The Dirtiest Word in Startups
Just
as karaoke machines created a nation of wannabe singers, and WordPress created
a nation of wannabe writers, so the imperfect storm of global connectivity,
crowd-funding, and America’s protracted economic and employment malaise (aka Lagflation)
have created a nation of wannabe entrepreneurs. While there are many articles out there urging
you to throw caution to the wind, chase your dreams, and “Go for it”…this is
not one of them. Instead, this essay is like a Simon Cowell wake-up call for
those considering becoming an entrepreneur and launching their own company. In
a world of Facebook friends cooing, “Believe and you will achieve,” this is the
counterbalance – an adult, “eyes-wide-open,” practicum which draws back the
curtain and cuts through the hype by zeroing in on the most controversial,
misunderstood, and unspoken word in startups.
Confessions and Credentials
I
begin with some confessions and credentials.
I love startups. I love building
things from the ground up. I love taking
a blank sheet of paper and transforming fantasy into reality. But more than
anything, I love the culture of the driven people comprising this community -
that audacious brotherhood of courageous pragmatists - who combine an
infectious, ambitious, and generous entrepreneurial spirit with a passion for
progress.
After
spending the first decade of my career marching through the corporate world, I’ve
spent the past 13 years as an entrepreneur.
I’ve launched five companies, written scores of business plans, investor
guides, and industry white papers, and know firsthand the exhilaration of a public
company exit. I’ve raised capital and spent
capital. I’ve consulted to private equity. I’ve pitched at “Stake and Egg”
breakfasts and VC dinners, as well as conducting countless presentations to investment
groups sporting edgy ironic names like ARCH Angels, JumpStart, North Coast
Angel Fund, and Idea Stream. My exploits
have included forays into risk management, consumer products, corporate social
media, commodities, bioinformatics, and commercial property, and I am currently
a stakeholder in 7 startup companies. I’ve
been interviewed on XM Radio, hung out with Robin Williams at CES, had products
featured in GE’s booth at RSNA, been on the Video Game Awards show red carpet, schmoozed
in Studio 54, was showcased by MTV and Spike TV, and even had CNN cover a
launch at COMDEX featuring a Bill Gates look alike. And yes, I’ve experienced
failure and financial setbacks, and carry the scars from former business partners
whose lack of integrity scuttled entire companies. I guess you could say I’ve
been around the block so many times I can’t remember my first rodeo.
The Dirtiest Word
It’s
been my experience that every meeting with a serious investor has what I call
“The Moment.” You’ve just presented your brilliant, bleeding edge, “The next
Facebook/Starbucks” idea, while bolding proclaiming, “Nobody else is doing
this,” and thereby positioning your firm with that critical, “First mover
advantage.” You’ve documented your industry research and market trends, you’ve smugly
smirked at your, “Lack of any real competitors,” and you’ve detailed your
product/service strategy, intellectual property, and price points. And if that wasn’t enough, you’ve fawned over
the stunning credentials of your veteran, experienced, top-shelf, blue chip,
management team, your launch plan rollout, and your estimated revenue, costs,
and profit margins - complete with requisite hockey stick growth projections (which
are – of course – “conservative”).
The
meeting reaches an emotional crescendo as you confidently answer the tough
questions regarding the amount of investment you are seeking, in exchange for the
amount of their stake in the startup. And
then there is “The Moment” – the moment they finally turn to the Excel
spreadsheet on the last page of your meticulously prepared Investor Guide…and
their eyes slowly scan down your projected expenses and use of capital…and then
they stop…they ALWAYS stop…at the dirtiest word in startups – SALARY. You hope it will go unnoticed. You pray for a matter-of-fact nod…but it
rarely comes. Instead, they lean back,
and start asking a series of awkward, personal, and uncomfortable questions
beginning with the word “So” (so as to appear disarming, benign, and spontaneous):
“So,
how much have you already invested in this startup?”
A
good question, for which you’ve got a good answer, but before you can reply,
comes the kicker - “…not including your TIME,” - at which point, no amount of
explanation regarding “opportunity costs” or “sacrificing family time” or “working
nights and weekends” will suffice.
Knowing
you’re on the ropes, the next question (a direct and deadly corollary to the
first), is as predictable as it is paralyzing:
“So,
how much of your OWN money have you put in?”
At
this point, the room starts feeling stuffy and uncomfortable, and you’re
startled to hear your once confident bravado replaced by a nervous stammer, as
your now suddenly dry mouth sheepishly attempts to choke out a cryptic
tabulation of what ultimately turns out to be an embarrassingly small amount of
actual cash out of pocket – particularly when compared to what you’ve just
asked them to invest.
As
the hushed meeting falls silent, you decide to uncork a last ditch “Hail Mary”
to salvage your dignity, demonstrate your commitment, and prove your passion
for this project, by explaining that these figures represent a huge sacrifice,
as you and the entire management team would, “Only be working at half our
current salary.”
