An entrepreneur-friend once inquired if it is normal to have all five partners with equal stakes in the business draw identical compensation. When I asked whether all partners were involved in the business, the reply was: "Not all." Apparently, he was running the business, another signs all the checks and the rest just wait for their cash dividends.
I further asked how they determined the cash dividends. He explained that every quarter, the partners ask about the cash position and how much is needed to keep the next quarter’s operation going. Cash position less money needed for the next quarter’s operation equals cash available for cash dividends. The amount is divided by five, thus allocating an equal share to each partner.
The money he needed for next quarter’s operations covered all anticipated collections from sales and receivables as well as payments to suppliers, commissions, salaries and other business expenses.
Since he was the one running the business, I asked if he got a salary over and above the quarterly dividends. He replied that the quarterly dividend was his compensation.
Somewhat perplexed and, perhaps, even vexed by my line of questioning, he asked the following questions:
Q. Should I get compensated separately for my role in running the business?
A. Definitely, yes! You must be compensated for your role in running the business. The financial rewards of the business to you as the person running the business is separate and distinct from the financial returns to you as an investor. However, this does not come without risk. If you fail to deliver the operating and financial expectations of the co-owners of the business, you can be replaced. Your compensation as the manager of the business has a counterpart responsibility. And this is to deliver the owners’ agreed upon results from the business.
Q. In my other business, I have no partners to share financial returns with. Should I still compensate myself for running the business?
A. Yes, but I start to doubt if you should be compensated for full-time work for both. The person running the business is expected to do full-time work.
Anyway, the concept of compensating the work of the owner is still valid. The professional work of the entrepreneur must be compensated separately from his financial rewards as an investor. If you do not compensate yourself for work done for the business, then you are overstating the net income of the business. While that is money from the same pocket, this has to be done to have a better and more realistic evaluation of your company’s performance.
Q. If an owner manages the business, how much should the compensation be?
A. The simple answer to this question is another question: How much is the competitive market rate for a person who can perform the function? The competitive market rate is the key word. This means that there is a match between supply and demand. Demand is defined by the responsibilities and deliverables of the function. Supply is defined by the competence and experience of the person in the position.
In simple terms, the owner of the business must fairly compensate himself for work done. If owner compensation is not done, then the business will never account for its true profitability. Worse, you may find out that you can never hire a professional manager to do your job. This is because nothing would be left to pay dividends or returns on the investments after a professional manager is paid a salary.
Q. Should this compensation be done from day one of the business? What if the company cannot afford to pay my compensation?
A. It should be done from the start. The acknowledgement of the compensation as part of the cost structure will show the true cost and, therefore, the real profits of the firm. It is possible that the firm may not have the cash to pay the compensation of the owner as manager. But it can be treated as a payable to the owner-manager and paid when the cash flow allows. But the idea is to make sure the firm is able to reflect the true costs and profits.
In the Master in Entrepreneurship program of the Asian Institute of Management, we push our entrepreneur-students to aspire for the three Ps: profitability, productivity and professionalism. Compensating the owner-manager has a definite impact on all three Ps.
(Alejandrino Ferreria is the associate dean of the Asian Center for Entrepreneurship of the Asian Institute of Management. For further information/comments, you may mail him at: ace@aim.edu.ph).