, or something close based on adjustments to “S”.

tableE

 
A reference guide like this, when fully sophisticated and if broadly accepted, makes it possible to systematically justify founders’ salaries without an assault on personal worth and the eventual loss of faith by the investor in the entire business concept. The only variable open for debate is the “S”: To what degree are you willing to sacrifice financially for the business. The founders can answer this in as many ways as possible to their advantage, and even turn around to demand a better upside equity-wise for themselves.

 
[Photo Credit: Pink Sherbet Photography via Compfight cc]

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Numbers guy and accidental entrepreneur. Founder, Numbers.com.ng

3 Comments

  1. 'laolu, I enjoyed reading your thoughts. Very well considered. I like the concept of the sacrifice coefficient, S, and using a capital multiple, M, to finesse the outcome in order to diminish the opportunity cost of startup life.

    It does seem like there are some subjective measures though. My main grouse is with the capital multiple. I don't think it portrays a credible reality in some cases, primarily for newbie founders. In fact, for anyone managing a plus $5m sized startup.

    To further understand your theory, could you clear something which has been niggling at me? Is the startup founder the highest paid individual at the startup? Also, what happens to an early-stage team of 3 co-founders who have only raised sub-$250k to date? What do they earn?

    By the way, great plug for PushandStart, you rock!

    1. Hi, The Taichou! Yes, this assumes that the founders are the highest paid employees. If they are so lacking in a critical area of expertise that they need to recruit an expensive talent to fill, then they should personally sacrifice deeper. Overall, I don't think salaries should represent more than 30% of the entire cash base.

      Using that logic, where there are 3 founders with little to no work experience or earnings history, who have raised, say, $200k, they should earn a maximum of about $12k each (Table C), leaving about 24k for other employees (likely 2-4 other people initially). If they need to pay someone else more than $12k, they need to sacrifice personally because it signifies that they're collectively deficient in an area that's so critical to the business at an early stage.

      Cheers!

  2. Wow. This is some priceless bit of information for startup founders. Know the math. Don't focus on it or get too carried away. but know it and let it push you towards growth/scaling.

    Thanks for sharing mate.

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