Doug Fath and Jeff Greco dive into operator versus business owner compensation and how to responsibly pay yourself and not steal from your business in their latest video. Click the video below to watch now.
| Doug Fath: | Hey I’m Doug Fath from Legacy Capital.
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| Jeff Greco: | Jeff Greco, also with Legacy Capital.
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| Doug Fath: | Today we’re going to be talking about owner compensation. Obviously a relevant and important topic, and in the previous video we were talking profitable partnerships and creating those partnerships. An important component of that is figuring out fair compensation for you as the owner, as well all of your partners. I think especially in the real estate space a common thing that we hear or a mistake that’s made is its like, hey I’m going to partner with you. We’re going to split things 50/50, and that’s not necessarily the best way to go about things. Because it collapses what we’re going to distinguish here, but it collapses operational contributions and asset contributions.
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| This is important when you’re looking at creating fair compensation for you and your partners, because it distinguishes between the different types of roles that you’ll be doing. So –
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| Jeff Greco: | Just before we get into that, so a typical structure that Doug was talking about, before come to us or even some of our existing clients, you’ll have someone who’s experienced in managing real estate and then they’ll have someone who has money. They say, you provide the money, I’ll do all the “work”, we’ll split it 50/50.
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| Doug Fath: | Right.
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| Jeff Greco: | Not really more than that is figured out, but that’s the idea, they may or may not have anything in writing. But they’re like, yeah that makes a lot of sense. ‘Cause the person wants with money wants to make more money, and the person who doesn’t have money but knows how to manage real estates thinking, if only I had money everything would be great. That typically works for a couple of months, maybe even the first deal and then things start to break down.
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| Doug Fath: | Well ’cause it depends right, if you’re saying hey we’re splitting things 50/50 and that’s how I’m getting compensated. What if there isn’t any profit or money to split for the first year or two years? The person that invested money, yes they’re not getting a return on their money but they’re not investing any time in it. As opposed to as Jeff’s saying, the person that’s the operator in that business, working day in and day out. If they’re working in that business for a year or two and not making any money, that’s probably going to cause some issues.
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| Jeff Greco: | Right, ’cause the person who has the money may have another job, or already sitting on the money, so they may be feeding the family, having a house to live in. Then the operator who doesn’t have any money or isn’t figured out how they’re getting money, saying, how I’m making my house payment? How I’m eating? How I’m taking care of the family? It only takes a little bit for that person to get annoyed, frustrated and some heated discussions.
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| Doug Fath: | Yeah, and look in this example, so this is perfect, if you’re saying it’s going to be 50/50 essentially that’s the ownership. So when we say asset, there’s asset contributions that you’re making and then what you get from that is your ownership. So it can be 50/50 but what about the person that’s operating the business, that’s in the business every day? They’re making operational contributions to that business and should be getting compensated for that. Or there should be a conversation about the contributions that they’re making, how are they getting compensated?
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| Look we just wrote down a few examples for in sort of the real estate space. But right an operational contribution could be doing the book keeping for the business. Another one could be if you’re doing the construction or if you’re managing construction. It could be managing the properties, if you’re acting as a property manager. Or maybe you’re an asset manager for the portfolio of properties that you have. If you were to go out in the market place and hire any of these operational roles you would be needing to pay for that. So why would you not, just because you’re a business owner, why would you not have an allocation or a stipend to compensate you for the operational roles that you’re performing?
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| Jeff Greco: | Right, and the common concern is that business owners will say, yeah I’m doing the book keeping or I’m managing the assets but the business doesn’t have any money. So Doug and I aren’t saying that even though we want you to understand and have a conversation about what the value of those services are, if you were to hire a third party person. There are still ways to account for those services and keep how much someone has “made”, even if those funds don’t get paid out. So as a simple example, if someones doing the book keeping for the business and it would take a third party person $250 a month, and you did it for 10 months without getting a dollar paid to you. Well then maybe having a $2500 payment that’s due to you, when the business has money to pay you back, is a way to solve for that and say, look we’re all acknowledging that I’m doing something of value.
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| You’re doing something of value, we don’t have to pay it out right now, but lets at least account for it so nobody’s saying, hey I’m doing all this and you’re doing all that. It’s a way to true up what the owners are bringing and it’s also a way to really start to understand as your business grows, when you really do need to bring in the third party. What is a realistic budget look like for the things that we’re currently doing? We may get to focus on other things, like looking for deals, or managing things at a higher level. But how much is it actually going to cost us to run this business?
