Deferred Cash Compensation

Along the lines of our last compensation post, cash is at an extreme premium in pre-VC funded companies. In that vein, you might be presented with a situation where you “defer some of your salary” until after the first institutional financing. This means that you are theoretically earning this portion of your salary and once the financing happens, you will get it paid out in one lump sum.

Be careful about expectation setting here – while some VCs will respect this arrangement, if this deferred compensation number starts to grow, as a condition of the financing the VCs will often require some or all of the deferred comp to be converted into equity. This isn’t a horrible situation unless of course you’ve already spent your deferred comp on a new car. (Note to self – don’t by a new car until after the company is successful and you get a windfall from the sale of the business.)

  • If you do accept equity as payment for deferred comp, make sure that the company pays any income tax and other payroll deductions that are owing; you do not want to be hit with a tax bill for income that was paid in kind. This kind of grossing up of the amount owed to you should be acceptable to your investors, since it conserves cash.
    Equally important, you should try to carve out shares paid for in deferred comp from any buyback agreement that your VCs require you to enter into.

  • TaxGeek

    Deferred comp paid upon funding is generally not compliant with Section 409A because funding is a not a permissible payment event nor is it a fixed payment date and therefore “funding” isn’t a possible payment time. The way we tax geeks generally structure around this rule is to require the recipient of the deferred cash to be employed at funding for the deferred compensation to vest and then require that the funded deferred compensation be paid out within the short-term deferral period. Doing it wrong is a great way to inadvertently cause a problem (40% extra tax for californians, 20% extra tax for non-californians)