Why do VCs insist on a pay cut?
Sanjay posted an interesting post on Venturewoods. His comment on acceptance of "delayed gratification" as a must for entrepreneurs caught my eyes.
One of the key things I look for in entrepreneurs is the ability to accept “delayed gratification” and the ability to deploy capital efficiently. In an Indian context “delayed gratification” could mean taking a CTC of Rs 20000 a month while your peers get say Rs80000 per month. Sometimes the delayed gratification can take very long and it may never happen.
As an entrepreneur, I do not agree with this view, or more specifically with the example given. Being a entrepreneur is hard. It means having to work insanely long hours, be on call 24/7, be accountable for every single thing that happens at work and make sacrifices on personal life. If, on top of that, VCs - especially in the Indian context, insist on delayed gratification in the form of taking a pay cut, it might as well drive most of us to harakiri. I am certainly not advocating exorbitant salaries. However, I think it makes complete business sense to at least fix founder/promoter salaries at an industry average level. This is specifically important in India because most young entrepreneurs would have almost no savings in the bank. By asking them to take a significant pay cut at a crucial stage in life, you put immense and unnecessary pressure on the folks who are at the helm. It also increases the level of risk involved in doing a startup. You could spend a good 4-6 years working like a dog and if you startup fails, you would be in your mid-30s (assuming you start in mid to late 20s as many entrepreneurs do) with almost no money in the bank. This sort of risk is unnecessary because the salaries of key executives, even at market levels (as per experience, not title) would be a small fraction of the total money invested in the business. Moreover, by insisting on low salaries, the investors increase the eagerness of founders to prematurely exit the business at the first opportunity.
We need to develop entrepreneurship as an attractive career option. While we wait for our first wave of successful startups to act as poster childs (I hope it happens soon!), prospective entrepreneurs need to be assured that the risk is not as high as it appears to be. There would still be delayed gratification because of immense sacrifices required in terms of time spent building a company as against climbing the corporate ladder. But at least it wont leave a failed entrepreneur burnt and broke.
p.s: Tekriti is self funded and we have not raised any VC money so far. The views here are just me reflecting on the common perception that its not a real startup unless there is a struggling and broke founder running it :)
Comments
Gaurav,
Sorry but I am going to have to disagree on this one with you. If entrepreneurs get paid the same as the corporate guys, it inherently implies that startups are not high risk/high rewards proposition. Startups require a different kind of mindset and delayed gratification is definitely one of the primary drivers. This is exactly the reason why you see founders get paid peanuts but own significant percentage of the company. It also sets a good example for other employees to see the founders have a lot of skin in the game. Just my 2c.
Posted by: Sunder Iyer | January 29, 2007 02:04 AM
I partially agree with Gaurav. It depends on how you work out the terms with VCs and your situation. If you are taking a paycut, make sure you ensure that VCs don't phase you out very fast and you could reap higher benefits in the future success. If you are willing to take a paycut, be tough on the negotiations with the VCs. Extract your pound of flesh for taking the paycut.
Posted by: Krish | January 29, 2007 06:47 AM
I agree with Gaurav. I have seen many IITians interested in opening startups but not able to do so because of monetary considerations. The example of a 30 year old with almost no money is probably the worst nightmare, moreover if the startup fails the experience will not be counted as The Best, right? Why do you think IITians want to go to IIMs? Because even good technical companies are also paying less than management companies forget about startups at all.
Posted by: Shubham | January 30, 2007 09:08 PM
Gaurav, I think Sunder has a point here. While it is easy to debate how much a promoter should take as a salary etc., we should remember that no one is forcing anyone else to be an entrepreneur. And in real business,there is no such thing as low risk/high reward (unless u r an Investment banker or analyst, but that is another topic altogether).If it is your money and the business generates cash, you can draw as much as you want as salary.If it is OPM, then the investors have a right to know how the money is being spent.The business landscape is littered with hi-living promoters who came crashing down after the easy OPM ran out.
