to slip) so Frank continues to under-pay himself indefinitely for his contributions.
Poor Frank is a terrible business manager as far as I am concerned!
Now his salary is much lower than it was when he had a job, and although he has invested all his savings he isn’t getting any interest like he did when the money was in the bank. At this stage he would be financially better-off by return to a salaried job; but he sticks it out because although he doesn’t know how to win this bet, he also doesn’t want to lose face.
Now, here is how you can win your own bet….
If you count up all that you intend to gambling right from the beginning, and set a timeline of how long you are prepared to place your bet for, then you will start out with a very clear picture of the exact bet you are taking – which of course also allows you to look more objectively at your alternatives…. It might suddenly seem worthwhile after all to stay in your job, with a renewed sense of security and gratitude for not working weekends, late hours and taking holidays.
But, if you do decide to go ahead in the very least do a “back of an envelope” budget (but preferably a fully fledged one) that includes all of these setup costs – time, investment and interest – then divide this total by the length of time (number of weeks) you are willing to wait for repayment. This will give you a weekly amount that you need to get back from your business IN ADDITION TO whatever is a fair salary for the daily time you contribute working in your business (fairy salary is the amount that needs to be paid to someone else to get the job done if you weren’t there). These two amounts when added together are what you will need to be equally as well-off as you are before you leave your job.
This initial clarity can be very confronting, and many people simply refuse to do it, but once you get over any shock the benefit is you can start making properly informed decisions. Having a complete understanding will undoubtedly drive you to be very clear about your pricing, and focused on exactly how many sales per week are needed to make sure your business gamble pays off.
Going back to our hairdresser example – for Frank these decisions may be something along the lines of:
- Initially setting his prices to cover costs, plus a 15% mark-up, without including any of his time (instead of pricing to undercut his competitor)and paying attention to extra special customer service
- Forgoing most of his “fair salary” for the next year as sales grow to $60,000 and spending the amount sacrificed on advertising (even though this further increases his bet)
- For the following TWO years he is willing to only take home no profit so he can invest in more advertising and better equipment until Sales grow by another 50% to $90,000
Up to this point he is still gambling by trading off his short term take home salary, against his perception he will get a greater income (profit) and capital gains(profit) in the long-run.
At some time in the first few years, Frank’s rate of business growth will most likely plateau.
- At the point of plateau the business operations will be well known, so prices can be raised a bit to improve profit levels sufficiently for him to pay himself a good salary, comparable to if he was hiring someone to do the work for him, AND also pay some profit as return for his risk.
After a few year’s of strategic decisions Frank’s business is able to operate just like any company on the stock exchange, with a good separation of ownership receiving returns for investment (profits), and employees receiving returns for work (wages)