Breaking Up With William: A Misunderstanding of the Very Important Matter of Economic Fairness

Thursday, March 7, 2019

Delray Beach, FL- I knew that William was a potential superstar the moment we started talking. He was smart and funny and confident – real confidence, not bluster.

He wasted no time establishing himself as a valuable employee. He then worked in overdrive till he was put in charge of his own product line. He hired and trained a crew that grew that product line into one that was contributing nicely to the company’s overall profits.

As CEO of his division, William made a six-figure salary plus a bonus of 10% of the profits. As his business grew, the bonus was increased to 20%. And as part of his contract when he made CEO, he was also promised 20% of the purchase price if his division were ever sold.

Some years later, the division stopped growing. And because I had an interest in the business, I was called in by my partners to speak to William about it. He was gracious and appreciative of my concerns, but he ignored my suggestions. He was comfortable with the division running at that level of profitability.

I’m not comfortable with an idling business. Unless you are seeking to grow profits, entropy takes over and sales gradually recede (along with everything else). But when William’s sales began to recede, he didn’t seem bothered.

I was bothered. And my partners were bothered. So when an offer was made to buy William’s division, they thought: good timing. To be fair to William, I recommended that we allow him to have a voice in the negotiating process. That proved to be problematic, as he had an unrealistically high idea of what the division was worth.

Eventually, it was sold at the right price. And William received, as promised in his contract, 20% of the purchase price.

Instead of feeling good about it, he shocked us by asking for 40%. His rationale was that he deserved an additional 20% of the profits because, in his role as CEO, he had somehow “earned” an extra 20% in “sweat equity.”

“Sweat equity” is a term that is sometimes used with start-up companies. To persuade a CEO (or other key executive) to work for a salary much below market rates, they are offered the chance to receive equity as a trade-off. For example, instead of paying Sally the $150,000 she would normally make, she is paid $50,000 and receives (after the year ends) $100,000 worth of equity.

That is how sweat equity works. It is a deal the two parties make beforehand. And it is not merited simply because someone works hard or successfully. It is essentially bought with the compensation that the executive willingly gives up.

When both parties agree to it, it’s fair. What William was asking for was, in our view, completely unfair.

I’ve always said that what is fair in a business relationship is relative. It’s relative to the people involved and to the situation, which is always changing.

If, as things change, your view of fair is in a range that doesn’t overlap with mine, we have a problem. Sooner or later (in William’s case, later), we will be at odds. And because our views of fairness are so different, there is a good chance the relationship will be ruined.

If you are entering into a long-term business relationship – whether it be a partnership, a joint venture agreement, or an employment contract – it’s not enough to agree on terms and to put those terms on paper. You have to spend some time talking about how the terms might change in the future.

My partners and I never did this with William. We just assumed, since he shared our views on so many other things, that he shared our sense of what fairness would look like as his role in the business became more important.

Had we done so, we might have realized that, for one thing, he had a very peculiar idea about meriting sweat equity based on his own assessment of his work.

Read MoreBreaking Up With William: A Misunderstanding of the Very Important Matter of Economic Fairness

What You Should Ask Your Money Manager… Right Now

Sunday, March 3, 2019

Delray Beach, FL.- Money managers – just like your broker, banker, and insurance agent – make their money by selling you a service. If you don’t know what exactly they’re doing for you or how much they’re charging you, you’re vulnerable.

And yet, most investors, probably 8 out of 10, don’t know these things.

If you hire a plumber to fix a leaky faucet, you know exactly what they’re doing and how much you’re paying them. But when your money manager recommends something – some sort of amazing new investment that guarantees your principle while simultaneously giving you an upside equal to the market – you probably only vaguely understand the transaction. And you may have no idea that they’re being paid multiple times for selling you that deal.

The financial industry is very, very good at three things:

  1. Inventing financial products that are difficult to understand
  2. Hiding the fees they charge their clients
  3. Making sure they get paid even if their clients lose money

There are plenty of regulations in place that are supposed to make such costs transparent. But most of the disclosures are in small print and peppered with legal terms.

