Extracting Cash From Investors

I am a firm believer that founders should attempt to extract as much cash as possible out of your venture-funded company.  I wouldn't recommend you saying this as one of your goals to potential investors, but there is an implicit understanding that part of what you get in return for taking an investment is a well paid job with a reasonable salary.

When you own the whole company, it really doesn't matter if the value in the company is in it or out of it, but once a venture investment is incoming, the reality of the situation is it is very unlikely that a founder will make a 'little' bit of money out of the company.  If the company has an exit that exceeds liquidation preferences and investments, you will make a whole lot of money, and if the company fails or has a downside acquisition, you will make very little if anything. 

There are a couple of ways you can extract cash from investors.  What I have found the primary barrier to getting money is NOT the VC themselves, but the relationships with other founders, angels,  and members of the management team.  Once you bring other people into the company that are involved in the fundraising process, you have made an implicit agreement with them by giving them stock or options or whatever it may be, and it may put you in a difficult position to try and usurp part of an investment for yourself.  Once you take a small friends & family or angel investment, you've committed yourself to start having a fiduciary responsibility to the company and so you can't INVENT things that go to your personal benefit anymore.  So do it BEFORE you take those initial investments (and just structure them all so the angels don't have to pay any of it).

First, I often read and have theorized about FOUNDER'S SALES, where an investor actually BUYS stock from a founder as part of an investment.  It is generally accepted that VCs HATE to do this, and it is nearly impossible to achieve except as part of LATER stage deals.  I haven't given up hope of some day accomplishing a founder's sale, but it may be a long shot.  If anyone can give me any insight for how a founder can actually make this happen in Series A/B fundings, TELL ME PLEASE!

Let's talk about more realistic options for you to deal with...

DEFERRED SALARIES...  Most investors ALSO don't like to see deferred salaries on your books for the founders.  I also have never been paid a deferred salary from a financing.  I would put a deferred salary for yourself on the books before you hire the first other person in the company.  Make it a low and definitely under-market salary (like 40k or something) so you making an obvious concession even though you do have it. It is very easy to knock this out in a financing when an investor objects to paying it (and they very likely will), but it is a negotiating point to start with on your side, and it is impossible that you will get any deferred salaries paid if you don't have it in your financials from day 1.

LOANS... As a founder, you NEVER want to structure any money you put into the company as an equity investment.  All you are doing is buying stock from yourself.  Instead, structure it as a LOAN that is due to be repaid, WITH interest, at a fixed date in the future or upon a financing of at least $X.  Write yourself a 1-page Note (you can find templates on Internet).  For some reason, the same investor who will raise holy hell at paying you 50k in deferred salary will have no problem at all at paying back a 40k loan and 10k of interest.  The key to getting a loan repaid as part of financing is for it to be of a trivial value.  An investor WILL raise hell if it is a lot of money relative to what is being raised, but if it is a small amount and that's what the papers dictate, they will probably be fine with it.

EXPENSES... Keep careful records of every expense from the founding of your company that can CONCEIVABLY be considered a company expense.  This DEFINITELY includes things like home office expenses when you are working out of your house, your cell phone bills, your self-insured  health insurance bills ($$$), travel, meals, all the things your accountant wants you to deduct off your taxes.  Since you will probably rack a lot of these up, these should all go into your financials as unpaid expenses.   My experience is that investors are usually fine (again to extent they are nominal total amounts) with paying back your unpaid expenses IF they are on all the financials they received during the due diligence.  Paying back lots of expenses is great because this is tax-free money.

CONSULTING... You probably have some friends that will help you out in various ways starting a company, and probably won't expect anything in return or maybe you did a stock deal with them.  It is very easy to structure compensation that in whole or part triggers a payment upon a financing round closing of a certain dollar amount.  While this won't personally benefit you, it is another way to extract a few thousand here or there from investors, and unlike the expenses where a VC could easily just tell you to nix it as part of the deal, they will feel more obligated to pay these off (and again if its SMALL they won't care).  Imagine the christmas gift you'll get from the friends that helped you out that year!

The biggest part of being compensated is of course your salary.  Exactly how much you will be paid varies a LOT.  Generally what I have found is that VCs hate to give you a number for your salary, they would rather force you to present a number as part of the overall budget and then react.  This is nothing more than a negotiating ploy on their part.  I have underpaid myself in the past just based on trying to have a conservative budget and be fiscally responsible and I consider it a mistake.  Founders are generally THE single most critical person to an entire company, and you should be well compensated not just for that fact but your salary is part of the deal that is also resulting from you giving up a huge amount of equity, control, and very often some type of vesting of your own stock.   A good salary would be something comparable to what you could make if you were hired for the same position you'll occupy at another more established start-up where you got some good stock options but didn't own the company.   Include a bonus in your compensation.

