It is really easy to underpay yourself in a start up. After all, there is typically not enough $$ to pay yourself well or at all. It is easy to cut your salary during a cash flow crunch. By using the word “easy”, I do not mean easy as in fun or simple. Rather I mean easy as in you have no choice. And having no choice is not too easy!
Prior to receiving outside funding, founders often work for very little salary. Ideally, everyone is motivated by their equity stake and the hope of future reward. A serious issue arises when the “salary not taken” shows up as deferred compensation on the company’s balance sheet or rears its head in discussions with potential funders. This is not going to make for a pleasant talk. It also makes for a messy balance sheet. It is difficult or impossible to get deferred compensation paid once you have outside investors. I think the most important point here is actually expectation management.
A similar situation arises when bonuses are granted even though they cannot be paid due to lack of cash. Is employee moral boosted by paper bonuses that might get paid in the future if cash flow improves? Doubtful. I am guilty of falling into this trap as a board member. The situation never ends well and, again, a messy balance sheet results.
I love to approve bonuses when cash flow exists to pay them (i.e., hey, we are selling product and making some profit). I love paying market salary when cash flow exists to support. I wish my VC fund were larger so that I could get paid more out of our management fee. Reality is……it is not. Reality is…..the payday hopefully comes later with exits.
Luckily, we don’t carry any deferred salaries on our books.
The biggest issues are often 1) potential violation of state wage and hour laws for not paying earned wages, and 2) nasty tax consequences caused by creating deferred compensation that doesnt comply with the complicated tax rules governing deferred comp. you could have to pay income tax immediately (before the compensation is paid even) and have a federal 20% penalty and an extra 20% penalty if you’re a CA taxpayer.
This is an area where you don’t want to “save money” by not hiring the right advisors.
Thanks Dave. All great points.