Tuesday, October 26, 2010

228. Exploitation of a top performer

The following is my advice to any person who wants to be a joint-venture partner without putting down cash.

In this case study, I shall call this person Alan. In this private limited company, there are 2 directors at 50:50 share. Alan feels that he should be paid $5,000 per month as a "salaried" director as he brings in the bacon. The other director, Bernice puts in the money 100%.

So, Alan will get $60,000 per annum for the first year of operation. Bernice does not get paid but contributes in administration and management of the staff and office. At the end of one year, Alan wants 50% of the net profits but he will not be responsible for any loss. He thinks that there will never be losses since he has a wide network of prospective and loyal clientele. Bernice is only a "godmother" who pays for everything including his "salary".

The important issue is that he wants to consider $5,000/month to be classified under "operating manpower expense". That means he gets $60,000 per annum for the first year whether the company makes a profit or loses money.

After deduction of this expense and other expenses like salaries of supporting staff, office rental, utilities and miscellaneous expenses which may amount to around $72,000 per year, the estimated "operating expenses" will be $72,000 and with Alan's "salary", the total will be $132,000. Bernice does not get a cent for that first year.

Therefore the total loss to the investing director for this first year, will be around $132,000 in the worst case scenario of losses.

Alan, the paid director projects "profits" based on his extensive network of relevant clientele and your more than 30 years specialising in the industry. He brings in the bacon (as the clientele and expertise are his initially), but he does not bear the financial losses if the business fails.

There may be SARS virus equivalent or long periods of haze when nobody travels, a regional war, Singapore being attacked by terrorists. Money is needed to keep the business going during such unforeseen times and also to advance to him as the "directors' fees" which he wants to considers as his "salary".

Now, if Alan is merely an employee of the start up agency, the $5,000/month is classified as "salary." If not, it is considered "director's drawings".

Man proposes. God disposes. If the reader does not understand this idiom, I clarify that there is no sure thing as success in any start-up business. If there is, why are there so many more employees than self-employed?

With Alan's proposal to get $60,000 and 50% of the net profits (if any) but not the losses, Alan is effectively taking more than 50% of the net profits if the business makes profits. He does not take the losses and so he can just say goodbye and look for another job by becoming another employee after one year.

I told Alan that his proposal is unfair and unacceptable to any investor. "Obviously, you have considered that Bernice, the investing director doesn't deserve any monthly payment as she does not bring in the bacon. Well, she does the necessary administrative work saving time that permits you to do business development and she is putting down the money where her mouth is."

I elaborated: "Both directors in this 50:50 share holdings must be fair. When 2 people start up, they put in money and their initial shares are based on the monies they invested. They may pay themselves a small salary or forgo salary. Certainly, $5,000 a month is not the amount the start up will pay the partner as that depletes the operating capital.

"Bernice also thinks she deserves $5,000/month too as she bears more responsibilities being answerable to the regulatory authority as the key executive officer, her valuable time spent in administration and in bringing some business (though Alan presumes he will be the only one doing it). The investing director is also responsible for the family money invested ($100,000 paid up capital). $100,000 is not a small sum."

Alan said" "I can easily get a 80:20 deal with established agencies whereby I get 80% of the commission as a referring agent."

I replied: "Well, you should do what gives him the highest financial benefit."
Alan did not like the idea of sowing his odds to various agencies as he would not be able to project a solid reputation.

Alan said: "My friend runs an agency himself. He is given a salary and a share of the profits."

I said; "You can be sure that it will not be 50% of the net profits in the general cases. Do check with him. If he gets 50% of the net profit and does not put his hands inside the till, he must be a very lucky person."

I continued: "I doubt it. It is just not financially viable for the investing partner to give such a big share when he does not put up a dollar.

"A start up is like a baby. It needs a father and a mother ideally. Obviously, a mother (in this case, Alan) can do it alone. Many single mothers have raised children to be outstanding graduates. But we hear of such success stories. Many more single mothers have had failed miserably and we don't hear sad stories. We don't want to hear sad stories."

In conclusion, I spent much time elaborating the realities of commercial business life to Alan. "You have had been a very good employee for much of your life time by being honest and able to deliver the sales without the company getting into bad debts. Such employees are in great demand but there is a limit to what most agencies can afford to pay.

"See the other side of the coin. Business is feast and famine. When there is feast, you, as an employee feels "exploited" as a top performing employee bringing in 6 million dollars worth of sales income. You don't get to share the fruits of your big deals or get "appreciated" by being given some percentage of the revenue generated. But how much of the crumbs will satisfy you?

"You feel exploited as you feel you deserve high financial incentives that the company should give you for generating the six million dollars' revenue. You do not realise that the net profits may be as little as 5% as there are lots of overheads of a company. You feel that the net profits from your sales are 15-20% but you don't take into account the cost of overheads of the company and other factors like depreciation.

"The company may give you some bonus but it can't be lavish on you alone as there are the managing director, the finance director, the accounts director and others to pay. These are the supporting staff.

"A business development person brings in the bacon but they do the support. If the business development person gets exceptional big bonuses out of his performance, what about the supporting staff and the Chairman who invested in the infrastructure of the business. Without his investment, this person will not have been employed in the first place. You contracted as an employee with an agreed salary and you had been paid for that amount. Any bonus would be up to the boss.

"When there is famine or office politics, you seek other employers. This is also the reality of the life of an employee. In a start up, you needs to understand that you are no longer an employee and must get rid of your "exploitation" mindset.

"There will be no more exploitation of you by anybody because you are your own boss. Bernice does not give you targets since she knows that a start up is an uncertain business, no matter how optimistic projections of past performance you have made. If you are so sure that the start up agency is going to be profitable, why not sell your HDB apartment, rent one for the family for the interim period and go all out guns blazing. Sure to win. In no time, you have made millions."

In conclusion, I reminded Alan the harsh reality: "A start up is not a sure to win business. Even a successful business will have its ups and downs. There will be economic recessions and Bernice has to continue payment to tide over the bad times. This is the other side of the coin that you, a long-serving honest and productive employee cannot understand as you have not suffered considerable losses of a business set up and encounter stiff competition to lower pricing and high demands for cheap and good services from Singaporeans and elsewhere."

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