Founder compensation - How to decide what to pay yourself

A tricky topic that every founder hopes to face is how much to pay themselves as the company grows. There are so many complicating variables. I’ve struggled with questions like: How can I justify paying myself more when I could reinvest that back into the business? Or how much can I justify paying myself before it seems unfair to employees and customers?

There’s no right or wrong answer here, but I’ve finally settled on a system that I feel happy with, so I figured I’d share it. I’m going break this explanation into two categories: Investing back into the business, and greed.

Investing back in the business

This is probably the most fundamentally tricky thing about founder compensation. Every dollar you pay yourself is a dollar that isn’t being spent to help the business grow. Instead of paying yourself, you could buy ads, hire more employees, give discounts to customers to help close more deals, etc. If those investments would grow the business, in the long run you might be better off making the investment. But you need to start enjoying the spoils at some point, right?

First, there’s a key question:

Do you plan on exiting?

If you ask a kid how entrepreneurs make money, they’d say something like: They sell stuff to customers, and keep the money the customers pay them.

How naïve. If you ask a professional investor how entrepreneurs make money, assuming they’re being honest, they’d say something like: They grow to a point where other investors think it’s worth a lot, and then sell their shares. The money that ends up in the entrepreneur’s pocket primarily comes from investors, not customers.

Either of these can be correct, but they’re not normally both correct. From what I’ve witnessed, you need to understand how you are going to make money. Is it by running the business long-term and taking a salary + profit distributions? Or is it by “exiting” and selling your shares to someone else?

If your plan is to exit, it probably makes more sense to reinvest in the business aggressively to drive up the valuation when you sell. Most exit strategies are based on short/mid-term sacrifice for long-term riches.

But if your plan is to make money the way the kid above described, it probably doesn’t make sense to delay gratification too long. You’ll never have that massive life-changing payout, so if you aren’t paying yourself along the way, when will you get paid?

What I did

This is all arbitrary, and again, I don’t think this is the “right” approach, I just want to explain what my evolution was. It’s important to note that we’re not planning on exiting, so my goal is to make money along the way.

In the very early days, my co-founder and I distributed a bit of profit to ourselves when we could afford to, but honestly, the amounts were so small that it didn’t matter. We were both working other jobs at the time.

Our first sort of legit salary started at $60,000/year something like 3 years into the business. I’m not 100% sure how we came up with that number, but I believe it was basically the amount we needed to live somewhat comfortably. I’d call it one step above ramen profitable for a young person living in a high cost-of-living city (I was in San Francisco at the time).

We stayed at that number for several years and plowed all additional profits into hiring more employees. Eventually we hit a point where (a) the employees were making more than we were and (b) our salaries were such a small part of the overall expenses that we could afford to pay ourselves a bit more without meaningfully impacting growth.

At that point, I started giving myself a roughly $20k raise each year, plus a bit extra if there was extra profit at the end of the year (we split profit between founders and employees). As of right now, after 12 years of running LACRM, I’m making $209k/year.

I can imagine people’s opinions on both sides. On the one hand, that’s a really nice salary compared to what most people in the world make. I don’t for a second take for granted how lucky I am. On the other hand, I’m the CEO and 50% owner of a business making $3.4 million/year. I’m sure a lot of people are confused as to why I don’t pay myself more.

Greed

Depending on your ideology around money, you may or may not relate to this, but I feel extreme guilt giving myself special treatment at LACRM. Yes, I have the legal power to pay myself whatever I want, but that doesn’t make my happiness any more important than the other people who work here. We wouldn’t be making millions of dollars without the efforts of the whole team.

At the same time, my co-founder and I have been at this longer than anyone. We took by far the most risk, and played the largest roles in getting the company to where we are today. Surely it’s not wrong for us to make more than other people. But how much more?

This is what’s so hard about picking founder compensation: It’s about balance. Balance sucks. It’s squishy and arbitrary. Tech people like optimization problems where you try to make a single number as big as possible. That’s clean and clear-cut. Balance is blurry.

After years of thinking about this, I landed at the conclusion that I’m ok being greedy, but that greed needs limits. I don't want to be one of those CEOs making 300x what the average employee makes. So I placed a limit on my own compensation. We have a policy that no one at the company (including me) can make more than 10x what the lowest-paid new employee makes, or more than 5x what the lowest-paid experienced employee makes (I’m defining that as someone who’s been with the company for 10+ years). We have a thing called the thriving wage, so that means I can’t make more than 10x/5x what someone on the thriving wage makes.

To be clear, I’m nowhere near that right now. I’m currently closer to 3x/1.8x, so I’ve got some room for growth, but it’s comforting to know where the ceiling is. This approach allows me to enjoy the spoils of the company I helped create while ensuring that my greed doesn’t grow out of control. Once I hit the 10x/5x limits, I have two choices: I can stay where I am, or I can raise everyone else up with me. I like having aligned incentives.

What should you do?

Probably not what I do! I mean, by all means, feel free to join me with the 10x/5x rule, but I’m guessing you have different values from me. But either way, I’d encourage you to spend time thinking about (a) whether you plan on making your money from an exit or from running the business long-term, and (b) how much greed you’re comfortable with. It’s been a huge relief to have clarity around this topic.

Have thoughts on this post? I'd love to hear from you! I'm @TylerMKing on Twitter.
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