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- The Hidden Cost of Founders
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Today I’ll teach you a trick to use when evaluating startups.
It teaches you to look for something that doesn’t exist on a startup’s balance sheet.
This trick can expose a critical flaw in a startup’s entire business model - and be the difference between a good/bad investment
Let’s get into it, after a word from our partner and some hot startups that are raising funds right now.
Startup PromoTix ($48M in traction) is saving the events industry
PromoTix is solving the event industry’s challenges around high ticket fees and low attendance. Ticketmaster and competitors charge up to 40% of the ticket price to book, deterring guests who can’t afford the added cost. Combined with a crowded marketing space, events struggle.
PromoTix is raising funds to expand. Already profitable, with 656k users and $48M in sales in its first 30 months, PromoTix has low-fee and no-fee SaaS pricing, as well as patented marketing tools that drive attendance.
NEW STARTUPS
Startups that you can invest in with as little as $100 right now:
⚛️ Atombeam - they crossed $3M within a week, you know I like this one (LINK)
🐶 GoodWag - the easiest way to deal with pet waste (LINK)
🫰 Ove Touch & Go - fingerprint payments for businesses (LINK)
THE HIDDEN COST OF FOUNDERS
Did you know that you can easily see how much a founder is paying themselves?
On a startup’s raise page, they typically link to several documents that are required by the SEC.
The Offering Circular document always contains a section titled ‘Compensation of Directors and Officers’.
Here you can see the exact compensation that the founder and other executives at the company receive.
For example, Boxabl’s two founder each made close to a million dollars in 2023:
These salaries will show up in the startup’s cash flow statement, which can be pivotal to understanding how profitable (or non-profitable) a startup is.
On a cash flow statement, salaries paid to employees are usually included under the ‘General and Administrative’ line
The cash flow statement is critical to understanding the health of the business - among many things it lets investors know if more money is coming in than going out.
WAIT, SOMETHING’S MISSING
Sometimes, founders will forego a salary in the early days of a startup.
Preserving cash in the early stages is mission-critical, and some founders will elect to instead put that money into the business.
This is generally perceived as a good thing - if a founder’s only compensation is their equity, the incentives are aligned for them to maximize the value of the company.
Founders are typically willing to take a $0 salary in the early days of the startup, but not past that.
They’ve got bills to pay too, and can’t live off of equity (which is illiquid).
As an investor, it’s important to anticipate a founder’s future compensation when determining the strength of a startup’s business model.
For example, you may be considering a startup that’s showing a $20,000 profit for the year. However, the startup’s two founders are currently not taking a salary as they grow out the business.
You should anticipate that the founders will eventually take a salary, each within the range of $100k - $300k (this can vary wildly depending on the size of the startup).
The business above appears to be sustainable since they are bringing in $20k in profits. But we know that’s not the full picture - there are two ticking salary bombs about to go off.
Let’s say the 2 founders each elect to take a $200k salary for their hard work (2 x $200k = $400k).
Now, this startup swings to a -$380,000 loss.
Perhaps not as sustainable of a business as we once thought.
SO HERE’S THE TIP:
Look at a startup’s offering circular to see if the founders are being compensated with salaries yet
If they are NOT, then factor in a ~$150k salary per founder to the cash flow statement
See how much revenue needs to increase to cover the cost of these salaries
Determine if this is a feasible amount of growth to achieve, which will help inform you decision to invest
Sometimes, you actually don’t have to estimate a founder’s salary if it’s not included. Companies may identify in their Offering Circular a compensation plan for the founder.
The planned salary is usually tied to fundraising and revenue goals. I’ve seen many that stipulate something like: ‘the founder will receive a $125,000 salary upon reaching $500,000 in revenue or raising $5M in funding’.
As we close out, just remember - it is okay if a founder is not taking a salary (I usually view this as a positive signal).
Just make sure that the business model remains viable once you add the anticipated salary into the equation.
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