Do You Pay Yourself First or Last?

December 18, 2013

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“So you pay yourself last?” That was the summary of an entrepreneur friend gave upon learning the economics of VC. Thought it was an interesting way of phrasing it, and applies more generally to one’s approach in creating value: do you pay yourself first or last?
Quick primer on the way VC works:

• You raise a fund from which to invest
• From this fund you get paid a management fee each year and then a percentage of the profits ultimately made after returning the entire initial investment to your limited partners (you pay back your management fees before you consider the fund “returned”)
• “Standard” terms are 2&20 – 2% annual management fees and 20% of the profits. I put standard in quotes because there’s room for negotiation based on your track record, size of fund, length of fund, etc
• If you’re raising a big fund every few years, your firm is often starting off with millions of dollars of management fees before you’ve even invested a dollar. This is why it’s ok to let big time VCs pay for your dinner. And why LPs don’t like mediocre investors, because they’re perceived to be getting fat and happy without creating value

If you’re Homebrew, a first time $35m fund, well, you can do the math. We’ll still buy you dinner but it might be more like a pizza and six pack than Saison. Let me be clear, I’m not claiming poverty. Homebrew pays me a salary less than I earned in 2001 but definitely have the potential to make substantial returns in profit sharing if we do well. Nothing wrong with that. But the only way we do that is to take the attitude of paying ourselves last.
If the entrepreneurs we back succeed (both economically and in being proud of what they’ve built – that’s our double bottom line), then our investors get their target returns and we see our share. Satya and I were very intentional to not try and innovate on our approach to startup cap tables or LP agreements. We want our pockets bulging because we’re producing results – and being able to raise a fund was just the starting gun, not the end game. This isn’t unique – there are many other VCs who think the way we do – although maybe not everyone
Remembering back to when I worked at Google, I took a similar approach, albeit not always to my benefit. I never did the “I’ve got an offer from Facebook so give me more money” dance. Many folks I know did. Some did it multiple times. I likely have colleagues who were lesser performers but had larger W2s because of their ability to find points of leverage and exploit them. I do that now, but I do it on behalf of my investments.
Am I jealous of those who did it on behalf of themselves? To be honest, kind of. But envy about the past isn’t productive energy. I was in the 1% economic class during my Google days. What would I rage against – that I wasn’t in the .5%?
Do you want to be paid enough, be paid fairly or be paid the most? I tend to be in the intersection of enough and fairly. But I’m also human, so I get my dander up when the folks with the most money seem to have gotten it without performing (which of course is just a personal value judgment full of its own bias).
The point of all this? Only some advice:

• Focus on paying yourself fairly but last
• Grow the pie before taking your piece. It’ll go better than seeing the pie as fixed and fighting for a disproportionate slice — and I think ultimately lead to great wealth for you if you’re any good

Oh, and any time I write about compensation, I link back to Mark Suster’s great 2009 post: Time to Learn vs Time to Earn.
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Hunter Walk

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