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On the investment side, seeing early founders pay themselves similarly to their employees or slightly less was usually a good sign that the founder was truly in

On the investment side, seeing early founders pay themselves similarly to their employees or slightly less was usually a good sign that the founder was truly in it for the long term. You don’t really want founders scraping by on ramen noodles and becoming financially desperate. Seeing founders pay themselves exorbitantly was not a great sign, though. If someone is truly building a company into something they believe to be very valuable, the salary shouldn’t matter very much beyond helping them not worry about bills while they grow the company. That’s all kind of obvious and well known. What I didn’t know was how the unscrupulous founders also know this very well and instead come up with creative ways to pay themselves outside of salary numbers. One founder liked to pay himself $100,000 consulting fees after fundraises to “reimburse” his work done before the raise at what he believed to be “below market rate”. It’s the kind of thing that won’t show up on cursory due diligence, but will poison later rounds when investors dig into finances and realize the CEO or other cofounders have been quietly extracting extra money for themselves. In one case it damaged a startup I was fond of enough that it cost the CEO potentially millions in equity in a later acquisition that failed.

ed25519FUUU 5y ago
> On the investment side, seeing early founders pay themselves similarly to their employees or slightly less was usually a good sign that the founder was truly in it for the long term. I don’t know. Just seems like accounting to me. They take a small salary but own 80% of the company you’re helping build for the same salary but 0.03% ownership.
- PragmaticPulp 5y ago
  Outside of cofounders and founding employees (who, by definition, joined before the company was funded and worth more), the total employee option pool might be around 5% of the company in an early startup. Note that it will grow in later rounds, but dilution will reduce the share of early employees in those rounds. If you hire 100 employees and split that 5% equally then you get 0.05% per employee. What else would you propose? If you tried to give everyone something like 0.5% then the first 100 employees would have to own 50% of the company. Doesn’t really work. The earliest employees who join when company size is less than 10 people or so, as well as key early hires like valuable VPs will end up with higher equity, but once a company reaches a point of paying market rate compensation then a 0.05% equity stake isn't really unfair.
  - runako 5y ago
    It would appear there are two main avenues: - Don't split equity evenly across the first 100 employees. A non-cofounding VP Engineering should probably get a bigger stake than a non-founding customer support rep. - Increase the employee option pool.
- ska 5y ago
  It's not just accounting, it speaks directly to the incentives of the founders & execs and their commitment to the long term success and growth of the company.
wpietri 5y ago
Agreed. As an occasional starter of things, if I really believe in my company, then all things considered, I'd rather have a surplus dollar in the company, as that's where I think my highest long-term ROI is. Early on, founders taking lots of cash out would be a negative sign for me. The $100k because-I-can fee strikes me as repulsively WeWork-esque. On the other hand, I've been reading lately about the vast acceleration in the pace of investor money since last I did a venture-backed startup. [1] To me this looks somewhat like the diet of a pâté goose: more to the benefit of the feeders than the goose itself. If my investors are in it for a quick flip, I would have to question how much I should be long-term focused. [1] Scroll down to "fast is in fashion" here: https://pivotal.substack.com/p/minsky-moments-in-venture-capital https://pivotal.substack.com/p/minsky-moments-in-venture-cap...
- PragmaticPulp 5y ago
  The "proper" way to take money off the table is for the founders to sell some of their own equity in a secondary sale. This way it's all above board, done in plain view of the investors (who might buy the equity themselves), and most importantly isn't extracting cash out of the startup. Investors invest in companies to give them runway and for hiring. If the founder is extracting that money back out of the company to line their own pockets (beyond a reasonable salary) then it doesn't help the company at all. Founders should be selling their equity, not withdrawing from the company's bank accounts.
  - tomrod 5y ago
    Reasonability of salary is my approach. For S-Corps, median of market passes the sniff test IMO.
  - wpietri 5y ago
    Oh, sure. I don't disagree. That's how I'd do it. But my point is that even when I last took venture money, more than a decade ago, I had some questions about how much the goal of investors was to "help the company". With the way funding trends have changed, that's an even bigger question. Which would then force me to ask: how much sense does it make for me to be more invested in the long-term future of the company than the investors are? Personally, my behavior wouldn't change. But the more investors are in it for their short-term interests, the more they should expect to attract founders who feel the same way.
CPLX 5y ago
Someone refused to acquire a company for (presumably) tens of millions of dollars because a founder took a below market salary and then made up for it after a funding round with a 100k payment? How did discovering this affect the acquirer's investment thesis? Presumably they felt like the company's growth potential and revenue was sufficient to invest many millions to own it, but then this changed their evaluation? Not that I think it's best practices for a founder to do this with investor money, but it sounds like a just-so story. I'm guessing there was more to it than this. It seems like VC's always have a perfect anecdotal narrative of why it's in everyone's best interest to do things that make the VC firm more money.
- anamax 5y ago
  > Someone refused to acquire a company for (presumably) tens of millions of dollars because a founder took a below market salary and then made up for it after a funding round with a 100k payment? Yes. It goes to the CEO's honesty and character. When you find something like this in due diligence, you start wondering what you haven't found. This is somewhat similar to https://www.insider.com/van-halen-brown-m-ms-contract-2016-9 https://www.insider.com/van-halen-brown-m-ms-contract-2016-9
- PragmaticPulp 5y ago
  More or less, yes. Although it wasn't a single $100K payment. It was a pattern of bragging about "taking a $1 salary in the early days" while doing essentially the opposite on the books. When investing you can't due diligence everything. When you find a couple instances of the CEO telling you one thing but then doing something else and using accounting tricks hide it, it raises red flags. It's rarely ever just a single lapse of judgment like that.
  - ska 5y ago
    Agree this would (and should) raise eyebrows. If enough of a pattern it probably makes sense to spike the deal. At very least, it's going to change your risk profile.
  - CPLX 5y ago
vmception 5y ago
My experience is that founders can have it all as long as they can articulate what the exit strategy is. But I dismiss anyone in it for the long term anyway, so I'm actually screening against that and instead of trying to figure out how they're lying about being in their new corporate forever home. Don't get married to positions. Different strategy.
6gvONxR4sf7o 5y ago
> If someone is truly building a company into something they believe to be very valuable, the salary shouldn’t matter very much beyond helping them not worry about bills while they grow the company. I don’t get that. If someone is truly sitting on a lottery ticket they believe to be valuable, salary still matters very much, because there’s significant irreducible risk that it doesn’t pay out. From a strictly financial perspective, it’s the same reason people don’t go all in on one company in the stock market, but rather diversify their portfolios: People maximize risk adjusted values rather than just expected values.
- xwdv 5y ago
  People diversify portfolios out of ignorance, not prudence. If you don’t have any special knowledge that lets you favor one company over another, then you might as well pick a bunch of them. But if you know one company is a good bet for specific reasons, it makes sense to lean your portfolio heavily on it. That is how you get so rich.
  - isbvhodnvemrwvn 5y ago
    Or homeless.
    - xwdv 5y ago
      You can’t truly become rich without risking becoming homeless.
      - rfrey 5y ago
        Do you think Bill Gates or Jeff Bezos were ever at risk of becoming homeless?
  - Thrymr 5y ago
    That is still doubling down on risk, so diversifying is indeed prudence. Even a good bet is not a sure bet, particularly if it has a chance of high payoff.

