Summary
How It Works
The Ownerle provides the capital including working capital for the business. The Workerle leases the assets of the Ownerle and make lease payments to the Ownerle. The Workerle pays deductible expenses. The Ownerle and Workerle share the profits.
Discussion
Ownerle Provides the Assets; Workerle Pays Deductible Expenses
The Ownerle leases the assets including capital for the business to the Workerle. The Ownerle procures these through conventional means such as retained earnings, equity financing, and debt financing. From the business revenue, the Workerle pays deductible expenses (except Ownerle interest expenses) and makes a lease payment to the Ownerle. From the lease payment, the Ownerle pays interest expenses and other financing costs.
Some of the expenses of business operations are for the purchase of assets or the improvement or renovation of existing assets. These are called capital expenses. They are expenses that show up as assets on the balance sheet of the Ownerle. The capital the Ownerle provides pays for capital expenses. The Workerle does not pay for capital expenses.
For convenience, the Ownerle and Workerle could rely on the US Internal Revenue Service (IRS) and accepted accounting practices to distinguish between deductible and capital expenses. However, the IRS allows some costs to be either deducted or capitalized, at the option of the business. If these costs are present in the business, the Ownerle-Workerle lease agreement should specify which party is responsible for them. Generally, these costs with optional tax treatment are normally capital expenses. It may be sufficient to write in the lease that all costs that could be capitalized are the responsibility of the Ownerle unless specifically noted otherwise.
The Ownerle may wish to pay certain expenses related to the preservation of its property rights such as property taxes and patent maintenance fees. If this is the case, these should be written into the lease and the lease payment adjusted accordingly.
Lease Payment
The lease payment is what the Workerle pays the Ownerle for the use of the Ownerle’s assets. Conceptually, it is the present assets multiplied by the average return on assets (ROA) for the business, where the ROA is calculated using earnings before interest, taxes, depreciation, and amortization (EBITDA). This metric may not be appropriate for all businesses. For example, in highly capitalized businesses not making steady investments, this metric would lead to falling lease payments as the book value of assets are depreciated even though the revenue potential of the assets remains constant. Of course, the Ownerle and Workerle can use any metric for the lease payment that is agreeable to both parties.
The use of the average ROA to determine the lease payment assumes that workers have been paid industry standard compensation. If this is not the case, an adjustment should be made. The conceptual goal for the lease payment and the worker basic compensation is that they are both standard, fair amounts that would be acceptable to both parties if neither party received more than this. Or in other words, just enough so that the owners don’t think about selling the business and the workers don’t want to go on strike or look for another job if that is all they received.
Calculation of Worker Basic Compensation
The workers’ compensation varies according to the revenue and expenses of the business. It has a basic and a profit sharing component. Each worker has a particular stated hourly wage or salary as in other businesses. If the difference between revenue and expenses is sufficient, they are paid their stated wage and salary. However, if the difference is sufficient to only pay a portion, the workers are paid that percentage of their stated wage or salary. This is their basic compensation. If the difference between revenue and expenses is greater than what is needed meet the basic compensation, the excess is used for the profit sharing component. See below.
A worker’s basic compensation is calculated as follows:
IF (R – E – L) >= ∑ (Si + Wi x Hi)
THEN Bi = Si (for a salaried worker) or = Wi x Hi (for an hourly worker)
ELSE Bi = (R – E – L) x Si / ∑ (Si + Wi x Hi) (for a salaried worker)
= (R – E – L) x (Wi x Hi) / ∑ (Si + Wi x Hi) (for an hourly worker)
Where:
Bi = Basic Compensation of each individual worker ($)
E = Deductible Expenses ($)
Hi = Hours that each individual hourly worker worked (hr)
L = Workerle Lease Payment to Ownerle ($)
R = Workerle Revenue ($)
Si = Salary of each individual salaried worker ($)
Wi = Hourly Wage of each individual hourly worker ($/hr)
Notes:
1. The Workerle is taxed as a partnership so that it does not pay taxes.
2. All variables are evaluated for the same time period (e.g., revenue per month, expenses per month, compensation per month, etc.)
