Should Founders Take a Salary?

One key decision startups have to make when establishing their business is whether founders will take a salary. Founders usually struggle to decide between reinvesting in their startup and their personal financial needs, which can often influence this decision. However, founders usually still have to meet certain financial obligations and basic living expenses, so however complicated this decision may be, some sort of compensation is often necessary.

What's more, young startups typically aren't able to pay out any salaries — let alone a salary to a founder — until they're able to start earning significant revenue and achieve more favorable operational finances. However, industry norms also vary by location, business model and sector — so while founders taking a salary isn't common until certain milestones are hit, it's also not unheard of.

In this post, we'll discuss the importance of founder compensation, the various options that startups have at their disposal to pay a founder and other considerations that should come with deciding whether to pay a founder's salary.

The Importance of Founder Compensation

Founders need to strike the right balance between their personal financial situation and the potential implications on their startup when it comes to deciding whether to take a salary.

There are several reasons why it makes sense to take a salary if you're a founder. For starters, taking a salary can set a positive precedent for future employees and investors. It can support personal stability and serve as a motivating factor for founders and all of a startup's employees, preventing burnout and improving focus. Compensation can also help attract future talent.

There's also a matter of professionalism tied to this. Paying a founder's salary helps establish your startup as a professional entity, which can be an attractive factor for future employees and potential investors.

Factors that Influence a Founder's Salary

So what factors should founders consider before deciding whether to take a salary? Also, should they take a salary, what should they set their salary at? There are several factors to weigh to answer both of these questions:

• Determine the stage that the startup is in: If you're taking a salary in the very early days of your startup, chances are it's going to be low. However, there's the potential for that salary to grow as your startup does, notably as it progresses with pre-seed and Series A funding. Most founders don't take salaries until their startup begins to earn some sort of revenue as it grows.
• Consider your location: If your startup is in a high-cost city, the salaries that it pays are going to have to reflect this — whether it's a founder's salary or other employees' salaries. The cost of living in the area your startup is operating in should influence what you're paying.
• Consider the status of your startup's funding: The initial salary may be low, but it's likely to increase as your startup secures investments and hits certain revenue goals.

Common Methods of Paying a Founder's Salary

If it's determined that a founder should receive a salary, know that there are options for how it's paid out. Here's a look at the common methods of paying a founder's salary and the advantages and disadvantages of each:

Salary Payment

A salary payment provides regular cash flow to a founder and can also be considered an advantage during funding stages to show stability to potential investors. By being paid a salary payment, founders can take care of their personal finances and also potentially put money back into the startup. 

Salary payments also make it easier for tax preparation purposes, as taxes are automatically deducted from the salary. Depending on the type of startup, the founder's salary may even be tax deductible for the entire business.

Dividends

Dividends allow startups to share profits with shareholders. In some cases, this may be the option used to compensate founders, which can demonstrate reliable and stable operation. Dividends can be paid out as additional shares or as stock dividends. There are some significant tax benefits to dividends, but how beneficial this is largely depends on business profitability. Paying out dividends is also flexible and can be based on your startup’s profits and cash flow. 

There are some key disadvantages of dividends, however. For starters, this structure may not suit all business structures or startups, especially in the early stages. Additionally, startups need to prioritize stable returns for this strategy to be effective.

Equity Compensation

Another option is to allow startup founders to get paid in equity stakes. Instead of a salary, this works by giving founders a partial stake in the startup. Also known as stock-based compensation, this strategy conserves cash for business growth and aligns founder incentives with company success. It can also yield significant financial rewards during liquidity events and comes with a vesting schedule to help maintain a long-term commitment. 

For a startup, equity compensation helps improve cash flow, attract top talent and allows for a sense of ownership. However, this isn't always the most stable strategy and it may also come with certain tax liabilities.

Owner's Draw

Fitting to the name, an owner's draw is when a founder withdraws money from the startup for their own personal use. Owner's draws are not typically fixed amounts and can occur whenever necessary. This is an ideal strategy for smaller startups with simple financial structures. It's also a flexible compensation strategy, allowing founders to pay themselves more when things are going well and less when things aren't going well. 

One downside of this strategy is that it requires careful financial management so owners can responsibly separate personal funds from business funds.

Reinvesting Profits Instead of Taking a Salary

Rather than take a salary, one strategy that founders can use to grow the startup is reinvesting profits to help accelerate business growth. Reinvesting can help boost research and development and hiring. It can also help demonstrate founder commitment to the startup. There are some risks associated with this strategy, however. Arguably the biggest disadvantage is that founders often don't balance their own financial needs when they opt to reinvest instead of taking a salary.