ed25519FUUU 5y ago

> On the investment side, seeing early founders pay themselves similarly to their employees or slightly less was usually a good sign that the founder was truly in it for the long term. I don’t know. Just seems like accounting to me. They take a small salary but own 80% of the company you’re helping build for the same salary but 0.03% ownership.

PragmaticPulp 5y ago
Outside of cofounders and founding employees (who, by definition, joined before the company was funded and worth more), the total employee option pool might be around 5% of the company in an early startup. Note that it will grow in later rounds, but dilution will reduce the share of early employees in those rounds. If you hire 100 employees and split that 5% equally then you get 0.05% per employee. What else would you propose? If you tried to give everyone something like 0.5% then the first 100 employees would have to own 50% of the company. Doesn’t really work. The earliest employees who join when company size is less than 10 people or so, as well as key early hires like valuable VPs will end up with higher equity, but once a company reaches a point of paying market rate compensation then a 0.05% equity stake isn't really unfair.
- runako 5y ago
  It would appear there are two main avenues: - Don't split equity evenly across the first 100 employees. A non-cofounding VP Engineering should probably get a bigger stake than a non-founding customer support rep. - Increase the employee option pool.
ska 5y ago
It's not just accounting, it speaks directly to the incentives of the founders & execs and their commitment to the long term success and growth of the company.

wpietri 5y ago

Agreed. As an occasional starter of things, if I really believe in my company, then all things considered, I'd rather have a surplus dollar in the company, as that's where I think my highest long-term ROI is. Early on, founders taking lots of cash out would be a negative sign for me. The $100k because-I-can fee strikes me as repulsively WeWork-esque. On the other hand, I've been reading lately about the vast acceleration in the pace of investor money since last I did a venture-backed startup. [1] To me this looks somewhat like the diet of a pâté goose: more to the benefit of the feeders than the goose itself. If my investors are in it for a quick flip, I would have to question how much I should be long-term focused. [1] Scroll down to "fast is in fashion" here: https://pivotal.substack.com/p/minsky-moments-in-venture-capital https://pivotal.substack.com/p/minsky-moments-in-venture-cap...

