How to Set Starting Salaries

Q: I'm starting a company with two friends. I will be CEO; they will be the CTO and COO. Should we all have equal salaries, or should they be different? I have enough in my budget to pay each of us something in the low six figures.

A: Setting salaries is an art, not a science. I've seen startups work great when each founding partner had an equal salary and equal share of the company. I've also seen startups work when there's great inequity between the partners. The question is: What criteria should you use to set the salaries?

First, salaries shouldn't depend on experience--not in my book. Salaries should be related to management results. Spending 10 years running a company that never showed a profit should command a much lower salary than 10 years spent running a spectacularly successful company in a variety of market and competitive conditions.

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But I'd make an exception: At the end of the day, results are only somewhat under your control. If a candidate had managed an unprofitable business but claimed to have very high-quality management and operational processes, that could be a good sign. In that case, I would want very detailed presentations of the management processes, so I could decide whether or not I was willing to bet on those processes in my company.

Salaries shouldn't be set based on a salary survey. In a cash-poor, startup environment, does it makes sense to pay anyone a six-figure salary? Prior to 1996, it was almost unheard of to pay six figures in a startup. You were expected to take a salary around 30 percent below market (assuming that still left you enough to live on) and do whatever it took to further conserve cash.

Here are some more things to consider:

• Are executive salaries your best use of cash? Running a startup is all about cash flow and conserving cash. Salaries in the six figures are high enough so that each of you is being paid about double the salary of a relatively senior non-executive. In a startup, who's more important, the executives or the people executing (note that executives might execute)? If I were running a start-up and could afford six figures in my salary budget, I'd give myself $35K per year and spend the remaining money on two or three high-quality engineers, marketing people and so on. As the founder who stands to get rich if the company succeeds, my short-term cash needs should defer to the health of the company.
• What bets do those salaries demonstrate? Salaries in the six figures are excellent in the United States. Those salaries in your company would signal to me, "These founders aren't betting on the company succeeding. They get a good deal no matter what happens."
• Do those salaries make sense from a financing point of view? Even if you just pay yourselves less and keep the cash as a buffer against a rainy day (hint, hint), giving yourselves lower salaries means increasing your profit, which will make it easier to get financing in the future and make profitability easier to come by. And when or if you ever go public, public companies are typically valued as a multiple of earnings. If you save $1 by giving yourself $1 less in salary, and you go public at a multiple of 20, then you just got back $20 in market value in return for deferring that $1 in salary.

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