Should Startup Founders Take a Salary? Legal, Tax & Business Considerations Explained

Yes, startup founders can take a salary, but whether they should depends on the startup's financial position, stage of growth, investor expectations, and legal structure. A founder's salary should be reasonable, properly approved, documented, and compliant with applicable corporate and tax laws. Depending on the business structure and circumstances, founders may also receive dividends, equity-based compensation, or other lawful forms of remuneration.

Can Startup Founders Legally Take a Salary?

Yes, startup founders can legally take a salary, provided the payment is permitted under the applicable legal structure and properly authorised. A founder is not automatically entitled to a salary merely because they own shares in the company.

General Legal Position

The legal position depends on the startup's business structure and the founder's role. In a company, a founder who also works as a director or employee may receive remuneration subject to the Companies Act, 2013, the company's constitutional documents, and applicable approvals. The Articles of Association (AoA) may also contain provisions concerning the appointment, powers, and remuneration of directors. Therefore, the company should ensure that the proposed remuneration is properly authorised and recorded.

Difference Between Founders, Directors, And Employees

A founder is a person who establishes or helps establish the business, while a director is appointed to the company's Board and performs duties under company law. An employee works under an employment arrangement and receives remuneration for their services. One person can hold more than one of these roles. For example, a startup founder may also be a director and an employee. In such a situation, the salary or remuneration should correspond to the person's actual role and comply with the applicable corporate requirements.

Whether All Founders Can Receive A Salary

Not necessarily. All founders do not automatically have a right to receive a salary. Whether a founder is paid depends on their role, the company's financial position, applicable approvals, contractual arrangements, and the terms of the AoA or Shareholders' Agreement (SHA) where applicable. For example, two founders may own equal shares in a startup, while only one works full-time as an executive. The company may therefore structure remuneration differently based on their respective roles, provided the arrangement is legally authorised and properly documented.

Also Read: Shareholders’ Agreement vs. Articles of Association

When Should a Founder Start Taking a Salary?

A founder can start taking a salary when the startup can reasonably afford the expense and the remuneration is justified by the founder's role and responsibilities. There is no single stage at which every founder should begin drawing a salary. The decision generally depends on the startup's financial position, funding structure, cash flow, and the expectations of investors or other stakeholders.

Pre-Revenue Stage

At the pre-revenue stage, founders often keep salaries low or defer remuneration to preserve cash for product development, hiring, technology, and other essential expenses. However, a reasonable salary may still be appropriate where the founder is working full-time and requires regular income to continue operating the business.

Bootstrapped Startups

In a bootstrapped startup, the founders are using their own funds or business revenue rather than external investment. A founder may start taking a salary once the business generates sufficient recurring cash flow to support the payment without affecting essential operating expenses.

Revenue-Generating Startups

Once a startup has stable revenue, founders may consider introducing a regular salary. The amount should be aligned with the company's financial capacity and the actual responsibilities handled by the founder rather than being based solely on ownership percentage.

Venture-Funded Startups

Founders of venture-funded startups can generally receive salaries, but investors may closely examine the amount and structure of founder remuneration. The salary should ordinarily be commercially reasonable and consistent with the company's financial plans and the terms agreed with investors.

Growth Stage Businesses

At the growth stage, a founder may receive a salary comparable to the remuneration of executives performing similar responsibilities in the industry. As the company's operations, workforce, and revenue increase, the founder's compensation may also be reviewed periodically.

How Should a Founder's Salary Be Decided?

A founder's salary should be determined through a documented and commercially reasonable process that considers the company's ability to pay, the founder's responsibilities, market benchmarks, cash flow, investor expectations, and the approvals required under the company's governing documents and applicable law.

Company's Financial Health

The company's revenue, profitability, available cash, liabilities, and projected expenses should be considered before fixing the salary. A salary that places unnecessary pressure on a cash-constrained startup may not be commercially sustainable.

Founder Responsibilities

The founder's role and level of responsibility should influence remuneration. A founder acting as the chief executive and managing employees, operations, fundraising, and strategy may reasonably receive different remuneration from a founder who has limited involvement in daily management.

Industry Benchmarks

Comparable salaries for similar executive roles in the relevant industry and geographic market can provide a useful reference point. Benchmarks can help establish whether the proposed remuneration is commercially reasonable.

Cash Flow

Cash flow is particularly important for early-stage startups. Even a profitable-looking business may have limited available cash because funds are tied up in receivables, inventory, expansion, or other working-capital requirements.

Investor Expectations

Where external investors are involved, the founders should review the investment documents and any applicable Shareholders' Agreement (SHA). An SHA may contain provisions relating to founder remuneration, investor consent, reserved matters, or financial controls.

Board And Shareholder Approvals (Where Applicable)

Where the founder is also a director, remuneration must comply with the applicable requirements of the Companies Act, 2013 and the company's Articles of Association (AoA). Depending on the nature and amount of remuneration, the required Board or shareholder approvals may apply. The company should maintain proper records of the approval and remuneration arrangement.

Founder Salary vs Dividend vs Equity: What's the Difference?

Salary, dividends, equity compensation, and founder withdrawals are different ways of receiving value from a business, and the applicable legal and tax treatment can differ significantly. The appropriate option depends on the business structure, the founder's role, the company's profits and cash position, and the terms governing the business.

Salary

A salary is compensation for services performed by a founder as an employee or, where applicable, as a director receiving remuneration. It is generally paid periodically and is treated differently from returns received merely because the founder owns shares.

