Imagine you are conducting a job interview. The candidate you are interviewing seems like a perfect match for your startup. You still need to ask a final question about their salary expectations, and then the job applicant says: “I’m not here for the money. I’m really excited about the idea. I believe in its potential, and I’d love to help it achieve success for free. When the time or VC comes, I’m sure I’ll be compensated in some way.” You wouldn’t treat a person like this seriously, would you?
If you are not on the payroll at your startup, you are that person. Read more about how to pay yourself as a business owner in this article.
Why founders should be paid
Let's begin with a psychological aspect. Achieving financial stability is essential for reducing stress and anxiety, which can be detrimental not only to the individual but also to the organization. Stress can impede clear assessment of situations and hinder creative thinking and problem-solving abilities.
Unsurprisingly, salaries also serve as motivators for founders. Startups typically demand long work hours and involve high levels of stress. Income motivates individuals to go the extra mile and provides a sense of being rewarded for their achievements.
A startup founder's salary is vital for an accurate portrayal of a company's financial well-being. It not only reflects the company's profitability but also its capacity to sustain and grow. Without it, the picture remains incomplete.
How are US companies paying their founders in 2023?
Here are the key trends from the latest in-depth 2023 Founder Salary Report by Pilot.
- Median and average salary increase: compared to 2022, both median and average founder salaries have increased by 15% and 6% respectively.
- No salary trend: the incidence of founders taking no salary has risen by 30%, from 5.5% in 2022 to 7% in 2023.
- Sub-$100k salaries: 40% of startup founders pay themselves less than $100,000 annually.
- Average funding surge: the average funding amount has increased by 48% to $12 million, up from $8.1 million in 2022.
- Bootstrapping trend: the incidence of founders bootstrapping their startups has surged by 180%, from 4.5% in 2022 to 11.5% in 2023.
- Common funding range: 25% of founders have reported funding between $1 million and $3 million.
- VC-backed vs bootstrapped: 93% of founders with salaries between $100,000 and $200,000 are VC-backed, while only 4% are bootstrapped.
- Salary ranges: nearly 70% of bootstrapped founders pay themselves below $100,000 annually, whereas 54% of VC-backed founders pay between $50,000 and $150,000.
- SF Bay Area: the highest reported salary for founders was noted in the SF Bay Area – $500,000.
How much should you pay yourself as a startup founder?
You probably often ask yourself this question: How much should I pay myself from my LLC? You probably started by investing your own money in the pre-seed stage. It's understandable that you want your startup founder salary to cover both the initial financial input and your ongoing efforts.
The response, though not specific, is true: it depends on the startup's stage of development, its financial condition, and individual expenses. Follow the steps below to find the right balance between your personal needs and those of your company.
Start by calculating your business’s net income
Net income provides insight into the profitability of your startup and is crucial for understanding your company's financial health and its capacity to support your salary expectations.
Net Income = Total Revenue — Total Expenses
Managing a company, particularly a young startup, necessitates a mature approach to long-term planning and budgeting. By aligning the founder's salary with the company's net income, you can forecast expenses, investments, growth strategies, and more.
If the salary surpasses the startup's net income, it will inevitably deplete the company's resources and may lead to legal and tax complications.
Set aside 21%* for taxes (*consult your local tax lawyers)
Taxes are a legal requirement, and neglecting to allocate funds for taxes can result in financial difficulties and legal ramifications. By giving priority to tax obligations, entrepreneurs demonstrate responsible management of their companies, ensure compliance with tax regulations, and avoid penalties.
Allocating funds specifically for taxes safeguards the financial well-being of the business. This fiscal duty empowers startup founders to make more informed decisions regarding their own salaries.
In the United States, limited liability companies (LLCs) are subject to taxation on up to 21% of their income. Local tax rates may vary, so we recommend consulting with your tax lawyers for further information.
Assess your personal financial needs
The allure of potential future profits from an exit event is often the driving force behind starting a startup. However, it is crucial to have a consistent income to cover day-to-day expenses and provide peace of mind.
When assessing your financial needs, begin by identifying all fixed expenses (rent, utilities, etc.) and variable expenses (groceries, dining out, etc.). Categorize them as essential or non-essential (e.g., entertainment, vacations).
Calculate your debts, including credit card balances, loans, and mortgages. Allow for potential increases in interest rates. Next, determine the size of your emergency fund. Evaluate your savings accounts and retirement funds.
Once you have accounted for all personal financial requirements, list any monthly or annual sources of income apart from your future startup founder salary, such as rental income or investments. Just like your company, you need a solid budget.
Pick a payout method
There are various ways to receive payment, not limited to the conventional method of a salary. In the following section, we will discuss dividends, equity, and the owner's draw. The selection of payout methods should be based on the startup's financial structure, agreements, and goals, such as its growth trajectory.
Seeking advice from legal and financial professionals can assist in selecting the most suitable option and ensuring that the payout scheme complies with the law.
Focus on long-term sustainability and company growth
When deciding on the size and structure of your startup founder salary, consider the company's ability to sustain your payout scheme in the long term. Ideally, expenses should not grow geometrically in a scalable model, but this may not be the case for early-stage startups. Keep in mind that you may still need to invest in your company's growth before any potential for VC funds arises.