Like any negotiation, I recommend with your salary that you START HIGH and let an investor bring you back to earth.  Amongst founders I have discussed it with, a typical post-Series A salary range seems to be from 100k for underpaid founders to 200k for very well compensated ones.

Comments

[Mohit Dubey]

Another very useful posts. I'm based in India and am just in process of talking to some angel/VC investors.These tips are useful. First to provide a better mindset and Second, to give insight into things which otherwise I'd realise once the deal is over.

[Justin Sullivan]

I will give you a solid "B" for balls in posting this...and you're absolutely right. There are many ways to get paid as a founder, and there are some ways to shoot yourself in the foot in so doing.

Candidly, I wish someone had given me this advice before I launched my first start-up. Very good stuff.

[Denny K Miu]

I agreed. This is a very good post and these are good solid advices.

I have done two startups, one with lots of VC money and one with none. And my own experience is that life is much more enjoyable without VC money.

I agree that once we take money from VC, we should try hard to put some of that money in our own pocket. In my experience, this turns out to be hard to do emotionally because our natural inclination is that this is still our company. The reality is that once we take VC money, it is no longer our company since our own financial interest is not always aligned with that of the VC. The following is what I have learned.

1) VC knows that they are a capital provider and not a service provider. With capital, entrepreneur can purchase quality service from service providers whose expertise is to provide service. Once we take VC money, they expect us to do the heavy lifting. So if we are a service provider like everyone else, we should feel free to get compensated like everyone else. In other words, since our job is to constantly put money in someone else’s pocket, why not ours.

2) VC knows that they are not a banker but they behave like one anyway. Having liquidation rights basically turns their investment into a loan. That is, they get to double-dip and when the company is sold, they get to have their money back first (often with mandatory accrued dividend which is basically interest) before getting their percentage of the proceeds. Therefore they have put their interest ahead of everyone else already. So if they are not afraid to put money in their pocket, why should we.

3) VC knows that they are not here to help build companies or to serve customers. They are here to ensure timely execution towards a financially successful exit, sooner rather than later. So to protect themselves, they demand draconian terms because if things don’t go the way they want, they will have no problem gaining control of the company and changing guards abruptly to ensure a timely exit. So however much we romanticize that VC is our friend, there is a limit. And like they say in Chinese, every banquet must come to an end. We need to constantly remind ourselves to put money in our pocket while we have the chance.

4) VC knows that they are an agent no different than any other agent who gets a cut on the transaction. Whereas we are expected to put in our own body-and-soul and our angel investors invest their own net-worth, VC is all about making use of someone else’s money. So unlike us, their financial interest is coupled with their professional interest, i.e., their career must come before ours (if they are not a partner, their personal goal is to make partner and we are expect to help them; and if they are not a managing partner, then their personal goal is to make managing partner, etc.).

5) VC knows that while they occupy a Board seat, their primary objective is not to fulfill their fiduciary duty. VC does not sit on Board to protect the interest of other shareholders. VC is there strictly as a portfolio manager and their job is to protect the interest of their investment. In other words, no matter how many times they tell us that they are our partner, the truth of the matter is that they already have partners, they are in their firm and their interest comes before ours.

6) While the financial interest of the VC might align with ours, they are not identical. Their portfolio is much more diverse than ours. Therefore, it is not enough that we succeed, we must succeed big enough to make up for their other losses (or losses by other partners of their firm). Therefore the VC and his partners are willing to take much greater risk than us since in the eyes of the VC’s senior partners, succeeding small is as bad as failing big. So by taking money from VC, we actually increase our own risk and force our financial outcome to be either zero or big. Therefore, it makes a lot of sense to put money in our pocket, since the probability of a zero outcome is quite real.

7) VC does not want us to run to them when the company is in trouble since they don’t have the operational experience or the technical knowledge to solve our problem anyway. But they expect us to inform them when there is the first sign of trouble because while there are plenty of people (including us) whom they can blame for company failures, there is no one else to blame for surprises when they are grilled by their own partners in the Monday partners’ meetings.

8) Statistically companies that do not take VC money have much better batting averages than those that take money from VC. Everyone knows that 10% of the VC’s make 90% of the money, therefore they are competing with 90% of the dogs for 10% of the meat. Since none of their general partners and limited partners expects miracles, neither should we. So if we can put some of their money in our pocket, we should. Otherwise we are taking risk on top of risk.