Dividend

A dividend is a distribution made to shareholders out of profits in accordance with applicable company law. A founder does not receive a dividend merely for working in the company. The founder must hold the relevant shares, and the company must satisfy the applicable requirements for declaring and paying dividends.

ESOPs/Equity Compensation

ESOPs or other equity-based compensation provide an ownership interest or an opportunity to acquire an ownership interest under the applicable scheme. Unlike salary, equity compensation is generally linked to the long-term value of the business rather than being a fixed periodic payment.

Founder Withdrawals (Where Applicable)

Founder withdrawals are treated differently depending on the legal structure. For example, a proprietor may withdraw funds from a proprietorship, while partners may make drawings from a partnership subject to the partnership arrangement. These withdrawals should not automatically be treated as salary.

What Legal and Tax Rules Apply to Founder Salaries?

Founder salaries are subject to both corporate and tax requirements. Where a founder is also a director of a company, the remuneration must comply with the applicable provisions of the Companies Act, 2013. The tax treatment, TDS, payroll obligations, and accounting treatment are governed by the applicable provisions of the Income-tax Act, 1961 and related rules.

Director Remuneration

Where a founder is also a director, remuneration must be structured in accordance with the Companies Act, 2013 and the company's governing documents. Depending on the type of company and remuneration involved, the prescribed Board or shareholder approvals and other statutory requirements may apply.

Employment Contracts

Where the founder also works as an employee, the salary arrangement should be properly documented through an employment agreement or other appropriate contractual documentation. The agreement can specify the salary, benefits, responsibilities, and other terms of employment.

Tax Implications

Salary received by a founder is generally taxable as income under the Income-tax Act, 1961, subject to the applicable provisions. Its treatment differs from dividends, capital gains arising from equity, or drawings by partners or proprietors. The founder and company should therefore determine the appropriate tax treatment based on the actual nature of the payment.

TDS And Payroll Compliance

Where applicable, the company must comply with the relevant Tax Deducted at Source (TDS) and payroll requirements when paying salary. Proper deductions, deposit of tax, reporting, and issuance of applicable tax documents should be completed within the prescribed requirements.

Accounting Treatment

Founder remuneration should be correctly recorded in the company's books as an appropriate business expense or remuneration entry, depending on its nature and the applicable accounting framework. Proper documentation, approvals, payroll records, and payment records help demonstrate that the remuneration was authorised and correctly accounted for.

Can Investors Restrict Founder Salaries?

Yes, investors can sometimes restrict or influence founder salaries through investment agreements, shareholders' agreements, and corporate approval mechanisms. However, the extent of such restrictions depends on the company's legal structure, the terms agreed with investors, and the applicable provisions of company law.

Investment Agreements

Investment agreements may contain conditions relating to founder remuneration, particularly where investors are providing substantial funding. The agreement may specify salary limits, approval requirements, or circumstances in which founder compensation can be revised.

Shareholders' Agreement

A Shareholders' Agreement (SHA) may contain provisions requiring investor consent for certain matters, including changes to founder remuneration. It may also prescribe reserved matters or financial thresholds beyond which Board or investor approval is required.

Board Approval Requirements

Where the founder is also a director, the company's Board of Directors may need to approve remuneration in accordance with the Companies Act, 2013, the Articles of Association, and applicable corporate procedures. Additional shareholder approval may be required in certain circumstances.

Common Investor Expectations

Investors commonly expect founder compensation to remain commercially reasonable, particularly during the early stages of the business. They may expect salaries to reflect the startup's cash position, the founder's responsibilities, and the company's financial plans rather than significantly reducing funds available for business growth.

Common Mistakes Founders Make

Founders can create legal, tax, and financial problems by treating company funds as personal money or failing to properly document their remuneration. Maintaining clear records and following the required approval and tax procedures can help prevent these issues.

Taking An Excessive Salary

Paying a salary that is disproportionate to the founder's role or the company's financial position can create concerns among investors, shareholders, and other stakeholders. Founders should consider market benchmarks and the company's ability to sustain the remuneration.

Paying Themselves Without Approvals

A founder should not assume that ownership of shares gives them unrestricted authority to withdraw money from the company. Required Board, shareholder, or other approvals should be obtained before remuneration is paid, wherever applicable.

Mixing Personal And Company Expenses

Using the company's bank account for personal expenses can create accounting, tax, and corporate governance issues. Personal expenses should generally be kept separate from legitimate business expenses and properly recorded.

Not Documenting Remuneration

Salary and other remuneration arrangements should be supported by appropriate contracts, resolutions, payroll records, and payment documentation. Poor documentation can make it difficult to establish the nature and legitimacy of payments.

Ignoring Tax Compliance

Founders and companies must comply with applicable tax obligations, including TDS and payroll requirements where applicable. Failure to correctly deduct, deposit, or report tax can result in interest, penalties, and other consequences under the applicable tax law.

You Might Find These Helpful

• Founders' Agreement: The Most Important Legal Document Every Startup Needs
• Difference Between Partnership And Proprietorship
• Can A Proprietorship Be Converted To An LLP In India?
• One Person Company vs Sole Proprietorship​
• Business Transfer Agreement, Share Purchase Agreement (SPA)

Conclusion

Startup founders can take a salary, but the decision should be based on the company's financial position, the founder's responsibilities, business stage, and investor expectations. Founder remuneration should be reasonable, properly approved, documented, and compliant with applicable corporate and tax requirements. Depending on the business structure, founders may also receive dividends, equity-based compensation, or other lawful payments. Maintaining clear separation between personal and company finances is essential for sound governance and financial compliance.