5 most common earning methods for business owners
Before selecting your preferred payout method, familiarize yourself with the advantages and disadvantages of the most commonly used options. Remember that the payment amount and structure are outlined in the agreement and may not be easily altered in a short period of time.
Salary
The most popular method for startup founders is a startup founder salary, as mentioned earlier. A regular salary, regardless of the company's performance, offers financial stability and personal well-being. This is beneficial for both the owner and the organization. It also serves as an important signal of commitment to investors and stakeholders.
However, a salary as a payout method for startup owners also has its drawbacks. It can strain the startup's cash flow and reduce the amount of money available for investment, potentially slowing down growth. Having a salary may shift focus away from the company's performance towards personal profits, which can affect motivation.
It is also critical to remember that an official wage is subject to payroll taxes such as Social Security and Medicare, which can cost the company extra money. In the US, the current tax rate for Social Security is 6.2% for both the employer and the employee, totaling 12.4%. The current rate for Medicare is 1.45% for both the employer and the employee, totaling 2.9%.
A startup founder salary can take different forms:
- Fixed salary: owners receive a consistent amount every month. This model provides stability and predictability for both the company and personal finances.
- Performance-based salary: remuneration is tied to key performance indicators (KPIs). The salary increases when the startup achieves milestones or targets.
- Hybrid model: the salary is fixed, but founders can earn bonuses based on the achievement of specific goals.
Dividends
If you're wondering how to pay yourself as a business owner, dividends may be a good solution. Dividends, as a payout method, refer to the distribution of profits to the company's shareholders, including its founders. This strategy allows you to maintain ownership while also partaking in the company's success.
Dividends are typically paid out periodically, usually quarterly or annually. The amount is determined based on the number of shares owned and the company's profitability.
While dividends can provide a relatively consistent source of income for founders, they may not be suitable for early-stage startups that plan to reinvest the majority of their profits to fuel growth. Owners should carefully consider the size and frequency of dividends to strike a balance between personal financial security and the company's potential for reinvestment.
If you are not the sole owner of the company, it is important to review your stakeholder agreement carefully, as dividends are often subject to various restraints and limitations. The profitability requirement means that dividends can only be distributed when a startup generates a certain level of profit. The liquidity requirement links dividends to a minimum level of cash or assets necessary to maintain operational flow. Some companies may require board approval, particularly when debt agreements or loan covenants restrict dividend payments.
A dividend is typically paid out to shareholders at a mutually agreed ratio. The calculation is determined by dividing the annual dividend per share either by the earnings per share (EPS), or by the net income dividend payout ratio on a per-share basis.
Equity
Equity is a method of compensation in which the founder receives shares or stock in the startup instead of a startup founder salary. When founders are given equity, their interests become closely aligned with the success of the business because they benefit from its growth and increasing value.
This form of compensation also incentivizes founders to remain committed to the business in the long term and work towards its profitability over an extended period.
Equity typically comes with vesting schedules, which require founders to stay with the company for a certain period to secure full ownership rights. This vesting period can last several years and is crucial for retaining talent.
If you’re partnering with other co-founders, have a look at our highly popular article on how to split equity among co-founders.
During an exit event, such as an acquisition or initial public offering (IPO), founders have the opportunity to sell their equity for a significant financial reward.
Owner’s draw
The owner's draw is a payout method for startup founders that involves regularly withdrawing funds or assets to cover personal needs. These withdrawals should not be considered as salary and, therefore, should not be included as expenses in the company's statement. Additionally, they are not subject to payroll taxes, such as Social Security and Medicare, but will be taxed as personal income.
Keeping a detailed record of owner's draws is crucial for monitoring the company's financial condition. Excessive withdrawals can negatively impact cash flow and hinder investment and growth.
Profit distribution as a salary
Profit distribution, as a form of compensation for startup founders, refers to the practice of providing them with a share of the company's profits. This model directly rewards founders based on the level of success the startup achieves, motivating them to prioritize profit and growth. This arrangement benefits both the founders and the organization as a whole.
While profit distribution gives founders a vested interest in the company's success, it does not offer the same level of stability and predictability as a fixed startup founder salary.
Concluding, how much should you pay yourself?
Determining your salary as a founder is a complex decision that involves multiple variables. It's crucial to balance personal financial needs with the startup's growth objectives and available resources.
Strategic questions to ask
- What are the short-term and long-term financial goals of your startup?
- How does your desired salary align with the startup's runway and growth projections?
- Are there any legal or investor-imposed restrictions on founder salaries?
Factors to consider
- Funding status: if your startup is VC-backed, you're more likely to draw a higher salary compared to bootstrapping.
- Company size: the number of full-time employees can be an indicator of how much you should pay yourself.
- Geographic location: cost of living varies by location; salaries in major US tech hubs like the SF Bay Area or NYC are generally higher.
General guidelines
- Early stage, bootstrapped: if you're in the early stages and bootstrapped, you might consider a lower salary, often between $1-$100,000.
- Early stage, VC-backed: salaries can range from $500,000 to $150,000, depending on the amount of funding received.
Mature, VC-backed: for more mature startups with significant funding, a salary upwards of $200,000 could be justified, especially in high-cost areas.
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