I’m not suggesting that all fees and charges are unfair. In fact, decades of consumer advocacy have reduced the number and types of tricks brokers, financial advisors, and money managers use to fleece their clients.

But there are still things to watch out for…

Some money managers and financial advisors don’t offer much to their clients. They’ll scratch the surface but, in the end, provide only a narrow range of financial services. Make sure what they offer fits your needs and includes diverse asset allocation, stock and bond recommendations, reporting, and so on.

Most of them will also charge you a fee for any financial advice. And some will collect commissions on any transactions. All of a sudden, it’ll start costing you to do anything with your managed money – including just talking about it.

Another problem is that they have a predisposition for mutual funds. They like mutual funds because they are easy. But as you know, mutual funds are very expensive.

And that’s not all…

Read MoreWhat You Should Ask Your Money Manager… Right Now

A Great Myth of Direct Marketing Why You Should Not “Go Easy” on Your Customers

Wednesday, February 27, 2019

Delray Beach, FL.- One of the most commonly debated topics in direct marketing is how much and how often one should market to a customer or potential customer. The most common answer is: Enough to make sales but not so much as to become annoying.

This is not true. More importantly, it is the wrong question.

Like every other semi-science, direct marketing is awash with “proven facts” that are bogus. One of these is that information publishers should give their customers at least as much non-promotional education as advertising.

You can find studies that support this position, but they are almost always small and specific. And that means they are unreliable.

I was once in love with marketing “rules” and tested every one that appealed to me. What I found out after thousands of tests to millions of customers was that there are very few rules that you can rely on. And even those, you cannot rely on 100%. But one of the rules I believe you can trust is that there is no limit to how often you should market to your customers.

For some, this defies logic. Advertisements are inherently annoying, their thinking goes. So if you want to have good relationships with your customers, go easy.

There is a simple fact that undermines their reasoning: The average American consumer sees more than 500 ads a day. (That number must include billboards and radio and television ads, as well as every internet ad that pops into view.) The number of ads that they actually notice might be 20% of that… but it’s still 100 a day!

Think about that. And let me ask you this: How many of the ads that you see every day do you remember?

Read MoreA Great Myth of Direct Marketing Why You Should Not “Go Easy” on Your Customers

Principles of Wealth #26*

Monday, February 25, 2019

Delray Beach, FL.- The financial industry promotes the idea that life insurance is something every sensible person should have. In fact, life insurance makes sense only in certain circumstances. For many people, it is unnecessary. For many more people, it costs more than it should. The prudent wealth builder will be very careful about how much life insurance he or she buys.

Almost nobody understands life insurance fully. Not lawyers. Not accountants.  Not even the financial planners and insurance agents that sell it.

There’s a good reason for that. Most policies – especially permanent life insurance policies – are complicated. They are written and sold using language that is incomprehensible to ordinary people.

To make matters worse, life insurance is sold using rhetoric that pulls on the heartstrings of potential buyers, inducing them to spend more than they might need to.

It would take a book to explain this in detail. But if you are considering the purchase of a new policy or want to understand a policy that you currently own, the following should be helpful.

Broadly speaking, there are two kinds of life insurance: term life and permanent life.

Term Life Insurance

Term life insurance is relatively simple. When you buy a term policy, you are paying a stated amount of money (the premium) for a stated amount of coverage (the death benefit) given to someone you choose (the beneficiary) if you die within a certain amount of time (the term).

Example: John Doe, a 40-year old executive, buys a million-dollar term life policy. It has a 30-year term. The cost is $100 a month the first year. Each year after that, the cost goes up. If he dies before he’s 70, his wife Helen gets $1 million. And that’s tax-free. (Life insurance benefits go to the beneficiaries tax-free.)

Sounds good to John. What can go wrong?

  • If he fails to keep up with his premium payments during the term, Helen gets nothing.
  • If he lives past 70 without extending the policy, Helen gets nothing.

But there’s another thing: What if Helen doesn’t need $1 million if he dies? What if she’s gainfully employed? What if all John needs is a $100,000 policy to cover his funeral expenses and some other odds and ends?

