This could have been said by Greta Garbo but certainly, she expressed it in a different way, “All human beings have three lives: public, private, and secret.”
― Gabriel García Márquez.
Same goes for businesses.
This problem came up just yesterday, so it’s fresh in my mind: Company A needs a $100,000 cash for marketing which its owner believes will generate large returns over the next three years. Company B wants to help financially to earn a fair return and to gain some strategic advantages through an alliance with company A.
However, the owner of Company A doesn’t want to report details of her business expenses and operations to the owner of Company B. And Company A does not want to be obligated to make fixed loan payments which may come due too quick. What to do?
The two owners discussed the traditional solution, while I listened. Company A, an LLC, will sell some membership units to Company B. Company B will then receive a defined portion of the profits of Company A. The discussion stopped when the owner of Company B said “And of course, I’ll have to see your tax returns and financial reports for the last two years, since I’m now a partial owner.”
The owner of Company A froze like a deer in headlights.
That’s when I said, “Hey you two idiots,” (actually I didn’t say “idiots”, I only thought it.) “Why don’t you just agree to split the revenue for the next five years, in exchange for the investment?”
They’re not so dumb after all because the owner of Company B responded “I thought of that, but then realized I can’t just write a check for $100,000 without being able to account for it. My accountant has to either book this check as a loan or has to book it like I’m buying something like membership units – like a share of ownership.”
I responded “That’s perfect. Tell your accountant that you’re buying a royalty contract. This contract is an asset. It’s just like buying a machine. When you buy a machine, you don’t know how much income it’s going to generate, you can only guess. Its initial book value is what you pay for it. Your accountant can then depreciate or appreciate the asset value in the future depending on how well it performs.”
Both owners of Company A and Company B looked at each other, smiled, looked back at me, nodded, and together said “Why didn’t we think of that?”
You’ll find a clever, entertaining and more in-depth conversation on the same topic, with much better character development, by Intelliversity’s Advisory Board Chairman, wall street veteran Arthur Lipper, here.
Key Takeaway: Strongly consider selling a royalty contract instead of selling membership unit or stock, when you are seeking cash to help grow your company, because that way, what is now private remains private. What is now secret remains secret.