Making money is important; it’s part of the startup journey and, especially for founders, you are taking a lot of big risks by starting a company from scratch. Therefore, hopefully, not only do you get the joy of building something and changing the world, but, ideally, you will also get compensated well. So how do founders make money?
Top ways founders get compensated
Everyone has heard stories about founders making millions, and certainly some do. There are typically two ways that founders can make money.
Collect a salary
The first way founders make their money is through their paycheck. If you are interested in what that salary should be, you can check out Kruze’s salary guide for founders/CEOs. We have a salary guide for startups at seed, Series A, Series B, Series C, all of the stages a company goes through. There is also a calculator on that page that you can use to estimate reasonable pay ranges based on your industry, funding raised and a few other variables. Using the guide you will be able to see the average salary that founders get paid at each stage. We have a huge data set, so we highly recommend having a look at it.
Usually, there are two big influences on the founder’s average salary.
- The stage of the startup. For example, if you’re a seed startup founder, you’re going to be raising a lot less money. This is because you’re still building your team and you’re still trying to get proof of concept. Consequently, you will probably be paying yourself, as a founder, a little bit less than a later-stage company.
- Total capital raised. For example, when you have a couple of million dollars and that’s all you’ve got in capital, you’re typically very careful with that. But when you’ve raised $50 million or $100 million, you have a lot more money to pay salaries, including your own.
Typically, the founder or CEO's salary is approved by the board. Here at Kruze we think that one of the most critical things, when it comes to setting that salary, is that the board should always make sure founders are paid equally regardless of gender, sexuality, ethnicity, etc. Equal pay for everybody.
Furthermore, the founders should be paid a living wage. This means enough money for the founder to live without being under financial pressure, as it could lead to them making suboptimal or desperate decisions if they are desperate personally.
At Kruze we are big advocates of paying founders an adequate salary so that they’re still incentivized, but they’re also not worrying about whether or not they can pay rent or whether they can go out to dinner tonight.
Equity and ownership
The second way founders make money is through equity. If you’re a founder, you’re typically going to receive a percentage of ownership in the form of shares of the startup. This is how VCs – and most top founders – think about their compensation and want to make money.
If you look at all of the top entrepreneurs in the US, you’ll see that they made pretty close to 100% of their net worth through the equity appreciation of their businesses. Equity is how founders want to make money.
With a new company, you and your co-founders will own the whole company. Then, every time you take more funding and more money from investors, you’ll provide shares to your investors. So you’re diluted by the venture capitalists.This also happens when you issue stock option pools; you’re going to be diluted that way too.
However, you will generally buy your founder’s stock very, very early on in the stage of the company – normally right when it first gets incorporated. At that point it’s very cheap, so you lock that price in. You then have capital gains tax rates on all appreciation after that. On top of that, you will typically have to vest (check our video on founder vesting for more info) and that is typically for a four-year period just like stock options would be.
Ultimately however, if your company has a big win and a big exit, then you should do really well in your equity.
Sometimes, there are periods of time, for example the condition of the markets right now, where it’s a much tougher situation. We are seeing more down rounds or sideways rounds where the founders end up picking up a lot of dilution, so their stake is worth less. Even so, they are still going to be some of the largest shareholders in the whole company and, if the company has a nice exit, you’re going to do really, really well on your equity.
Selling secondary shares is becoming more common
On the subject of founder compensation, there is another phenomenon that has popped up over the last three or four years, which involves founders selling secondary shares to venture capitalists who couldn’t get into a given round.
Say you’re raising your Series B, the company’s really hot, and you, as a founder, still own 25% of the company. There may have been a venture capitalist who just couldn’t get into the deal. They lost. They came in second place.
More often than not you will see those VCs come back around and say, “Hey, can I buy some of your common founder shares directly from you?” They love your company; they want a position in it; and they may ask for 3%, 4%, or even 10% of the business. That means that founders can make money through secondary sales.
To be frank, we do have slightly mixed feelings when it comes to secondary shares. As a founder, you definitely want to take some money off the table if you can, but you also don’t want to get so diluted that you find that in five or six years, if something good happens to the company, it still won’t be very meaningful for you.
So, do it carefully. Take a little bit of money off the table, make your life a little bit easier in terms of secondary shares, but don’t go crazy.
If you have any other questions on founder salaries, valuations, startup investing, startup accounting, or taxes please contact us.