Profit Sharing
Profit is defined as the remainder of revenue after the lease payment, expenses, and basic compensation have been paid. The profit is divided between the workers and the Ownerle.
More than anything, the determination of the division could prompt emotional reactions in both workers and owners. Under the Liberty Workforce model, workers and owners have significant business risk. The workers carry the risk of rising costs and falling revenues. For example, rising fuel prices for an airline might result in workers being paid less than their basic compensation, but this will not affect the lease payment. On the other hand, the owners have capital tied up in the business. If the business becomes insolvent, the owners lose all this capital, but all the workers suffer is the trouble of finding another job. Due to the risk they bear, both parties are going to want significant shares of the profits. This is desirable. One of the goals of the Liberty Workforce model is that workers think and act like owners. As both the workers and the owners bear significant risk in the enterprise, they should share in the rewards of the enterprise.
The goal of profit sharing is to provide motivation to workers to excel and to potential investors to fund the growth of the business. To accomplish this, the profit sharing has to be significant. A profit sharing to the workers that amounts to a small percentage (e.g., 1%) of their base compensation in a good year can actually be de-motivating. Some workers might think, “I put all that effort in for this! Never again!” Research would probably show that a bonus in a good year would need to be at least in the 5-10% range in order to have a positive motivational effect. The same would probably be found for potential investors. It would take at least a 5-10% increase in earnings to be considered noteworthy.
Recommended Ownerle-Workerle Split Ratio
A suggested starting point for discussion between the Workerle and the Ownerle is choosing a split in the profits that results in the same impact on the workers as on the owners, i.e., choose a profit split percentage that results in a percentage increase in the Ownerle’s after-tax earnings (assuming it is taxed as a corporation; otherwise, use the pre-tax earnings to be equivalent to the worker) that is the same as the percentage increase in the worker’s basic compensation.
Recommended Distribution Ratio among Workers
There are several different ways to divide up the Workerle profits among the workers. See the article “Worker Compensation” in the Human Resource category for a discussion of these. The one that is recommended is a worker’s share of the profits will be equal to a percentage of his basic compensation and that percentage is the same for every worker in the Workerle.
The profit sharing percentage, P, is calculated as follows:
P = [(R – E – L) / ∑ (Si + Wi x Hi) – 1] x F x 100
The profit sharing distribution to each worker, Di, is then calculated as follows:
Di = P x Si (for a salaried worker) or = P x Wi x Hi (for an hourly worker)
Where:
Di = Profit Sharing Distribution to each Worker, ($)
E = Deductible Expenses ($)
F = Fraction of Profits for the Workerle (the Ownerle fraction of profits = 1 – F)
Hi = Hours that each individual hourly worker worked (hr)
L = Workerle Lease Payment to Ownerle ($)
P = Profit Sharing Percentage for all Workers (%)
R = Workerle Revenue ($)
Si = Salary of each individual salaried worker ($)
Wi = Hourly Wage of each individual hourly worker ($/hr)
Excessive Wage Inflation Takes Profits from Ownerle
In a typical business, more wages for the employees results in less earnings for the owners. It is a zero sum game. But, in the Liberty Workforce model, the Workerle pays the Ownerle before it pays itself. This assures the Ownerle fix earnings that do not depend on the amount of compensation paid to the workers. The Workerle can give its workers whatever compensation increases it desires without impacting these fixed Ownerle earnings. As workers are paid according to the available revenue up to the amount of their basic compensation, the Workerle can with impunity hand out inflated raises. As the Workerle is only obligated to pay its workers what is has available to pay, it can increase the worker’s basic compensation without being obligated to deliver that increase to the worker if funds are not available. Nonetheless, such compensation increases will affect the amount of profits, and therefore, the amount of profit sharing that the Ownerle could receive. By sufficiently inflating the worker basic compensation, the Workerle could assure that there were never any profits so that it would never have to share anything with the Ownerle beyond the lease payment. This would not be fair nor be in keeping with the spirit of sharing the fruits of the enterprise as well as the risks. Therefore, the basic compensation wages and salaries in the Workerle need to be kept at parity with industry. Systems need to be put in place so that decision makers and workers can see what parity is at any time. Also, there should be a periodic audit to assure the Ownerle that the basic compensation of the Workerle is at parity with industry.