Wouldn’t he be wiser to get a  $100,000 policy and cut his monthly premiums by 70% or 80%?

Permanent Life Insurance

Permanent life insurance is complicated. First of all, it comes in a variety of forms – whole, universal, and variable being the most common. But let’s not worry about that. Let’s stick with the basics.

When you buy permanent life insurance, you are paying for two things: a life insurance policy plus a tax-deferred savings account.

Because of the investment aspect, permanent life insurance is considerably more expensive than term. How much more expensive depends on how much you want to invest and how much the insurance company is going to charge you in management fees, sales commissions, and administrative charges.

So for a million-dollar permanent life insurance policy, John might pay in $300 a month – of which maybe $100 would go towards the insurance and the rest towards his savings account and various fees and commissions.

Those fees and commissions can be costly. With some policies, they can be 50% to 100% of the initial premiums.

It is for this reason that one should be skeptical about permanent life insurance. The question is always: Would it be smarter to buy term insurance separately and put the rest of the money into a tax-deferred savings account?

There are 4 upsides to permanent life insurance:

  • As the name implies, your coverage lasts forever.
  • The savings portion of it accumulates tax-deferred. Over a 30- or 40-year period, that savings can make a considerable difference.
  • The obligation to pay the premiums can work as a sort of forced savings for people that don’t feel they would have the willpower to regularly contribute to a separate savings account.
  • Because of the savings component, your policy has a cash value that builds tax-free over time. You can borrow against it while you are still living. And the “loan” can be paid off by the policy’s death benefit after you die.

As for the downsides:

  • As with term life, if you fail to keep up with the premium, the policy lapses.
  • Permanent life usually requires a medical exam. If the exam indicates that there is a statistical probability that you might die earlier than would be typical for someone your age, you will likely pay more for the same amount of death benefit.
  • Because of the high costs of fees and commissions, the cash value of most permanent policies is very low for at least the first 10 years. Much of your “savings,” in other words, go to enriching the agent and the insurance company, not you.
  • Over the long term – in 30 or 40 years – the cash value of the policy may not be what you expected it to be. In selling permanent policies, agents are allowed to show you “expected” returns based on “expected” stock and bond market averages. But these are not guaranteed.

Read MorePrinciples of Wealth #26*

How to Maintain (or Regain) Control of Your Growing Business

Tuesday, February 19, 2019

Delray Beach, FL.- If you are in the fortunate position of seeing your business grow to the point where you have more than 50 employees, there’s a good chance the grip you thought you had on it will begin to slip away.

There is a good reason for this.

It has to do with the human capacity for attention. Experts say it’s basically impossible to manage more than seven or eight people. I can attest to that. There have been times when I’ve had more than a dozen people reporting to me — and it was problematic. I was not able to stay on top of their work, and they knew it.

What you may do is spend more time with some of the people who report directly to you and ignore the others for long periods of time.

If your top people are ignored, you are not doing the best job of managing them. You are not provoking them enough, not keeping a close enough eye on their performance, and not giving them the feedback and support they need to be successful.

But even if you do limit your direct reports to, say, seven, you can still lose control when the payroll exceeds 50. Here’s what happens:

Your seven direct reports understand you and your vision. Their subordinates report to them and not you, but the size of your company is still small enough that they see and hear from you all the time. They know what you want even if their boss has different ideas.

But when your company grows to the point where the subordinates of your top people have their own subordinates, the connection to you is all but lost. So what do you do when you have 50 (or 100 or more) employees and you feel like things are falling apart?

First, you should open your mind to the possibility that you aren’t the manager you think you are. In fact, it’s possible that your business isn’t being managed at all.

As an entrepreneur, your attention has been correctly focused on growth and profitability, not management. Your style of leadership might have been formal or casual. Your frequency of communication might have been regular or impromptu. You might have been a nice boss or a bastard. It hasn’t mattered because the seven that reported directly to you adjusted themselves successfully.

Their subordinates made dual adjustments: to their bosses and to you. But now that there are so many employees, you have to find a way to make sure they all understand your business goals and your expectations of them.

For all you know, they are getting bad ideas and directions from their bosses. You can’t see it, because those managers don’t report to you.

