Monday, October 01, 2007

VC and Founder Compensation are so totally different

Sramana Mitra has an excellent post about how skewed compensation is at startups. (Emphasis mine)

As for the compensations, General Partners at Venture Firms make anywhere between $1 Million to $3 Million a year without counting performance incentives. The carry is all upside.

In contrast, the poor entrepreneur bootstraps a startup, takes enormous risks, and if (s)he raises venture money, the first thing a VC does is to restrict his/her salary to a minimum.

Only one out of 50 startups succeed (or may be one out of 100, I don’t know the exact ratio), so the equity component of the compensation package rarely pays off after the liquidation preferences, etc. are settled.

1) For the entrepreneur, the compensation as salary is kept absurdly low by the VCs. And their equity returns are kept even lower with liquidation preferences, drag-alongs and such. The argument usually starts with saying that the founder needs to have the hunger and then moves quickly to "the golden rule is that the man with the gold makes the rule".
2) VC managers on the other hand have "carry" as an unrequired bonus, and get fat paychecks thus ensuring that their success is not linked to the success of their investments.

Patently unfair you think? There are simply two different kinds of skills: Fund raising for further investment, and fund raising for a startup.

The attitude of the former is: "Listen, I have this deal for you. You give me [x] million bucks. I then take a fat paycheck out of that as a 'management fee'. I invest the rest into some 10 companies. One of ten investments might succeed. I say might, it's like saying the sun might rise from the west. If anyone does make it, I get a piece of the profit. If they all go down the drain, you lose all your money, and I still get my paycheck. No I don't know which companies or even the broad area I'm targeting, but I'll choose them, that's why you're giving me money. If we go down the drain, then it's your money, not mine.".

When it comes to the entrepreneur raising funds, it's like: "Listen, I have this great idea. It's not just an idea. I've got a prototype. And this fantastic team. We have to work on bare minimum salaries? No problem. All our equity goes back and vests over four years? Uhm, ok. And if we fail you get your money first and then us? Ah, ok. Then you can fire us and we lose unvested stock? Oh, fine. And you want a drag-along so if you feel like the roses didn't smell good that morning you will sell my company and I *have* to sell my shares too? ok. Do you want me to bend over and grease up as well?"

Isn't it ridiculous then that venture capitalists find entrepreneurs "arrogant"? No wonder successful founders always tend to go and set up funds of a very different variety or start really helping other founders (like VentureHacks).

But closer home, there are very few instances of founders crossing the chasm, one of them being Alok Mittal of Canaan Partners, who also runs VentureWoods. (Disclosure: I have posted there earlier). Another founder - Prashant Prakash of Netkraft - co-manages a seed level fund named Erasmic.

Unfortunately some "angel" funds in India seem to ask way too much of the founders. Questions like these, requested by a member of the Indian Angel Network, seem to demand a lot an angel level presentation: while questions about the team, competitors, market etc. seem to be on the line, needing analysis of stuff like SWOT, IP (which is a ludicrous thing in India, I feel), marketing innovations (which I could game easily), "are you getting good sales/adoption?" etc. are simply premature (and do not belong in a pitch, they should be in an exec summary or q&a on the pitc). This isn't angel investing, it's a more like an early stage VC.

Note: I've just started Moneyoga which is a stock market website (still being constructed) and we have been thinking a lot about whether to get institutional funding. The decisions we're making is going to sound astounding when we write about them and look positively arrogant, but I think that there's a position where a lot of things come together, and give us a good life and excellent returns. Will talk about it when our stuff pans out.


RYK said...

good post, why don't you post this on VW where you'll get lots of interesting comments

Deepak Shenoy said...

RYK: thanks for that - will do so, a little bit later since I've just posted there a couple days back. Some commenters seem to not like it if anyone posts too often there!

But point taken, that's a far better place to post such stuff.

income.portfolio said...


Very interesting perspective.

VC vs. founder compensation also depends on (i) type of idea - iterative change, revolutionary, or short term business proposition; (ii) type of product - software vs. hardware; (iii) realization potential - short term, intermediate term, long term.

In the end, VC are also in money making business. These guys are smart and have listened to umpteen proposals. VC tend to ask for higher compensation on software/iterative product. For revolutionary stuff, I think they will have a fair sharing proposal. If there are ten VCs clamoring for the same project, I bet founder will get more.

just an observation...

Best Regards,

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