The
next few minutes are the ones that stay with you, as the relaxed congeniality
and respectful man-to-man camaraderie which marked the first part of your
meeting are replaced by a dismissive air of mild annoyance, as they launch into
a belittling, cliché-riddled lecture on the merits of “hard work” and “sweaty
equity” and putting “skin in the game” and “keeping you hungry,” because heaven
forbid, “We don’t want you getting too comfortable.”
The
dirtiest word in startups is “salary” because of its proclivity to upset,
offend, and alienate your investor audience and because it exposes the great
hypocrisy and the dirty little secret resident within this community, and it is
for these reasons that the word is seldom discussed or even uttered in polite
company.
Salary: The Elephant in the Punchbowl
The
problem with salary, and the reason it’s so controversial, is because it does
not accurately reflect reality – and in their heart of hearts, everyone in the
industry knows this. Here’s how the
flawed circular logic plays out.
First,
the typical entrepreneur, by his or her very nature, is ambitious and driven -
motivated not by a fear of failure, but rather by an overriding optimism regarding
the potential of the business opportunity, combined with a steadfast confidence
in their abilities and passion to succeed.
Second,
it is acknowledged and understood within the industry that the most important
component of a successful startup is the experience, quality, and expertise of
the leadership team. While “past
performance does not guarantee future results,” it is still the best predictive
measure for extrapolating outcomes, and it is for this reason that investors
give preference to management teams comprised of accomplished professionals
with demonstrated track records of career success.
And
finally, the blindingly obvious. If
these professional have already been successful in their careers (which, again,
is what investors prioritize and rank most highly on a startup management team),
then they will usually enjoy the fruits of their labors, including a nice house
with a mortgage, a contemporary car with a monthly payment, and other lifestyle
indicators of affluence.
The Problem with Investors
My
problem with most investors is that, for some reason, they seem to think that
when a person starts a business, Maslow’s Hierarchy of Needs no longer applies
to them. That suddenly, once a business plan is complete, the entrepreneur will
no longer require food to eat, clothes to wear, or a place to sleep. Hello?
As
an investor and entrepreneur who has spent time on the both sides of the table,
I completely understand the desire of funders for initial capital to be
allocated with an emphasis on product completion. However, by failing to provide a means of
sustenance for the founders during this critical ramp-up time, they
inadvertently increase the risk profile of the very startup they want to
succeed. Remember, you’re investing in this business because of the novelty and
promise of the idea and the accomplishments of the management team. Since entrepreneurs are by their very nature
highly motivated people, a failure to offer a salary to cover living expenses
is not an “incentive” – it’s a distraction!
How can we expect people to make rational, strategic decisions on the
future direction of the company when their hair is on fire trying to figure out
how to pay the mortgage and put food on the table?
Why
do you think so many of America’s greatest success stories involve companies
started by a few guys in a college dormitory?
It’s because when they’re living on a campus, all of their lower level
needs for food, clothing, heat, shelter, and safety are being met and paid for
– providing them with the necessary time to invent, explore, and workshop
ideas, and then nurture them into actual businesses. Why do so many firms like Apple trace their
humble beginnings to “Working out of Mom and Dad’s garage?” It’s because, within this environment, all of
their needs for immediate survival were being met, providing them with the necessary
time required to focus on building something of lasting value.
Most Incubators Lay an Egg
The
word “incubator” is plastered all over the startup community, but the concept
usually falls frustratingly short in practice. Why? Because while incubators often provide “nice
to have” WANTS like tables, chairs, whiteboards, mentors, and Wi-Fi, they
rarely provide aspiring entrepreneurs with a sufficient amount of cash to meet
their lower level NEEDS – money necessary to buy precious innovation time, enabling
them to survive during the critical phase when their idea goes through the
process of gestation, development, and refinement. (Remember, if your 3rd
grade incubator didn’t provide heat, food, and shelter, your tiny yellow chick
would have never survived).
The
impact of this overlooked or ignored disconnect within the entrepreneurial
community is significant. Not only do
these challenging financial dynamics serve as a barrier to entry for millions
of would-be entrepreneurs, but they can create a detrimental bifurcation in the
demographics of the startup community, resulting in founders who are either YOUNG
(just out of school and still living with their parents so their financial
needs are minimal), or OLDER (over 40, who have been successful enough to
“retire” with a nest egg providing sufficient residual income to get by). If not reconciled, the net result produces a
hollowing out of what I call the “sweet spot” – that huge swath of the most
eager and available 20 - 40 year olds - who shun startups simply because they
need a predictable salary to meet their commitments.
CoolCleveland’s
Thomas Mulready recently interviewed Blackstone LaunchPad’s Founding Director
Mike Nock, who poignantly observed, “College kids and young people have a lot
of time and a lot of ideas AND they don’t have a lot of obligations like
mortgages, braces and babysitters.”
While his comments are on target, they still fail to paint a complete
picture, as today’s four-year college students are graduating with nearly $27,000
in student loans (with monthly payments starting within 180 days of graduation),
meaning that most are so indebted that they can’t even consider a job that
doesn’t have a functional level of salary.