So you were right to focus on growth and profits. But now your business is in a different stage. Now you have to introduce some level of formal management throughout the business… which may mean that you have to become a more formal manager yourself. That would entail focusing on three things:

  1. Controlling growth operations
  2. Managing maintenance operations
  3. Communicating your vision

 Controlling Growth Operations

Every good-sized business is sure to have multiple operating parts – marketing, sales, accounting, customer service, product development and fulfillment, data collection, etc.

When your business was small, you could give short shrift to some of them. Now they are all important. None can be neglected. So which do you take on personally, and which do you trust to someone else?

Read MoreHow to Maintain (or Regain) Control of Your Growing Business

Ego, Inspiration, and Achievement*

Friday, February 15, 2019

Delray Beach, FL.- It’s impossible to see the pyramids of Giza, the Colossus of Rhodes, or the Great Wall of China without thinking about the will it must have taken to build these wonders of human creation. They were built thousands of years ago when the technology for building at that scale didn’t exist.

Even something as “ordinary” as the Palace of Versailles, built in the 17thcentury by Louis XIV, is awe inspiring.

Or how about what it took for Michelangelo to paint the frescoes in the Sistine Chapel… or Mozart’s gargantuan struggle to compose his Requiem… or Thomas Wolfe’s painful work revising Look Homeward Angel

And that’s to say nothing of scientific or business or military accomplishments.

Most of what we think of when we talk about human “achievement” is the result of one part inspiration and nine parts long and sustained effort, often under difficult conditions, focused toward a specific objective.

In fact, this quality of sustained and focused activity towards “making” new and bigger and better things could be said to be distinctly human. Animals are capable of hard and sustained work to create food and shelter, but they do not create new things for the purpose of bigger and better.

Put conversely, if human beings were not capable of such focused effort, civilization would have enjoyed few (if any)  scientific, industrial, social, and even artistic innovations throughout history.

The impulse to fix, improve, enlarge, and beautify seems to be hardwired into our brains. There is no human society that hasn’t produced inventions and art.

But what is the thing that drives people to do these things?

Read MoreEgo, Inspiration, and Achievement*

Are You An Information Addict?

Wednesday, February 13, 2019

Delray Beach, FL.- “Let’s have lunch,” DK said in his email. “There’s something I need to talk to you about.”

Two days later, we were eating chopped chicken salads at City Oyster on Atlantic Avenue. We talked a bit about family news, but it was clear that he wanted to talk about a question that was on his mind.

The question: Should he spend $100,000 on the highest level of an internet marketing program that he had been looking at?

“It looks really good,” he said. “But I’m not sure it makes sense for me to invest that kind of money.”

“A hundred grand is a lot of money,” I said.

“But you get an awful lot for it,” he explained. “They do all the technical stuff for you, which I’m not very good at. All I have to do is come up with the product idea.”

The waitress filled our drinks.

“So if you invest in this marketing program… what kind of products would you sell?” I asked.

“I don’t know,” he said.

“How about this: If you had all the money you could ever need, how would you spend your time? What would you do to give your life purpose?”

“That’s a good question,” he said. “Actually, I like the idea of purposefulness. Maybe I’d do something along those lines.”

Read MoreAre You An Information Addict?

How to Come Up With the Idea That Will Make You Millions

Saturday, February 9, 2019

Delray Beach, FL.- When people start a business for the first time, they often do so with an idea for a particular product that they believe to be both brand-new and also acutely needed – some sort of “better mousetrap” that will put their business on the cover of Inc. magazine.

Having a brand-new product idea may be the most common way to start a business, but it’s not always the best way.

Why?

Because brand-new products usually crash and burn.

They fail for a number of reasons – weak marketing, insufficient cash flow, poor product reviews. But the most common is this: The appetite for them is much smaller than the would-be entrepreneur has imagined.

When some enthusiastic young person comes to me with a “great” new idea, I always ask about the size and variety of competition. When they say “That’s the best part! There is none!” I have to explain why starting a business with a product for which there is no proven market is a big mistake.

