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The Founder Discount

Posted on October 10, 2006

The latest podcast in Pascal Levensohn’s VC-IO entrepreneur series came out today and the subject matter was CEO compensation and the founder discount. Compensation in start-ups is something I am very interested in and, as long time readers know, I have talked about ways compensation could be structured differently to better align entrepreneurs with VCs (the previous link is to the first in a string of “fixing the VC model” posts). Little did I know that there was a man by the name of Noam Wasserman, Harvard Business School professor and blogger (I am now subscribed to his feed), who has done a lot of research in this area.

The fifteen minute discussion that ensues between Noam and Pascal on the podcast covers a lot of material so I will highlight some key points here although I suggest listening to the whole thing if you can.

• Difference in (cash) comp between founders and non-founder averages $30k per year in the non-founders favor
• This gap persists in booms and busts
• There are some voluntary (take a pay cut to keep the burn rate down) and some non-voluntary (board won’t give founder CEOs a raise since they know the founder doesn’t have any ground to stand on because the business is their “baby’) reasons for this gap
• As the company grows the gap starts to disappear
• About 50% of CEOs in the study make the same or less than one of their subordinates and almost all of the 50% are founder CEOs
• Non-founder CEOs are less aligned with investor interests
• Equity is an important thing to consider but these findings take equity into account

As Pascal asks in the podcast - Why should we care about this? Isn’t this what being an entrepreneur is about? Taking pay cuts to work on your “baby” and to gain on the upside of your equity stake? At first blush caring about this may seem silly but when you look deeper you can see that there are significant issues brought on by compensation.

Founders will eventually be faced with hiring non-founders that get paid more than they do at which point they will begin to wonder why they are worried about saving that extra $30k for the company. The founders can also become distracted by their lack of pay and begin to lose focus on the business. In these cases, if the founders were just paid adequately they would be able to focus more on the business and less on how they are going to pay their bills and whether or not they may ever see any upside on their equity stake (this could be another case for partial founder buyout although PFB has its’ drawbacks as well).

Founder compensation definitely plays a role in how a company will move forward and I know I will continue reading Noam’s blog for the latest in compensation and other studies on how non-founders and founders differ.

Noam’s latest paper on founder/CEO compensation can be found in the October 2006 issue of the Academy of Management Journal and is one of a series of papers dealing with the differences between founders and non-founders.