Should I include founder salaries in burn rate calculations?

Should I Include Founder Salaries in Burn Rate Calculations?

Understanding your startup💡 Definition:A small business is a privately owned company that typically has fewer than 500 employees and plays a crucial role in the economy.’s burn rate is crucial for financial planning💡 Definition:A strategic approach to managing finances, ensuring a secure future and achieving financial goals. and ensuring long-term sustainability. One common question founders face is whether to include their own salaries in these calculations. The answer is a resounding yes. Including founder salaries provides a true picture of your operating costs💡 Definition:Costs incurred in running a business that can reduce taxable income and improve cash flow. and helps in realistic financial planning, particularly when attracting investors. Below, we delve into why founder salaries are essential in burn rate calculations and how to incorporate them effectively.

Why Include Founder Salaries?

Accurate Operating Costs

Founder salaries are a significant part of your startup's expenses. Including them in your burn rate calculation ensures you have an accurate understanding of your true operating costs. This is critical for making informed financial decisions and avoiding future cash flow issues.

Investor Expectations

Investors expect to see realistic expense modeling, including founder salaries. This transparency demonstrates sound financial planning and assures them that you understand your cost structure. Excluding these salaries could raise red flags about your financial management capabilities.

Planning for Future Salaries

Even if founders are currently working for reduced pay or equity💡 Definition:Equity represents ownership in an asset, crucial for wealth building and financial security.-only compensation, planning for market-rate salaries is vital. This approach prepares your company for the point when founders will💡 Definition:A will is a legal document that specifies how your assets should be distributed after your death, ensuring your wishes are honored. need to draw a salary. It helps in 💡 Definition:A spending plan that tracks income and expenses to ensure you're living within your means and working toward financial goals.budgeting💡 Definition:Process of creating a plan to spend your money on priorities, including fixed expenses like pet care. for future expenses and avoids unpleasant surprises when the time comes to adjust compensation.

How to Include Founder Salaries in Burn Rate Calculations

Gross vs. Net Burn Rate

• Gross Burn Rate: Incorporate all operating expenses💡 Definition:Operating expenses are the costs required to run a business, crucial for measuring profitability., including founder salaries. For instance, if your startup spends $50,000 on salaries (including founders), $10,000 on rent, and $15,000 on marketing, your gross burn rate is $75,000 per month.

• Net Burn Rate: Subtract your monthly 💡 Definition:Income is the money you earn, essential for budgeting and financial planning.revenue💡 Definition:Revenue is the total income generated by a business, crucial for growth and sustainability. from the gross burn rate. If your monthly revenue is $20,000, your net burn rate would be $55,000 per month.

Scenario Planning

Calculate two scenarios:

• Current Burn Rate: Reflects actual cash outflow, useful for current operations.
• Normalized Burn Rate: Includes market-rate founder salaries to show potential future expenses.

This dual approach provides a comprehensive view of both present and future financial needs.

Real-World Examples

Consider a startup with the following monthly expenses:

• Salaries (including founders): $40,000
• Rent and Utilities: $10,000
• Marketing: $15,000
• Total Gross Burn: $65,000

If the startup generates $30,000 in monthly revenue, the net burn rate becomes $35,000. This calculation includes founder salaries, providing a realistic assessment of the financial runway.

Adjusting Salaries According to Funding Stage

Founder salaries typically vary by funding stage:

• Pre-Seed: Minimal or zero salary to extend runway.
• Seed Stage: Approximately $100,000 annually.
• Series A and Beyond: Salaries can range from $183,000 to $250,000, aligning with increased funding and company growth.

Common Mistakes and Considerations

Excluding Founder Salaries

Excluding founder salaries from burn rate calculations can lead to underestimating cash needs. This oversight may result in premature cash shortages and financial instability.

Reasonable Compensation

Ensure founder salaries are reasonable and align with company stage and investor expectations. Excessive compensation can raise concerns about capital efficiency.

Excluding One-Time Expenses

Separate one-time expenses from recurring burn calculations to avoid distorting runway estimates. Focus on regular cash flow for an accurate picture of financial health.

Bottom Line

Including founder salaries in burn rate calculations is essential for accurate financial planning and investor communication. This practice ensures you understand your true cost structure and are prepared for future salary adjustments. By incorporating founder salaries, you align with industry best practices, paving the way for sound financial management and sustainable growth. Always strive for transparency and accuracy in your financial models to maintain investor confidence and ensure your startup's success.