Industry and Investor Expectations for Founder Series

Whether a founder takes a salary can also have an impact on industry and investor expectations. For instance, investors expect founders to take modest salaries to align founder interests with growth. How modest? Usually, it's around $50,000 pre-seed funding, $100,000 at seed funding and $150,000 at Series A funding. This average startup founder's salary amount may vary based on many factors, including the location of the startup and cost of living in that particular area.

Higher salaries can often serve as a red flag for investors. However, this largely depends on the industry in which your startup is operating and how far along it is in its journey.

Legal and Financial Considerations for Founder Salaries

Founder salaries still must comply with legal and financial requirements, an important consideration to keep in mind when setting these amounts or determining what method of compensation the founder will receive.

For instance, different entity structures have varying tax obligations — and they must be adhered to. What's more is that personal and business finances must be separated to maintain professionalism and liability protection. If you need help optimizing the founder's salary for tax benefits and compliance, make sure to work with a trusted financial advisor.

How to Determine a Fair Salary for Founders

There are various factors that you'll need to weigh when determining a fair salary for founders beyond just the status of your startup. You'll need to consider living expenses and any family obligations, and weigh them against your startup's cash flow.

It's also important to take a look at the business landscape and market around you to determine what the salary should be and ensure it's competitive and fair — even when it comes to a startup.

Finally, as startups grow and earn more revenue, it's only fitting that salaries will also grow. Compensation should be adjusted accordingly as certain milestones are met and the startup's revenue and profile increase.

Balancing Personal Needs and Business Growth

Founder salaries are not static. They should grow as a startup evolves. What's important, however, is striking that balance between sustainable growth and personal well-being. Thoughtful compensation helps build trust with investors and employees.

Well-structured CoAs help with financial tracking, decision-making, expense management, budgeting and forecasting, and tax compliance. All in all, they can help streamline internal processes and minimize the risk of error. For more information on the importance of CoAs and how they can help your eComm startup, contact Graphite Financial or explore our accounting services for startups.

Learn More About Startup Finances with Graphite

For more information on founder salaries and founder salary options, and to learn more about startup finances, contact Graphite Financial today. As a trusted financial partner from seed funding to exit, our financial expertise knows no bounds. We understand the needs and nuances of growing startups and many of the decisions that must be made along the way, including important decisions regarding payment and salaries. For more information and to schedule a free consultation to better understand your startup's finances, contact Graphite today.

Visit our website to access a variety of accounting tools, templates and resources to help manage the accounting in your startup or contact us today to schedule a free consultation. As an experienced accounting services provider, we specialize in the likes of startup accounting services, financial modeling and CFO services, and tax and compliance management. 

Contact us today to learn more about how we can help optimize your eCommerce accounting with a chart of accounts or by implementing other strategies.

FAQs

When should a startup founder start paying themselves a salary?

A startup founder should begin paying themselves a salary when the dynamics can afford it. Often, this is after they raise capital or after they reach a certain revenue milestone. Other factors to weigh on when to claim a salary include any potential implications on the startup that the decision could have.

How much do startup founders typically pay themselves?

Common salary amounts founders receive after raising capital are usually $50,000 pre-seed funding, $100,000 at seed funding and $150,000 at Series A funding. However, these typical benchmarks can vary based on several factors, including the status of the startup and the area in which the startup is operating.

Can founders take both a salary and dividends?

Yes, founders may take a salary and dividends. However, it isn't very common for early-stage startups. Typically, if a founder takes a form of payment, it will either be one or the other. As the startup grows, this may become a more viable option as a means of properly compensating the founder.

How do investors influence founder salaries?

Investors are committed to protecting their assets in a startup, so while many agree that founders should receive a salary, they work to help ensure that it's done responsibly so that the startup can adequately focus on growth simultaneously. While investors may influence founder salaries, founder salaries can also have an impact on potential future investors.

What are the tax implications of founder salaries?

Tax implications of founder salaries largely depend on the type of salary that a founder is receiving. For example, if they take a conventional salary, they'll have to pay income taxes on earnings. Stock is also taxed as ordinary income. Before you pay your startup founder a salary, make sure you're well aware of the tax implications and how it could impact your business. Some have positive tax implications, while others have negative tax implications for the startup. Consider working with a qualified financial advisor if you need assistance to find a solution that's beneficial for all parties.

Is it better to take equity or a salary as a startup founder?

While this largely depends on your startup, it's believed that it's better to take equity in the early days of the startup. That's largely because incentives are aligned with company success, and equity also allows startups to reinvest back in their startup to help facilitate growth. A salary is intended for founders to cover their personal expenses and have personal financial stability in the early days of a startup.