Startup payroll: stay lean

Back from a trip to Silicon Valley, I thought a few lessons from there on CEO and founder salary in a startup would be most beneficial to our middle eastern startups. I had the chance to interview a few CEOs and venture capitalist, and discussed with Quanergy founder Louay Eldada his 3-year without salary and then 50% salary cut in paycheck in year 3 when he started his company, despite a recent closing on a $30 million dollar-round. Louay left a position as CTO at SunEdison to found Quanergy. His effective salary the first 3 years was negative as he was bootstrapping the company. He repeatedly mentioned the huge financial sacrifice he went through, “but this is what got me here” he says.

Low founder’s pay is indeed particularly striking in Silicon Valley, all the more so when you consider the high cost of living in cities like San Francisco. Data (from compass study mentioned below) shows that 75% of Silicon Valley founders pay themselves less than $75,000 per year and 66% pay themselves less than $50,000 per year. This salary would still be subject to taxes, bringing actual pay to even lower grounds compared to the mainly tax-free Arab region.Read this quote from Peter Thiel, entrepreneur and investor, co-founder and previous CEO of Paypal, it says it all:

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.[1]

The matter touches on incentive, relative pay compared to other employees, and alignment of interest with shareholders. One key positive element of low Founder/ CEO salary is obviously incentive and skin in the game, more readily attracting trust from investors.

Another one is relative compensation compared to other employees. A founder and CEO at 70K sets the tone for other employees joining the company and claiming for more. This is when the beautiful game of Employee Stock Option Plans (ESOP) comes into play, as a new recruit will look at total compensation including stock options. Employees in the Arab region are not used to looking at it from this angle, but mentalities have to change, and guess what: the job market is overheated in Silicon Valley too and it is also very difficult to recruit talent. This is when the founder and CEO becomes the #1 salesperson in the company, selling his company and its future potential to his employees. It is just a matter of believing in it enough to make it work. This approach also has the added advantage of reducing running costs of the company – ultimately, the perceived disadvantage of “losing” stock to the employees is in reality counter-balanced by lower financing needs and, as a consequence, less dilution from investors to cover increased running costs. And the payout for employees is potentially unlimited and conditional on the employees doing a kick-ass job and creating value for everyone. The all-around advantages of ESOPs have led to their generalization in companies of all sizes, not only in the US but also overseas (Chinese electronics giant Huawei is said to be 99% held by its employees, with its stock price having risen fivefold since the implementation of its ESOP in 1997[2]).

I come myself from a company, Comgest, 100% owned by all employees and I have to say that the quality and motivation of all employees was unparalleled. The feeling of ownership brings the best out of people. Some people like to limit ESOP to top employees, but sometimes even symbolically involving everyone gives execution an extra edge. I would strongly discourage hiring people who want a big paycheck, with the exception of sales people who have their own incentive tools, as it breaks the spirit and culture of a lean startup. More often than not, you will end up regretting such a hire.

Finally, on alignment of interest with shareholders, the founder and CEO with a significant stake in his company should become rich, like the venture capitalist, from capital gain, not from cash and pay checks. It is not about living uncomfortably, but more about having the bare minimum to live decently and betting on a big cash out. Money invested in the company should not be burnt in high salaries but rather on putting an aligned and motivated startup team together, building the technology and the route to market.

The idea is not however to put the entrepreneur is an uncomfortable situation, but rather find the right balance between actual needs and incentives.

Below are numbers come from a Compass study that collected salary data from more than 11,000 startups. Food for thought: neither the stage or the rounds of funding raised by the startup affect the salary level. The graphs below illustrate this quite well.

Avg Founder Salary by LevelPicture2

[1] http://techcrunch.com/2008/09/08/peter-thiel-best-predictor-of-startup-success-is-low-ceo-pay/

[2] On the success of Huawei’s ESOP, see https://hbr.org/2015/09/huawei-a-case-study-of-when-profit-sharing-works and http://www.ft.com/intl/cms/s/0/469bde20-9eaf-11e3-8663-00144feab7de.html#axzz3nFAMGy5z