Most founders in the early stages of their startup agonise over every dollar spent. And paying yourself or your co-founder a salary will limit how much capital you have to inject into your startup. However, it’s not sustainable (nor nutritious) to survive off canned tuna.
In our experience, founders typically wrestle with two questions:
- Can I pay myself or my co-founder with sweat equity, instead of a minimum wage? and
- When should I start paying myself a market-rate salary?
We’ve set out some rules to help guide you around when you should go about cutting yourself a cheque. In particular, what you are legally entitled to under Australia’s employment law, and how to maintain cash flow in your business.
Can I Pay Myself With Sweat Equity?
A founder usually forfeits a market-rate salary in the early stages of their business and is compensated instead through shares (also known as a ‘sweat for equity’ arrangement).
If you or your co-founder work full-time in your startup in exchange for equity, you might also be an employee and would likely have a written employment contract.
Under the Fair Work Act 2009 (FWA), an employer must pay an employee at least the national minimum wage. From 1 July 2018, the national minimum wage for employees not covered by an award is $18.93 per hour. Or, approximately $37,405 a year (before tax) for a full time (38 hours per week) employee. Even if the employee and the employer agree, an employer cannot lawfully pay the employee below minimum wage.
If your startup doesn’t pay its employees the correct minimum wage entitlements, it will breach Australia’s employment laws, and your company (as well as its directors) may need to pay significant fines.
So it’s important that you have a document in place setting out what work you are performing for the business and how you are compensated for that work.
What if I’m the Director and the CEO/Founder?
If you are a founder and director of your startup, but not an employee, you may be paid directors’ fees for performing key duties. These duties are usually agreed by a company resolution or set out in the company constitution, for example, managing the board. In this situation, a director is not entitled to minimum wages under the FWA.
But it’s rare that in the startup’s early stages, a founder would not work in the business as an employee.
Practically, a founder who is a director and an employee can help the business’ cash flow in the following ways:
- choosing to feed your directors’ fees back into the business through a directors’ loan; and
- authorising your employer (i.e. the startup) to deduct money from your wage (also known as a permitted deduction under the FWA). An employee (i.e. you) must authorise the deduction in writing, and it must be principally for your benefit. In this instance, you will derive the most benefit from your startup’s success as a co-founder.
We’ve set out the legal documents that you will need in the table below.
|Cash-flow Assistance||Legal Document||Key Terms|
|Directors’ Loan||Loan Agreement||
|Authorised Deduction||Addendum to your employment contract||
You should also review these terms every six months.
When Should I Start Paying Myself a Market-Rate Salary?
If you’re funding your startup through external investment instead of bootstrapping, it’s unrealistic to think about paying yourself a market-rate salary until you’ve raised seed funding. Experienced angel investors and venture capitalists understand the importance of a founder committing themselves 100% to the business’ success, so they will expect you to allocate a portion of the investment towards your salary.
If you’re raising capital to pay yourself and your co-founder a wage, remember that you will need to accept an equity dilution and this will impact your return from your business. So you should weigh up if it’s worth giving away a significant ownership percentage of your company for cash in your bank account.
How Do I Know How Much is Reasonable?
If you’re raising from a VC, you might see a founder salary cap included in the deal. This cap will depend on the round. In our experience, a standard cap for a seed round is $100,000 and between $100,000 – $150,000 for a series A.
When deciding how much to pay yourself, you should ask yourself the following questions:
- How much money have you raised to date?
- Do you have, or intend to bring on board, any co-founders? and
- When will you raise your next round?
When determining how much to pay yourself, it helps to look to other startup founders and see what is standard for your type of business and industry. If you are working in the business as an employee, ensure that you are receiving the minimum wage. And if you choose to pay your co-founders and employees through a ‘sweat for equity’ arrangement, ensure that you seek legal and tax advice to avoid falling foul of Australia’s employment laws.
If you have any questions, get in touch with LegalVision’s startup lawyers on 1300 544 755 or fill out the form on this page.
Glen Pauline contributed this article. Glen is a Practice Leader in LegalVision’s Disputes and Litigation team. He has significant experience in conducting litigation in both state and federal courts, tribunals and through alternative dispute resolution, particularly in employment matters. Before joining LegalVision, Glen practised as a barrister at the Victorian Bar for more than 15 years and since 2010, Glen has been a nationally accredited mediator.
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