Sometimes, what derails a deal isn’t the science, IP, or market opportunity. I’ve seen many promising companies lose investor interest because of founder compensation and the signals it sends about the alignment between founder and investor incentives.
Investors want founders to build wealth alongside them, through the appreciation of founders’ equity ownership rather than through cash compensation. In the early stages, founders are compensated with equity and moderate salaries to conserve cash, allowing more investment dollars to go toward achieving milestones. As the company hits milestones and becomes better funded, compensation can be adjusted with each subsequent fundraising round. However, founder compensation should not create the impression that founders are becoming complacent with comfortable salaries. Investors want founders’ primary economic incentive to remain equity in the company to drive a successful exit for the investors. The last thing the investors want to fund is a perpetual lifestyle company where the founders are simply collecting paychecks.
Founder loans and deferred compensation are other areas that attract scrutiny. Sometimes, founders personally finance the company or defer their own pay to keep the business alive. Those decisions can demonstrate commitment. However, they also lead to questions about how and when those obligations will be repaid. Investors want to understand the amount owed to founders and how those obligations are structured (for example, whether the loan accrues interest). More importantly, investors will try to assess whether it represents an early liquidity event for the founders, reducing the founders’ financial risk while investors are being asked to risk their own capital. The issue is not necessarily the amount, but the signal it sends. Even if some investors are comfortable with the repayment, they recognize that it could become an unnecessary point of friction in the current or future financing rounds. Keeping the capital structure clean makes it easier for subsequent investors to focus on the business rather than founders’ financial arrangements.
Investors expect founders to be compensated fairly. What matters is alignment. Compensation should enable founders to focus on building the company without creating the impression that financing is being used primarily to provide liquidity to founders. The closer the alignment between founders and investors, the fewer distractions there will be during fundraising.
Fundraising is ultimately about trust, and compensation structure is one of the ways investors assess whether founders and investors are working toward the same goal. That’s why investors pay attention to founder compensation.
The observations shared in the From the ChaosBio Review Desk series are generalized lessons drawn from reviewing early-stage life sciences companies. Company identities, specific technologies, and other confidential details have been omitted or modified to protect confidentiality. The views expressed are my own and are intended solely for educational and discussion purposes.