This post is a part-3 of multi-post series by Barry Bainton on What I am worth. Checkout Part-1, Part-2, Part-4
Ownership/Debt
Once you start working full time for the start-up firm, you want to be compensated for the present value of your future contributions to the company and its business. Generally in a mature company this would take the form of a salary or wage based on some industry-wide standard for a particular job description or responsibility level.
A Start-up is not a mature firm. It cannot afford the high overhead such standards would impose. It needs to raise and spend cash in the most efficient and strategic way to achieve its financial objectives.
Debt Financing:
For a start-up, a secondary funding source is debt. The most common source is the personal loan made by the principals to the enterprise. Another source are loans made by friends, family and “angel investors.” These loans are unsecured based on the good faith between borrower and lender, or they may be secured by the pledge of the borrower’s personal assets to the lender in the event of default.
A company uses debt financing to meet an immediate need for cash to achieve a business purpose that it could not achieve without it. It leverages its current assets to acquire the needed cash from a lender based on a promise to repay the loan with interest out of the future earnings.
While established small business firms may obtain financing through SBA backed small business bank loans, commercial loans from banks, micro-lending facilities, among others, these sources are not generally available to the startup company. Start-ups must be more creative.
Debt as part of your Compensation
Active owners/managers are often are expected to accept a compensation package, or salary, which is some combination of cash, and deferred salary or a loan to the company (debt). The cash you take home is payment for your present service and represents a direct cost of doing business to the company. The deferred portion is a loan to the company.
The loan is the compensation you have earned for your services but are willing to defer to a future date. It is a claim on the company’s future earnings. You, as the lender, can demand an interest payment for the company’s use of the money. The interest rate is the added price you charge the company for deferring payment for using your labor/services..
How much is that loan worth?
If you really want to work for this start-up then you need to determine what you would be charging (or being paid) for your time if you were to work for someone else in the same position, in a company at the same stage of development?
Don’t try to compare your value to someone in an established, or mature, company! Otherwise you are comparing apples and oranges.
If you are offered a base salary less than what you might expect elsewhere, or less than you valued your equity contribution, then you will be losing the difference between the two. For example: The company offers you $50.00/hr; your next best offer or opportunity is $60.00/hr; and you valued your original contribution at $75/hr. This is $10 to $25 difference. You need to determine for yourself: “What are my basic personal requirements?” For example: If the company can only pay you $50/hr in cash, can you afford to live on that rate? Next, “How much can I afford to lend to the company?” “ $25/hr or $10/hr?”The company has to determine: “What it can afford borrow from you?” “$10/hr or $25/hr?” If you both agree that $60.00/hr is fair and agreeable then you have established the base salary rate. The base salary is a starting point for negotiation, NOT the ending point. Next, you need to negotiate the amount to be paid in cash and the amount to be deferred. If the company can pay $50/hr, you will have to determine and agree how the $10.00 difference will be paid. In what form of IOU should the loan be made — preferred stock, warrants, options, etc. for the other $10.00/hr deferred income?
Conclusion:
When you consider going to work, full or part time, for a start-up business, you might consider accepting a mixed compensation package that includes a debt component. That is, lending part of the cost of your services to the company in return for an IOU. As the owner of a start-up company, you might consider using debt as part of the package you offer to someone whose services you could otherwise not afford.