As a startup founder, one of the most crucial aspects of building a business is determining how to pay yourself. In the early stages of a startup, it can be difficult to balance personal finances with the needs of the business, especially when cash flow is limited and the business is in its growth phase. However, as a founder, it's important to establish a reasonable compensation structure that aligns with the financial health of the company while ensuring you can meet your personal needs.

Here’s a breakdown of how startup founders typically pay themselves, along with some considerations for determining the best approach for your situation.

1. Understanding Startup Funding Stages

The way a founder pays themselves often depends on the stage of the startup. During the early stages, when the business is in its bootstrapping phase, founders may not pay themselves at all or may take a minimal salary. The priority in these stages is typically reinvesting profits into the business to help it grow. However, as the startup progresses through various funding rounds (e.g., seed funding, Series A, etc.), founders may be able to draw a salary as the business becomes more financially stable.

2. Salary vs. Draw

There are two primary ways that founders typically compensate themselves: through a salary or a draw.

• Salary: This is a fixed, regular payment, much like a traditional employee salary. Founders can set themselves a salary based on the company’s available cash flow, industry standards, and the amount of money they’re raising. This approach helps the founder maintain a consistent income stream while still being an active member of the company. It is usually common once the startup is in a position to generate revenue or has raised external funding.

• Draw: A draw is an amount the founder takes from the business's profits as needed, without committing to a fixed salary. This can be more flexible than a salary, especially when cash flow is inconsistent. A draw may work best for startups that are still in early development stages or haven't secured significant funding yet. However, frequent draws may limit the startup’s ability to reinvest in growth.

3. Industry and Market Norms

Startups often have to pay themselves in a way that is aligned with industry and market norms. If you're building a startup in a highly competitive industry, such as technology or biotech, it’s essential to consider the competitive salary levels for founders and executives in those sectors. Investors or other stakeholders may have expectations about the founder’s compensation in order to retain talent, and being aware of industry trends will help ensure that your compensation is within a reasonable range.

4. Taking a Minimal Salary

In the early stages of your startup, it’s common for founders to take a minimal salary, often below market value. Many founders do this to conserve cash for operations and business development. By keeping the salary low, the business can reinvest any available funds into product development, marketing, or hiring other team members.

Taking a minimal salary also helps demonstrate to investors that the founder is committed to the business and willing to sacrifice personal compensation for the long-term success of the company. However, it's essential for founders to balance this with their own personal financial needs to avoid burnout or financial strain.

5. Equity as Compensation

While a low salary may be necessary in the early stages, many founders compensate themselves with equity in the company. Equity ownership offers the potential for significant financial reward if the company succeeds, and it can be a great way to align the founder's interests with the long-term goals of the business.

For example, if you’re unable to take a high salary in the early stages, you may take a larger equity stake in the company to increase your potential payout in the event of a merger, acquisition, or initial public offering (IPO). This approach allows founders to remain motivated while not overburdening the business with immediate compensation costs.

6. Taking Bonuses

Once the business starts generating profits or successfully closes funding rounds, some founders opt to take bonuses in addition to their salary. Bonuses are typically tied to company performance, such as hitting revenue or growth targets. For example, if your startup achieves a specific milestone or closes a funding round, a performance-based bonus might be a way to reward yourself for your hard work while also ensuring the business remains focused on reinvestment.

It’s important to structure bonuses carefully to avoid overcompensating at the expense of the company’s long-term growth. Bonus structures should be based on clear, measurable milestones to align founder compensation with the company’s success.

7. Living Below Your Means

Many startup founders live below their means during the early years of their business to stretch their limited income. By minimizing personal expenses and avoiding large financial commitments, founders can dedicate more of their income to the business while maintaining personal financial stability. Living frugally can be a temporary solution while the startup is still in its growth phase, and it allows founders to take fewer risks when it comes to paying themselves.

8. Using Profit Distributions (For LLCs)

For founders who run their startup as a limited liability company (LLC), profit distributions are a common way to compensate themselves. Unlike salaries, which are subject to payroll taxes, LLC distributions allow the founder to take out a portion of the profits without the same tax burden. Distributions are typically based on the company’s earnings, and they can be a more tax-efficient way to pay yourself compared to a traditional salary.

However, LLCs must carefully consider the impact of these distributions on the company’s cash flow and its ability to reinvest in business operations. It’s also important for LLC owners to maintain proper accounting practices to ensure that they are complying with IRS regulations.

9. Tax Implications of Founder Compensation

Founders should also consider the tax implications of how they pay themselves. Salaries and bonuses are typically subject to income taxes and payroll taxes, while equity compensation may be taxed differently depending on how it's structured. For example, stock options or equity grants may be taxed at capital gains rates if the founder sells their shares in the future, which is usually more favorable than ordinary income tax rates.

Consulting with a tax professional or accountant is essential to ensure that founders are minimizing their tax liability while structuring their compensation in a way that is compliant with tax laws.

10. Consulting with Investors and Advisors

Lastly, when deciding how to pay yourself, it’s important to consult with investors, mentors, or advisors. If you’ve raised money from venture capitalists or angel investors, they may have expectations regarding your salary or compensation structure. They may encourage you to take a reasonable salary based on the stage of the business or industry standards. Additionally, advisors can help you determine an appropriate compensation level that balances both your personal financial needs and the business’s long-term success.

Conclusion

Paying yourself as a startup founder is a delicate balance that requires careful consideration of both your personal financial needs and the financial health of your company. Whether you choose to take a minimal salary, use equity as compensation, or rely on performance-based bonuses, it’s essential to structure your compensation in a way that supports both your personal goals and the growth of your startup. By taking a strategic approach to founder compensation and consulting with investors and advisors, you can ensure that your salary and benefits align with the business’s needs while positioning yourself for long-term success.