Photo by Jeff Standen

Naturally, not all businesses have a choice of whether or not they’re going to be funded or bootstrapped. Some business plans will always require major equipment, inventory, real-estate, licensing or other initial costs that simply cannot be paid for by actual customers voting with their wallets. A software company, on the other hand, simply requires a computer, a desire to constantly learn new things, a great idea, and the ability to spend most of your day (or night) staring into the embracing glow of a computer screen.

When you aren’t bootstrapping a software startup you usually have the funds available to pay people a competitive salary, grant stock options, or give them an environment that’s so engaging they’re willing to trade a bit of their paycheck to work on “the next big thing”. Everybody can still pay rent. There likely isn’t a founder sitting there thinking about how many sales it takes to keep the lights on (just how many sales it takes to bank a million). The downside is you can spend too much time having fun in “abstract business plan land” and burn through your funding without setting up the infrastructure required to generate a sustainable money train.

When you are bootstrapping a software startup you usually can’t avoid setting up the infrastructure for creating the money train, because you likely wouldn’t survive more than a few weeks without something in place early on. This organic growth is incredibly dependable as things mature because you always know people are willing to pay for your expertise or service. There is nothing hypothetical about the plan. You can feel the pulse of your business, and the merit of your ideas, by the flow of cash from customers into your business. However, many homegrown businesses don’t get off the ground (or out of the spare bedroom) because of the glaring catch-22 prescribed by “it takes money to make money”.

(I think I’ve pumped the maximum amount of sunshine into the bootstrapping side of the equation.)

My current software company was born in the second camp, initially funded by credit cards and a lot of founder-donated, unpaid overtime. We had no lack of late nights spent clicking away on keyboards, appeasing compilers and cursing out Internet Explorer. Yet, 6 years ago, we sold our first copy of our first product within 2 months of picking a name and writing the first line of code. (yes, it was a time of many “firsts”).

Ever since that first early sale, we’ve adopted a policy of rapid development and letting sales be the barometer of how well we were spending our time. If we weren’t responding to community feedback, or we ignored glaring problems to work on more glamorous ones, money would stop flowing in and we’d go bust — or at the least we’d be playing a game of “rent, ads, electricity, health insurance, DSL. Pick any two.” We’ve designed the company to maximize that constructive pressure, and it persists even six years later.

This seems like a rather common-sense revelation at a glance: “people pay you more when you’re doing your job better, and less when you aren’t”. But it’s not that simple, because it’s so easy to separate sales and development into two isolated groups that only work together when, and because, they have to.

It’s much more difficult to tie every single founder and partner to the cashflow of the business, so that development knows how to help sales to its job and vice-versa. We can dig into that collaboration in future blog posts. For now, let’s skip ahead to what to do when money starts trickling in.

Obviously, if you have $8,000/month in early sales you can’t mandate that Dwight the lead programmer makes $75,000/year and Jim in sales has a base salary of $40,000/year plus commission. (If you haven’t had your coffee yet, the explanation is that those numbers add up to at least $9,584/month and don’t even include business expenses or other payroll — the money just isn’t there).

You certainly don’t want to start keeping an I.O.U. from the company to the partners, to be paid back “when you make money”. That is important, and it warrants repeating: Do not set up I.O.U. salaries.

All that is going to happen with an I.O.U. salary is complacency, and inevitably a founder will leave and expect to cash out their accrued “overtime” balance. If the company isn’t producing money, nobody deserves anything at the current point. You can’t avoid that if someone is leaving and divesting stock/options, but don’t fall into that trap with salaries.

However, it’s certainly a good idea to know roughly what each person is contributing and how that should translate to a realistic target salary. The process of determining that should be transparent and candid, and involve all the partners. In our previous example, if sales balanced perfectly with payroll, Dwight would take a 65.2% split and Jim would take a 34.8% split. Those splits are distributions of profits, as you always have to pay business expenses first.

What I would advise for Dwight and Jim is this:

1. Set up a simple spreadsheet with three columns. The middle column would hold the target salaries, the column to the left would hold a scenario of “less than ideal” income, and the right column would be “bonus” income.

2. The top of the spreadsheet, above the salaries, would contain all the immutable expenses of the business, such as: rent, DSL, health insurance, ads and utilities. There should also be a miscellaneous category of historically-averaged discretionary spending (for books and snacks), and a “slack” category to ensure some profits are returning to the company every split. The slack can be used as a buffer during bad weeks, or as a war chest for investing (e.g., hiring new people, expanding, unexpected expenses or repairs, or literally investing in some asset).

By my plan, the amount distributed to the buffer is completely arbitrary and might change often or cease entirely after a specific amount is saved. It really depends on everyone’s comfort level, but you should strive to split as much of your early profits as possible.

If you chase the pot of gold at the end of the rainbow too long, you’re going to get there alone, in poor health, with less friends than you started with — if you get there at all.

3. Every Friday the gross income should plug into the top of the spreadsheet. It should then percolate through the expenses and buffer (which are represented by their weekly costs). The resulting remainder is the net profit. This is the amount you actually have available to pay everyone.

Set up the spreadsheet to use the middle column (salary targets) as percentages. These establish the proportions for the columns on either side. For example, the ideal salaries from the example above required $9,600 per month, which is about $2,240 per week.

If $1,500 of net profit comes in the door this week, Dwight gets $978 (65.2%) and Jim gets $522 (34.8%).

If $3,000 of net profit comes in the door this week, Dwight gets $1,956 (65.2%) and Jim gets $1,044 (34.8%).

The reason you set up 3 columns is so you can play “what if” with your income during the week (better or worse than the goal). Usually I have the current income in the left column until it passes the goal, and the right column is always set to an attainable bonus goal to give us something to constantly strive toward.

4. At some point, it’s no longer going to be realistic to split 100% of the profit between the partners. At our company we currently set this cap at 120% of our target salaries, as long as we have a good business use planned for the remainder (buying more ads, hiring more people, investing in more assets). We won’t cap splits if the only thing we can think of doing is creating a big pile of “buffer” money and then swimming around in it.

5. Re-balance the target salaries when you’re constantly passing them or when you add new partners.

As you can imagine, it takes a lot of trust and candor to set up a system like this, where everyone can plainly see how much the business values their input against everyone else. Target salaries should be established by the group and voted on. If you’re running a proper meritocracy (this is the software industry, after all!) it’s probably pretty clear to everyone already what is brought to the table in terms of time, experience and talent.

If you don’t think your group can handle individualized valuations, then just establish salaries per role. But leave yourself the option to reward all-stars. You can quickly rationalize to the naysayers that this person will make slightly more, but so will everyone else though their efforts at boosting the overall income. You don’t want to burn out an all-star any more than you want to constantly cater to a naysayer.

Having the burden of expenses clearly shouldered by (and apportioned to) the entire group also helps trim needless spending from the startup’s budget.

We’ve carried this system into our 6th year of business and adjusted it as new partners came on-board or our expenses grew. We’ve added payroll employees as expenses at the top of the spreadsheet. We’ve regularly gone through the expense categories as a group and looked for waste. This transparent system has focused everyone’s eyes on the bottom line — and we’re a leaner and more efficient company because of it.

If you’ve bootstrapped a startup with full-time partners, how did you decide to distribute cash before there was enough to go around?