Founder-CEO Compensation

Founder-CEO compensation doesn’t really matter when you are bootstrapping.

After VC funding, all of a sudden, this topic is propelled from the realms of the ordinary to the remarkable! It is so for a variety of reasons. Too high a compensation is likely to result in the overall salary burn of the leadership team going up significantly and shortening the runway for getting to the success metrics. For a startup that is still burning cash and counting upon subsequent funding, the more damaging impact of glaring CEO compensation could be the negative impression it can leave with new investors who have been brought up to believe that conservatively compensated founder-CEOs are more focused on driving towards their dream. At the same time, too low a salary can result in the founder-CEO getting distracted and despondent, which is neither good for the business nor good for the investors. The founder-CEO needs to stay awake at night worrying about the right problems. There can be nothing more harmful to a startup than the founder-CEO worrying about paying bills and dealing with the associated resentment that the VC is shortchanging her.

Let’s first see what some of the respected and articulate VCs have to say on this topic, before we proffer our views:

This is what the Foundry Group venture capitalist Seth Levine has to say:

• Companies that have raised $1M or less tend to pay their CEO between $75k and $125k, skewed to the low end of the scale.
• Companies that have raised less than $500k tend to top out at $75k for CEO comp.
• Companies that have raised between $1M and about $2.5M tend to pay their CEOs around $125k.
• Companies that have raised more than that, pay more.

Levine adds, “Investors are not looking to turn the founders into slave labor. Don't starve. There is no sense in paying yourself so little that you can't live or will be overly stressed about paying your bills. You don't need to tighten the belt so much that it ends up distracting you from your focus on building a great business.”

Venture capitalist Jason Lemkin, a partner at Storm Ventures and previous CEO co-founder of EchoSign (acquired by Adobe), dittos that, “Putting yourself in a position where you are overly stressed about making enough money to live is just going to damage the company's growth potential now.”

Back in 2008, in an interview with Techcrunch50, this is what Peter Thiel, founder CEO of PayPal, had to say: “The CEO's salary sets a cap for everyone else. If it is set at a high level, you end up burning a whole lot more money. It [a low salary] aligns interest with the equity holders. But [beyond that], it goes to whether the mission of the company is to build something new or just collect paychecks.”

When asked what the average salary for CEOs from funded startups should be, his response was, “between $100-125k”.In a class on startups at Stanford, this is what he had to say: “A categorical rule of thumb that Founders Fund has developed is that no CEO should be paid more than $150k per year. Experience has shown that there is great predictive power in a venture-backed CEO's salary: the lower it is, the better the company tends to do. Empirically, if you could reduce all your diligence to one question, you should ask how much the CEO of a prospective portfolio company draws in salary. If the answer is more than $150k, do not invest.”

The issues surrounding founder-CEO compensation are not rocket science. The problem is getting the balance right.

Conservative CEO-compensation is generally a good sign. Some even go to the extent of saying that this correlates well with the ultimate success of the startup. We have said elsewhere in this book that correlation is not causation and we believe that is the case here as well. We don’t think anyone seriously disputes the view that conservative CEO compensation is a positive sign from a VC/investor perspective, and obnoxious CEO-compensation is a red flag.

The challenges are often with the extremes. Lifestyle obsessed founders who can break the bank to pay themselves are just as bad as VCs/investors who will go to any length to stifle reasonable human aspiration in an attempt to drive up valuations. Both sides to this contentious issue need to demonstrate some empathy for the other side. As much as empathy for the other side, they need to see what is in their own long term interest. Repeating your position like a broken record, however logical it may sound, does not serve the purpose. It does not help for a VC to repeatedly draw attention to deals that were killed by distasteful CEO compensation or to data that shows up a correlation between low CEO compensation and success of the startup. Similarly, a founder needs to get the point that conservative behavior on their part will engender trust and drive long term value creation.

Therefore, it is not about the complexity of the topic as much as the challenge of getting the balance right. If both the founder CEO and the VC are reasonable and equally committed to the dream, things are never difficult. Founder CEO-compensation discussions have a strong emotional element attached to them, because they are so personal. Therefore they need to be dealt with sensitivity and empathy.