Startups: A Special Case
During the startup phase of the business, the method for determination of worker compensation will have to be changed. At this phase, revenue, if present, is insufficient to cover expenses and worker compensation. The lease payment is the Ownerle’s guaranteed share of the revenue. As there is little or no revenue, there can be no lease payment during the startup. Once there is sufficient revenue, the normal lease payments and variable worker compensation concepts of the Liberty Workforce model can be engaged. Prior to this time, other methods of determining worker compensation must be used.
The following are possible methods:
- Pay the workers a fixed percentage of their basic compensation and offer them stock options.
- The Ownerle pays the Workerle a fixed amount of money to meet a milestone (a certain amount now and the rest upon satisfactory completion). The Workerle divides this money among the workers using a similar calculation as for normal basic compensation. The difference is that the payment is not per a time period, but until a milestone is reached. This makes it a form of variable compensation consistent with the Liberty Workforce concept.
Payment Priorities
There is a priority in the Workerle for the payment of obligations. First, expenses are paid. Then, the lease payment is made. With the remaining funds, basic compensation is paid to the workers to the extent possible. If there are any funds left after meeting these three obligations, they are profits for sharing. The requirement is that the expenses and the lease payment will be made for sure, and that compensation to the workers will be reduced to accomplish this, if necessary.
In practice, the nature of cash flow requires predictive financial tools to achieve this requirement. The workers cannot wait to be paid until the end of the year when actual revenue and expenses are known so that the amount of money available to distribute to the workers can be determined. Compensation is paid to workers every two weeks typically and in some cases, monthly and weekly. The workers in the Workerle must also be paid at least monthly. Thus, they will be already paid before it is known for sure what their compensation should have been. They will not be able to give it back if it is found that they were paid more than the Workerle could afford. To manage this, the Workerle will use a tool to monitor current and predict future expenses and revenues in order to determine how much compensation to pay the workers in any given time period. If circumstances change such that the tool predicts lower future revenues relative to the current pay period than predicted relative to the prior pay period, compensation would be adjusted downward in the current time period to not only align with the current revenue prediction, but to recapture excess compensation paid in prior pay periods. Obviously, this tool would have to smooth out these changes (such as employ a moving average) as workers cannot tolerate huge swings from paycheck to paycheck. The goal of the tool is have paid workers the correct amount of compensation throughout the year so that by the end of the year there are funds to make the lease payment and pay the expenses, despite the fluctuations in revenue and expenses.
Financial Management and Cost Accounting Information
The Ownerle and the Workerle operate from common financial and cost data. The Workerle’s tax accounting will be a view of the data. The Ownerle’s tax accounting will be another view of the same data. Proper accounting controls will be in place to create separation between the two legal entities. For example, the Ownerle can view the cash accounts of the Workerle, but cannot conduct any transactions.
This transparency is necessary to preserve the trust between the two entities. It also creates efficiency. For example, if the Workerle leases a building from the Ownerle, that building will occur once in the data base. As the Workerle makes capital improvements in the building and records them against the building, this cash flow will be tagged as capital rather than expense. To the Ownerle, it will then appear as a cost to be capitalized.
In the Workerle, many more people than just management will need access to the financial management and cost accounting tools. Their access will be according to the use. For example, the worker’s compensation is variable. To make wise decisions in their personal lives, the workers will need access to summary predictions of future compensation and profit sharing. On the other hand, Senators will need detailed access to these tools to make budgetary decisions. And then each worker will need access to cost information to make informed decisions about their particular work stewardship. Cost accounting and financial management tools and information need to be widely available throughout the Ownerle and the Workerle, but limited according to their use.