PragmaticPulp 5y ago
The "proper" way to take money off the table is for the founders to sell some of their own equity in a secondary sale. This way it's all above board, done in plain view of the investors (who might buy the equity themselves), and most importantly isn't extracting cash out of the startup. Investors invest in companies to give them runway and for hiring. If the founder is extracting that money back out of the company to line their own pockets (beyond a reasonable salary) then it doesn't help the company at all. Founders should be selling their equity, not withdrawing from the company's bank accounts.
- tomrod 5y ago
  Reasonability of salary is my approach. For S-Corps, median of market passes the sniff test IMO.
- wpietri 5y ago
  Oh, sure. I don't disagree. That's how I'd do it. But my point is that even when I last took venture money, more than a decade ago, I had some questions about how much the goal of investors was to "help the company". With the way funding trends have changed, that's an even bigger question. Which would then force me to ask: how much sense does it make for me to be more invested in the long-term future of the company than the investors are? Personally, my behavior wouldn't change. But the more investors are in it for their short-term interests, the more they should expect to attract founders who feel the same way.

CPLX 5y ago

Someone refused to acquire a company for (presumably) tens of millions of dollars because a founder took a below market salary and then made up for it after a funding round with a 100k payment? How did discovering this affect the acquirer's investment thesis? Presumably they felt like the company's growth potential and revenue was sufficient to invest many millions to own it, but then this changed their evaluation? Not that I think it's best practices for a founder to do this with investor money, but it sounds like a just-so story. I'm guessing there was more to it than this. It seems like VC's always have a perfect anecdotal narrative of why it's in everyone's best interest to do things that make the VC firm more money.

anamax 5y ago
> Someone refused to acquire a company for (presumably) tens of millions of dollars because a founder took a below market salary and then made up for it after a funding round with a 100k payment? Yes. It goes to the CEO's honesty and character. When you find something like this in due diligence, you start wondering what you haven't found. This is somewhat similar to https://www.insider.com/van-halen-brown-m-ms-contract-2016-9 https://www.insider.com/van-halen-brown-m-ms-contract-2016-9
PragmaticPulp 5y ago
More or less, yes. Although it wasn't a single $100K payment. It was a pattern of bragging about "taking a $1 salary in the early days" while doing essentially the opposite on the books. When investing you can't due diligence everything. When you find a couple instances of the CEO telling you one thing but then doing something else and using accounting tricks hide it, it raises red flags. It's rarely ever just a single lapse of judgment like that.
- ska 5y ago
  Agree this would (and should) raise eyebrows. If enough of a pattern it probably makes sense to spike the deal. At very least, it's going to change your risk profile.
- CPLX 5y ago

vmception 5y ago

My experience is that founders can have it all as long as they can articulate what the exit strategy is. But I dismiss anyone in it for the long term anyway, so I'm actually screening against that and instead of trying to figure out how they're lying about being in their new corporate forever home. Don't get married to positions. Different strategy.

6gvONxR4sf7o 5y ago

> If someone is truly building a company into something they believe to be very valuable, the salary shouldn’t matter very much beyond helping them not worry about bills while they grow the company. I don’t get that. If someone is truly sitting on a lottery ticket they believe to be valuable, salary still matters very much, because there’s significant irreducible risk that it doesn’t pay out. From a strictly financial perspective, it’s the same reason people don’t go all in on one company in the stock market, but rather diversify their portfolios: People maximize risk adjusted values rather than just expected values.

xwdv 5y ago
People diversify portfolios out of ignorance, not prudence. If you don’t have any special knowledge that lets you favor one company over another, then you might as well pick a bunch of them. But if you know one company is a good bet for specific reasons, it makes sense to lean your portfolio heavily on it. That is how you get so rich.
- isbvhodnvemrwvn 5y ago
  Or homeless.
  - xwdv 5y ago
    You can’t truly become rich without risking becoming homeless.
    - rfrey 5y ago
      Do you think Bill Gates or Jeff Bezos were ever at risk of becoming homeless?
- Thrymr 5y ago
  That is still doubling down on risk, so diversifying is indeed prudence. Even a good bet is not a sure bet, particularly if it has a chance of high payoff.