Some specific thoughts

• At the bootstrap stage, sweat equity should be the only compensation. Bootstrapping is akin to an investment phase.
• However, beyond a point, unless the investment begins to return something, either as dividends or a salary, sustenance is difficult. Every round of funding is a good time to review CEO compensation.
• The bigger the size of the round, the more the room for bumping up the compensation without putting the finances of the startup at risk. The duration for which a startup was bootstrapped, during which the founder CEO was under-compensated (and the extent to which she was under-compensated), should play a role in determining the extent to which her compensation needs to be bumped up after funding. A startup entails serious risk, and can fail at any stage. An extended period of being under-compensated can permanently jeopardise the financial security of the founder/s.
• Tying compensation to funding rounds cannot be applied uniformly across startups. Take a case of a startup that turns profitable very early in the life cycle and grows on its own steam without say a series B round. In such a case, compensation adjustments can be linked to overall revenue and profitability rather than the round of funding.
• Does the CEO compensation determine the ceiling for everyone else? Not necessarily, though as the startup reaches maturity this would undoubtedly be the case. Until Series B, we believe the CEO compensation being a tad lower or a tad higher than the compensation of the other key function heads is not unusual. The compensation of the founder-CEO should be benchmarked to the market after benchmarking the rest of the function heads to the market. The founder-CEO compensation breaks out of the CXO pack either after Series B or after the startup hits certain scale and profitability benchmarks, whichever is earlier. This of course does not mean that there are no exceptions or no finer nuances. On “total compensation” which should include cash + incremental stock grant, the broad principle of the founder-CEO compensation being ahead of the rest of the pack is valid. However, purely on cash compensation, there may be one or two direct reports of the CEO, running critical functions that suffer from perennial talent scarcity, who may make more. But these are exceptions.
• Should the CEO compensation be determined by the family situation and financial commitments? After Series B there is no case absolutely for linking the two. Series A and prior, one can argue this both ways. Our belief is that the “total compensation” should not depend upon the family situation. However, one can argue that the quantum of cash compensation can be partially tied to the family situation and this should be made up by an incremental stock grant to compensate for the cash cut. This should be discussed between the founder and VC in a non-hostile manner and win-win intent.
• Does the compensation depend upon location, and cost of living? Partially yes, but in today’s global world and equality of lifestyles, the cost of living for this segment of professionals is not very different for Beijing and Cupertino. There can be some discount though for Beijing & Bangalore. In our opinion, a 30%-50% discount is reasonable. The extent of discount depends on a host of factors. 
• At what point of time should the startup create a compensation committee? Board committees are an essential component of corporate governance that should be put in place as the startup scales. Startups where founders and investors have a past experience and understanding of the importance of these governance mechanisms put them in place earlier in the life cycle than those run by founders without this experience. We haven’t seen any consistent pattern, and frankly, do not understand the subtleties and nuances well enough to recommend a specific point in time when a compensation committee should be setup. Normally the compensation committee, as also the audit committee, is chaired by an independent director, and hence the decision to appoint an independent director/s and setting up a compensation committee go somewhat hand in hand.

Of late, founders have been able to negotiate some pre-exit liquidity by getting investors (especially new investors with deep pockets) to buy out a small part of their stake (referred to as “secondaries” in startup lingo). This is not strictly compensation, but addresses the cash needs of founders and takes off some of the stress from the founder-compensation discussion.

CEO compensation is largely an outcome of trust and value alignment between the CEO and the VCs. Both need to take balanced positions. It is not fair for a VC to overlook the hardship that the CEO has gone through during the bootstrapping phase and the basic comforts she has had to forgo. It is also not fair to conveniently quote studies that justify continued austerity and temperance. Similarly it is immature on the part of CEOs who want to flaunt their success, even before their investors and other stakeholders have become a part of this success. Benchmarking and data is helpful only if there is an underpinning of trust. If the trust is missing, benchmarking and best practices are worthless. If there is an abundance of trust, benchmarking can be redundant.

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