A startup’s Series A financing shouldn’t be a large liquidity event or salary payday for the startup’s founders. While a startup typically receives millions of dollars in a Series A, if too much of that $$$ flows guaranteed to the founders, various incentives get out of whack.
Not all startup founders understand this tenet.
Earlier this year, this issue presented itself when a client was the lead investor in a Series A round of about $2MM at a $4MM pre-money. The term sheet was pretty much a done deal, when the startup’s CEO demanded a salary of $25,000. Per month.
My client countered with a reasonable startup CEO salary, but the startup’s CEO didn’t back down from his $300,000/year figure. You can guess what happened to the deal.
In addition, here’s an example of how a startup CEO’s huge salary didn’t help his startup: CEO’s $500,000 Salary Burns Startup Into Fire Sale.
The Importance of Startup CEO Salary
The startup community focuses most of the term sheet discussion on liquidation preferences and anti-dilution, but startup CEO salary is nonetheless an important issue. According to Peter Theil, Startup CEO salary is a predictor of a startup’s success:
“The lower the CEO salary, the more likely it is to succeed.
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 aligns his 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.
In practice we have found that if you only ask one question, ask that.”
If a startup CEO’s post-Series A salary is too high, he or she may not have a true sense of urgency to implement and/or create shareholder wealth.
This doesn’t mean a startup CEO must continue to make Costco runs for ramen noodles. But if the startup’s CEO gets a huge salary, the startup CEO could likely view his or her equity stake as “house money” (i.e., even if the startup fails, the CEO won’t feel too bad because he still received got a hefty salary).
Furthermore, a demand for a high startup salary can signal that you don’t believe all those things in your investor pitch.