You might not think so from everything you see in the business media. Journalists understand the power of a good story, and the best-loved stories about entrepreneurs are those that feature the lone and courageous person with a brand-new idea that he spends all and risks all to bring to the market, against huge doubt and even criticism, only to be proven right in the end with a huge success and the fortune to go with it.

But the reality of a successful start-up business is much more like this:

Read MoreHow to Come Up With the Idea That Will Make You Millions

The Challenge of Charity: My Failure to Help Marcus and Gabriela

Thursday, February 7, 2019

Delray Beach, FL.- First I felt ashamed. Then I was hopeful. Then I was disappointed. Now I’m resigned.

Marcus and Gabriela came to work for us in 1999 after we built a second home in Nicaragua.

Marcus tended the landscaping. Gabriela kept the house. Antonio, my Nicaraguan partner, had recommended them to us. Their parents and siblings had worked for him.

They were very young at the time – in their late teens or early twenties. But they were already burdened with the responsibility of being parents. Gabriela’s husband worked in construction. Marcus’s wife worked part-time cleaning at a local restaurant.

Neither spoke a word of English, so we had to communicate in the very rudimentary Spanish I had at the time. They showed up every morning at 7:30 and worked, not energetically but dutifully, until 3:30. Then they were gone. In those early days, they left without saying goodbye.

They were shy and I did my best to relax them in that American sort of egalitarian way. But Nicaragua, like all countries, lives with its history. And the vestiges of Spanish colonialism still existed. Most upscale households in Nicaragua employ domestic workers, who are, I gathered from observation over the years, treated with respectful condescension.

I asked Antonio what I should pay them. He told me $150 a month.

“A month?”

“That’s the going wage,” Antonio assured me. ”If you pay them much more, it will cause problems in the community – for them now, and for you later on.”

I knew that he was right, but I wasn’t going to accept it…

I sat down with Gabriela and Marcus and told them that if they wanted to earn more money, I could give them jobs that fell outside of their normal duties. Marcus could give a room a new coat of paint. Gabriela could plant flowers along the side of the garden. That sort of thing.

And they could do these extra chores during their regular hours, I told them. (Which would work out just fine for me, because I didn’t really have eight full hours of work a day for them.)

I thought they would be delighted with the opportunity, but they were not. Nestor, a local friend and colleague, explained their lack of enthusiasm.

“They probably think you are trying to take advantage of them by asking them to do extra work,” he explained. “Even for extra money.”

“Huh?”

It was another vestige of the country’s history – in this case, the years it had existed as a Communist state.

But although they were reluctant to do “extra” work, they were not averse to asking for financial “help” with family problems – a sick parent, a leak in the roof, etc. I was more than happy to give them what they needed, but I insisted that they work the “extra” hours for the extra money.

For a few years, it seemed to be working well. They used the extra money they earned to buy themselves bicycles, cell phones, and clothing.

But when I had the opportunity to visit their homes, it was clear that the extra money had bought them all sorts of things that put them in the upper economic ranks of Limon, the hamlet they lived in. Still, like everyone else in the area, they were living in simple mud and wood shacks.

Despite free-market views to the contrary, this huge gap between their homes and mine bothered me. I had to find a way to increase their income yet again so they could at least have proper windows, doors, and floors.

So I came up with a solution that was popular among charity advocates at the time: I’d give them micro-loans to start their own side businesses. My idea was that they would follow the strategy I’ve recommended for years to other would-be entrepreneurs: Start small. Test the product and the pricing and the pitch as quickly and efficiently as possible. And then, if the business starts to take off, expand.

Considering their earlier reluctance to do extra work for pay, they were surprisingly open to the idea of having side businesses, businesses that could be run by an unemployed sibling or relative while they were at their regular jobs.

I told them, stupidly in retrospect, to choose the businesses they wanted to have. (I thought that this would provide them with the extra motivation they might need to succeed.)

Gabriela decided on a children’s clothing store. Marcus decided to open up a pulperia, a rustic version of a mini 7-Eleven, in front of his house.

Two very bad ideas!

Read MoreThe Challenge of Charity: My Failure to Help Marcus and Gabriela