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| Doug Fath: | So that’s the operational side of things, but then there’s the asset side, and the asset contributions that you can make to the business. There can be a handful of different options for that. So one, probably the most common is money, right, and the example that we gave where you’re an operator and you’re going to go partner with someone that’s giving you money. But money can be an asset contribution, maybe they’re contributing real estate and that could be maybe there’s a free and clear property that they own, that they’re going to contribute to the venture. Or maybe for you, for bringing the deal to them and finding the deal, giving them that opportunity that, that’s something that you’re contributing to the partnership and want to be allocated appropriately for.
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| Jeff Greco: | So sometimes people in partnerships have one partner who’s stronger financially, either with money or credit. So where does, if one of the partners has strong credit and they go to get a loan, either from us or someone else, where does credit fit in here? Is that an operational or an asset?
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| Doug Fath: | Yeah credit would be another example of an asset contribution. That’s something to consider when … Because you want to figure out what are you contributing from an asset standpoint? What is your partner contributing from an asset standpoint? The last thing here is, not the last thing but the last example we have is like intellectual property. So if you’re an investor that’s been doing this for 10 or 15 years, there’s certain intellectual capital that you have, that you know from your experience that is valuable. There should be some allocation for that, and you want to identify and talk about what these contributions are. Because it’s really the asset contributions is what should dictate what the ownership is.
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| A common mistake investors make is, oh we’re just going to do 50/50 and some of their operational contributions is sort of how they justify their ownership. The problem is if you’re not being compensated for your operational roles, or said another way, if how you’re being compensated for your operational roles is ownership in the business, you’ve got yourself a job for life. You can actually never remove yourself as the operator because if it’s tied to your ownership and you stop doing this, you end up with no ownership. As investors and business owners, the whole purpose of setting up our businesses is we want to create passive income. We want to build the business to a point where we don’t need to work in the business anymore. The only way that you have a chance to do that is by drawing a line and distinguishes and allocating for the operational contributions and the asset contributions.
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| Jeff Greco: | Right, so as business owners, as Doug was eluding to, we especially to get started are an operator in the business and we own a part of the business. So even though it’s the same person, almost thinking about it as I’m Doug the owner and I’m Doug the operator. Even though they are the same person, so at some point whether you always are the operator or you chose to do different things in the operational role. There’s a way that solved for the ownership part and the operational part, so it can be handled as the business scales and peoples involvement changes.
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| Doug Fath: | Yeah, and it also makes it really clear for making some of those changes, when you want to remove yourself or maybe change the role. Because that’s going to have a financial impact on you as the business owner, and you’re able to clearly see what that is. So you have your ownership, you know what you’re getting paid through distributions. You have your operational compensation, you know what you’re getting paid as an operator. So you can see, hey if I stop being an operator in the business I’m going to lose this operational contribution here. So there’s a financial impact, but I’m still the owner and I’m still going to get those owner distributions. It becomes really clear instead of guess work, or figuring out how it’s going to impact you.
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| Jeff Greco: | We’ll talk about this in a next video in terms of business owners stop doing everything themselves. But one of the things to also think about for instance in the book keeping role, is as business owners want to do higher value activities for the business you can start to understand what are the things you’re doing that, either you’re not the best at or you don’t enjoy doing. Or frankly you could pay someone else to do and you could go do other things, for instance could you go find more deals, or could you exit a deal quicker or so forth. So when you have these operational contributions laid out and you attach a real true value to them, you can start to clearly say, okay as the business grows and scales what should I or we as the business owners really be focusing on to continue to maximize our earning potential?
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| Doug Fath: | Yeah, and I think the last thing to touch on there is as you identify what the operational contributions are, these are expenses to your business. So it’s obviously going to lower your net income because these are expenses. It may, it doesn’t necessarily mean that this is going to happen, but it could then impact how much ownership you have. So maybe now you’re getting paid as an operator and because you’re getting paid for the operational roles that you’re doing the partner or the other partners may say, hey you know what 50/50 isn’t fair. It should be 60/40, you’re getting compensated here but really for your asset contributions now that we’ve distinguished the two, it’s not really worth 50% of the business, it’s worth 40% or 30%.
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| Just because you’re getting paid as an operator does not mean that your ownership needs to be decreased, but that is a possibility inside of this concept and philosophy of fair compensation. Fair compensation for you as an operator and fair compensation for you as a business owner.
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