A Compensation Compromise
While
the challenge of salary can never be completely erased from the startup
culture, I believe there is room for a pragmatic compromise to effectively
split the difference. Do I want to enable
lavish lifestyles supported by my investment capital? No! Do I want to discourage aspiring
entrepreneurs by insisting that my capital goes towards building the product
and not towards the income they need to survive? No! I believe there is a middle-ground
whereby the NEEDS of startup entrepreneurs can be met, but not the WANTS. The effective allocation of investment capital
requires a very individualized and intimate discussion regarding the monthly
bills of the principals and the amount required to keep them solvent. Will they
earn enough to buy a new car, take expensive vacations, max out 401K
contributions, and go out to eat regularly at pricey restaurants? No!
The idea is to provide just enough cash flow to cover their monthly
commitments - so that the entrepreneur knows their NEEDS are being taken care
of - and thereby allowing them to focus on a successful launch. By ensuring their survival needs are met,
entrepreneurs will no longer need to waste energy grappling with the daily struggle
for compromise – deciding between making the best strategic decisions for the
long-term growth and viability of the company OR the short-term urgency to rush
things, just to get some cash in the door.
Keeping Entrepreneurs Respectable
In
addition to providing cash flow coverage, this investment approach also
provides something far less obvious yet equally important to company founders –
RESPECT. By allocating a portion of
capital investment for salary, investors show their respect for the
entrepreneur by both honoring their track record and body of work to date,
while also affirming their belief that their best work is yet to come.
One
of my clients (Evolution Capital Partners) is a private equity firm which
embodies this practice of respect in their investments in other companies
(although their focus is on established Second Stage firms). While their model
involves taking a controlling interest in their portfolio companies, they
structure these deals so that they respect the success of the founding entrepreneur
by providing a significant cash-in-hand payout at the close of the initial
transaction, as well as a roadmap for an even more lucrative return at a larger
exit down the road Like signing a 4-year contract for a proven
veteran NFL quarterback , this income commitment is a tangible recognition of
their confidence in the idea and the individual, and clearly demonstrates they
are “Putting their money where their mouth is” regarding their belief that the
leadership team is the most important component of the startup. For those who claim that human capital is the
most important, yet fail to recognize and respect them with a modicum of
salary, my inclination is to question the validity of their stated belief. As the old saying goes, “The proof is in the pudding.”
Entrepreneur or Entremanure?
If
approached in this respectful way, salary doesn’t have to be a dirty word – for
investors OR entrepreneurs – and the reason it works is actually
scientific. The DNA of the entrepreneurs
I’ve met shares a similar “motivation” gene. These aren’t people satisfied to be coasting
along with compensation that just gets them by month-to-month. No way! These are individuals who go above and beyond because
they’re high achievers - that’s just how they’re wired. The decision to provide sustenance-level
salary to these ambitious individuals returns the dual benefit of providing
entrepreneurs with the confidence that their NEEDS are being met, while
providing investors with the confidence that their decision matrix is not being
dominated by a tactical “tyranny of the urgent,” but rather informed by measured
actions as part of a long term strategy.
My Solution
Over
the next 18 months, my firm Briarcliff Capital is going to take this concept
one step further by combining the best attributes of “Campus and Company” to
design an entrepreneurial environment which truly covers all of the bases. Our goal is to offer a self-contained
entrepreneurial ecosystem which provides not only for the corporate and capital
needs of our members, but the physical needs as well. By providing office space, infrastructure,
working capital, and mentoring, as well as efficient living quarters and
attached community area, we’ll have the opportunity to maximize the impact of
every dollar invested in our portfolio companies, as we seek to create an
integrated entrepreneurial tribe of like-minded professionals committed to
incubating the next generation of big ideas.
Conclusion and Caveats
I
conclude with a few caveats. As I
mentioned in the opening paragraph, the purpose of this article is to serve as
a counterbalance to the irrational exuberance which often surrounds the
euphoria of wannabe entrepreneurs. As
such, the enclosed storyline represents a purposefully heavy-handed caricature
of some of the salary discussions I’ve participated in over the years, with the
goal of attempting to level-set this conversation by sharing this unflattering
reality of working in and around startups. The truth is, while I actually HAVE
received a respectful salary at some of my startups, it’s also true that on
other occasions that has not been the case, and the discussions paralleled the
awkward exchanges described earlier.
My
purpose for composing this piece is to educate would-be entrepreneurs of the
fact that – within startups - the topic of salary is dicey, nuanced, and grey -
and will hinge on a lengthy list of variables including your age, experience,
credentials, idea construct, location, and regional customs (e.g. West Coast
vs. Midwest), not to mention your context (incubator, accelerator), your stage
of development (Seed, Angel, Series A, VC), and the specific investment terms.
Hopefully
this article will better prepare you for the nuances of this potentially
prickly salary conversation, and thereby increase the chance of achieving a balanced
equilibrium in the risk/reward continuum, and a beneficial compromise between
investors and entrepreneurs. Remember,
it’s always easier to “Pay it forward” when you know someone’s “Got your back.”
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