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Comment by _pius | Hacker News Reader

Joel Spolsky has weighed in on this: https://gist.github.com/isaacsanders/1653078

"if someone goes without salary, give them an IOU. Later, .. you'll pay them back in cash ... when the money comes rolling in ... pay back each founder so that each founder has taken exactly the same amount of salary from the company."

This doesn't seem fair. The founder who takes an IOU rather than cash bears the very real risk that he never gets paid back. There should be an interest rate attached to the IOU: something like 15-25% to account for the risk.

how does the tax work on that I can see the IRS wanting to get their cut of the gain

More importantly in the short term: are payroll taxes due on the face value of the IOUs? You've gotta pay taxes in cash...

That's something I believe, too, but I never see it mentioned.

If it's "just like cash", then you've made a significant early investment in the company. How is getting paid back what you put in fair?

There should be an interest rate, because the value of money changes over time. There is a difference between the value of $50,000 in hand today, and the expectation of being paid today's $50,000 a year from today. That difference is reflected in the interest rate. Risk is also accounted for in the interest rate, although fundamentally, not all risk can be accounted for. There is always going to be the risk that the startup goes bust before it can pay back its IOUs, and it would be silly to expect an interest rate exorbitant enough to account for all of that risk. A rate of 15-25% is probably fair to the individual in a nominal sense (more than fair, actually), but it is unfair to the company. This is a case where the individual will need to bear some of the risk in the financial interests of having a successful company. He is not a loan shark, after all.

"A rate of 15-25% is probably fair to the individual in a nominal sense (more than fair, actually), but it is unfair to the company."

I think we are in agreement on the first part, i.e. that a rate of 15-25% should adequately compensate the individual for both the time value of money and for the large risk of default.

I don't agree that it's unfair to the company. Consider:

- The company has no alternative, cheaper sources of debt financing

- The capital and interest will be deferred until such time as the company has money to pay (e.g. from a Series A) so will not cause any hardship by constraining cash flow

- These IOU are non-participating, i.e. they don't get any of the upside should the company do well.

If you think about it, it's similar to an investment by an angel: you want to compensate for the risk, you don't know when you will be able to return the cash, you don't have a reliable way to come to consensus on valuation.

Perhaps the right way to structure these IOUs is as a capped note with a low coupon (2-5%) but a reasonable conversion discount. That way the equity-like element of the note compensates for the risk, instead of requiring a large coupon on the debt-like part.

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