Founder compensation: Basic ideas, approach, and possible implementations

Summary

Who should be entitled to receive founder:inside compensation? What should be the maximum amount? What are the concrete needs? How, when and in what amount? Since it is often difficult to decide on the amount for start-ups, a process can be defined, for example, which is started at a certain point in time.

The basic idea behind founder compensation

Steward-ownership is based on the idea that individuals within a company should be compensated for their roles, responsibilities, and performance, rather than simply for their status as shareholders. The principle of self-determination ensures that steward-owners, who hold voting rights, are actively involved in the company. However, during the startup phase, it is often not feasible to compensate all employees for their services, and if compensation is provided, it is typically well below market value. In classical startups, this uncompensated work is later reimbursed through dividends or the sale of shares during an exit. For steward-owned companies, founder compensation can also be provided for these services, as is common among many startups. Ultimately, compensation is dependent on the company's development and success. This document provides an overview of how to approach individual founder compensation, what factors typically influence the amount of compensation, and the role of the controlling shareholder in the process.

The decision regarding the compensation for the founder and the appropriate amount is a highly personal and individual question that requires personalized attention. One must acknowledge and identify their own subjective needs to arrive at an appropriate solution. The following descriptions are intended to provide a framework and inspiration for approaching the topic but cannot replace the need-based approach described above.

Approach and factors

The first step is to understand the compensation range that the founders are looking for by examining their needs and wishes. This should move from abstract monetary compensation desires to specific answers to the following questions: How much? When? Why? The answers to these questions should provide a general understanding of the needs and perceived demands of those involved and facilitate a discussion about them.

The "why" question is particularly critical in the subsequent process, especially when dealing with a controlling or veto shareholder (in case veto power needs to be exercised). Therefore, you can find a list below of some of the factors that typically influence the argumentation for the amount of compensation:

Salary sacrifice: Salaries from previous professions or comparisons from the industry are often used as a benchmark.
Invested capital: Share capital and other investments in the company can be included in the consideration with interest.
Risk and Commitment: A factor or amount for the risk the founder (s) took (and all the sleepless nights).
Time in the company: The payment of compensation itself can also be linked to a certain length of service in the company.

If the Purpose Foundation is to become the controlling shareholder

The following applies to Germany: If the Purpose Foundation or the Purpose Stiftung gGmbH is to take over the administration of the veto share in order to safeguard the principles of steward-ownership, the founder compensation will also be reviewed as part of the "Veto-Share Check". For this purpose, a proposal for the amount and design of the founder compensation should be written and handed over to the Purpose Foundation for review.

The assessment of whether the company's proposal aligns with the idea of steward-ownership is based primarily on the following criteria:

The compensation is capped.
Compensation should be reasonable and coherent with the responsibilities and role(s) assumed by the founder(s). The following factors are often considered by companies (see above):

Salary sacrifice (relative to time).
Monetary investment
Risk

In addition, there is a needs-based component, which considers factors such as retirement provisions or the life situation of the founder(s).
Compensation may be linked to the performance of the company, but it should not be speculative or create incentives that would influence the management of the company to the detriment of its long-term purpose.

Founder Compensation and Financing

If the compensation for the founder(s) has been determined, it is mostly relevant during negotiations with investors. From the investor's perspective, there is often a need to ensure that the compensation is in line with the liquidity requirements of the investors. In such cases, you may be required to provide further explanation about the amount and modalities of the compensation, especially in relation to the investors' profit claims.

Idea

Imagine that you are standing on a stage and reporting on the topic of steward-ownership and your company. Then, the question of how you addressed founder compensation comes up. You have to explain how you arrived at your compensation. How does your explanation to the audience make you feel? Your answer doesn't have to and shouldn't suit everyone, but you can use this question to reflect on what feels authentic and coherent to yourself.

Possible methods of implementation (non-legal)

The following compensation solutions have been implemented so far by steward-owned companies:

There is no need for founder compensation: Sufficient security can be generated to meet their needs via a salary, possible salary increases, bonus payments if the company is doing well, and other steps, such as company pension plans. In fact, this approach is implemented by many steward-owned companies.
In a start-up situation, it can be difficult to determine appropriate compensation levels. Therefore, a process or timeline should be established to clarify compensation in the future. For companies that use the Purpose Foundation as a veto-share service: If compensation is based on profit distribution (whether hidden or not), it must be approved by the Purpose Foundation, which will assess it according to the criteria mentioned above.
Some start-ups also develop a model that allows them to calculate compensation for the future at the time of founding. The actual amount of compensation is then determined by the model. The compensation itself is then paid at a later date, and the instrument is also determined then.

Legal implementation

As with the entire process towards steward-ownership, the legal implementation of founder compensation should be addressed as soon as the needs have been clarified. The choice of legal instrument depends heavily on when, how much, and how the compensation should flow back to the founders/early employees and cannot be answered in a general manner. You can read more about different instruments in Financial security for entrepreneurs

For German companies, however, we generally recommend using contractual instruments for implementation, particularly because a later transformation into a possible legal form (in Germany) for steward-ownership is easier to achieve. The individual implementation, especially for larger amounts, should be developed or coordinated with a tax advisor and corporate legal counsel.

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Published by: Purpose Schweiz

Graphics and illustrations: Purpose Stiftung