I think, if you need a "market salary" from your start-up, then probably you are not ready financially. Scared money never wins and businesses need staying power.All this means that you should have enough financial stamina to be in business for a year or so, even if there is no cashflow from the business.Otherwise, you simply are not ready for the risks of starting and running a business.
Posted by: venky | January 30, 2007 10:02 PM
We can consider it another way - what if VCs say they are going to give full salary . Then everyone - even if he doesnt want to do enterpenuership- would like to start a company. This would definitely reduce the quality of guys doing a startup. Hence I believe its not such a good idea to give a market salary.
Posted by: Eklavya | January 31, 2007 12:10 AM
Gaurav - in the end it's about structuring something that balances the different (and often conflicting) interests of the two parties - VCs and founders. And like any deal, there is no right framework, and thus the outcome is determined by the negotiating skills and the balance of power across both parties.
having been on both sides of the table, I can tell you that you've captured the entrepreneur side quite well. ironically, though, the aspect you mention as a negative is precisely what the VCs want. "Moreover, by insisting on low salaries, the investors increase the eagerness of founders to prematurely exit the business at the first opportunity". The measure of success in the VC biz is the IRR - the internal rate of return. that is driven as much by the ROI on their investment as much as the duration of the investment. any VC will take a 5x exit in 1 year instead of waiting in the hope of a 50x exit in 5. Therefore, just as you identified the nightmare scenario of being-30-plus-with-no-money, the worst-case scenario for a VC is the following - a financially successful company generating ample profits with healthy salaries for all involved, but with no exit in sight. in VC parlance these companies are called the "living dead".
in short, VCs will insist in striking a deal that maximally aligns the entrepreneur to look after the VCs interests (motivation to exit). the entrepreneur will try to maximizing his/her interests (giving up minimal equity, keeping a decent amount of salary, and maintaining the flexibility of when to exit).
Posted by: gunjan | February 1, 2007 12:20 AM
I agree with Sanjay to the argument of Sanjay to the level that taking pay cut is a way of signalling committment ( http://en.wikipedia.org/wiki/Signaling_(economics) ) but agree to you when you say that making it an end rather than the means is going to tax the entreprenuer heavily.
But then the venture business ( note I am not saying entreprenuership) is hit or miss business. :)
Rajan
Posted by: Rajan | February 2, 2007 01:22 AM
Please w do you mean exactly by the words
Enterpenuership- ?
Entrepreneur ?
Thanks
Alicia Neu Carrion
Posted by: Alicia Neu Carrion | February 2, 2007 11:22 PM
Hey gaurav,
Whatever happened to New Delhi Times 2.0
Posted by: Kris | February 3, 2007 09:09 PM
Thanks for the comments folks. The point I was trying to make was that an entrepreneur is taking a significant risk even without taking a big salary cut. For an angel round, I agree that a pay cut (or even no salary) is expected. But when a VC comes in and pumps in a few million dollars into a business, it might be short sighted to insist on low salaries for founders.
Gunjan, your insight on the "living dead" companies is interesting. I can easily see that happening to many companies which can get very profitable but might not provide significant exit options!
Kris - NDT2.0 will happen! Am just a little too tied up with work these days. Need to get back into the groove soon!
Posted by: Gaurav | February 4, 2007 09:11 PM
Same Q as Kris, I also have. Everytime I visit this blog thinks -might see a New look of New delhitimes.
Work and all are excuses. Now change it. :)
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Posted by: nazish | May 9, 2007 11:01 AM
Hey all,
I would primarily go by Gaurav's comment with the following possible options for a entrepreneur.
1. We should remember, that the Indian ecosystem for product entrepreneurs is just starting to build up. Its unlike the US system
2. To vouch for a high risk / high rewards proposition, the entrepreneur should be ready for a pay cut, even if it does not match the average industry standards.
3. But the Angel investors, or the VCs, also should keep in mind, when the guy is ready to put his 24X7, personal sacrifices and commitment, paying his bills and his covering his liabilities should be an open option.
4. The entrepreneur should be ready for a 6 months contract negotiation of pay cut.
deeps
Posted by: Deeps | September 23, 2007 08:19 PM