Owner salary for a startup

[princesultan]

Hello everyone,

I'm confused about the salary that should (or shouldn't) be taken for a startup. I'm looking to start a new business which would require about 250k in startup costs and about 150k of working capital for the first year (hoping to have positive cash flows near the end of year 1). The company would be in a loss position of about 150k in year 1, and hopefully be profitable in year 2. I'll be borrowing most of the money from family & banks, while I have some of the money myself. I've included a tentative owner salary for myself of 40k per year in my projections.

My question is, should I even be taking a salary? I was told by someone that since I'm borrowing the money and since the company won't be profitable in year 1, that I'll essentially be borrowing money to pay myself. Obviously I need to pay my mortgage and living expenses (which would be scaled down of course).

What would people do in this situation? Is it unheard of to take salary when the business is losing money?

Thanks.

[ArcSine]

Not at all unheard of to extract some conservative draws from which to put beans and rice on the table during the start-up phase. In fact, that's the typical modus operandi for many VC-backed launches.

The VC or angel typically wants the entrepreneur to stay focused on getting the wheels turning and getting to a cash-flow-positive position as soon as possible, and that means free from the distractions of trying to figure out where his next meal is coming from, or of getting burned out holding down two part-time jobs evenings and weekends. Hence the financier will often "over-finance" the new business, specifically to create a surplus cash fund from which the entrepreneur can withdraw basic living expenses.

But it's important to note the conditions that are always present in such a situation, and evaluate your particular plans in light thereof...

• Banks typically have no interest in funding this 'living expenses' portion of a deal; they prefer their cash to be plowed directly into hard assets in which they take a security interest. I have seen exceptions, but don't count on 'em. It's the equity investors (VCs, angels, PE guys) who will be helping the entrepreneur keep the lights turned on at home. This, I'd assume, would correspond to the "family" part of the financing structure you mentioned. As long as the bank is well collateralized, and there's sufficient excess cash in the cigar box to allow for some reasonable living expenses without jeopardizing the bank's debt service one whit, they'll likely be fine with it.

• As you'd reasonably expect, the backers in such deals will estimate how much the entrepreneur needs, and it'll be a conservative number that doesn't allow for anything above the necessities. The allowable draws will then be strictly capped to such limit. Considering that in your case it's family, they might be a bit less hard-nosed, but for the same reason (it's family) you'll probably be motivated to be frugal. The family Christmas gathering might be less pleasant if your backers have yet to see their first dime of return, but you're sporting a fresh St Croix tan On a related point, if the entrepreneur has personal funds available, the financiers would want to see him draw at least a portion of his living expenses therefrom.

• Whether or not it's even feasible in the first place is a function of how the backers see the future unfolding, based in large part on your forecasts and projections. They have no problem bankrolling a reasonable schedule of personal expenses, provided (a) they expect it'll pay off in the form of higher profits flowing back to them later, since you were able to give it 100%; and (b) the projections strongly suggest it'll only be for a fairly short period of time.

So yeah, it's do-able, provided all the right conditions are present. Essentially, the backers have to be convinced that allowing you to stay 100% committed to the start-up will give them a larger and/or sooner return, and they'll compare this favorable variance against the extra cost of doing so.

Cheers, and best of success with the new venture.

[princesultan]

That makes a lot of sense is very helpful. Thanks!

Any other opinions are greatly welcomed.