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The Three Business Owner Types and Why You Need to Know Who They Are

January 16th, 2016

There are 3 basic types of people involved with business ownership. They are Investors, owner-managers who primarily work “IN” their business so we’ll call then IN-guys, and owner-managers who primarily work “ON” their business so we’ll call them ON-guys. If you want to grow the business advisory side of your firm you need to be an ON-guy yourself and most important, you’ll need to direct your marketing towards ON-guy owner-managers because they will be the ones who offer you the greatest opportunity to create value and therefore be able to capture value.

Investors

Investors provide capital to the entity and (hopefully) receive income in the form of dividends and business value growth. In return for the risk they take they seek an economic benefit from the business that is a passive return in the sense that they do not physically work in the business. Of course, some investors may do some work in or for the business or play an advisory role, and may be paid a fee for their services but the essential difference between an investor and what I call an owner-manager is that investors are not involved with managing the business on a day-to-day basis.

business_owner_types

ON-guys and IN-guys

Owner-managers also provide capital to their business (in some cases this make take the form of sweat equity) but in addition they are responsible for day-to-day management. Some owner-managers, intentionally or otherwise, focus their energy and attention on doing what the business does. That is, they see their role as being primarily that of a technician rather than a business builder. These people are the IN-guys. Other owner-managers primarily focus their energy and attention on the things that need to get done to grow the business. I call these people ON-guys.

There is no question that the potential for improving profitability and driving business value growth comes from the activities associated with the work done by ON-guys guys rather than the IN-guys.

To illustrate this point consider a case everyone on the planet is familiar with: Apple Inc. Apple was founded by Steve Jobs (an ON-guy), Steve Wozniak (an IN-guy) and the lesser known, Ron Wayne (an investor). As it happened, not long after they started the business Wayne sold his equity back to Steve and Woz for $800 which might be remembered as the worst decision in business history but that’s a story for another day even though it highlights an important fact: economic success is fundamentally about choices made in the face of risk and uncertainty, sometimes they’re good choices, sometimes not.

The Jobs-Wozniak team was a perfect fit for the Apple startup. Jobs was the marketing guy, the visionary, the negotiator. Wozniak was the genius technical geek. Jobs could sell ice to Eskimos, he had an amazing eye for design and a sensitivity to what people would buy when they saw it. Wozniak could design a motherboard that would go on to change the world of computing and the world period. If Jobs had been a computer geek the Apple we see today would never have happened simply because he and Wozniak would have both spent their time designing motherboards and disk drives.

While it is clear that the contribution to the business made by Wozniak was epic the main driver of Apple’s success was the role played by Jobs. This is always the way. The greatest contributor to business value growth comes from the people who work ON the business not on the things the business does. Creating and delivering what a business does is essentially IN work and while some people are clearly better at it than others, and are therefore more valuable, they are not the primary drivers of value.

For a startup to succeed you need all three owner types unless one or both of the owner-managers are also able to contribute financial resources or sweat equity by working 80 hour weeks, eating ramen noodles, showering at the gym, and sleeping under their desk.

For an established business to survive you need an IN-guy owner-manager but for a business to grow you must have an ON-guy and an IN-guy helps but is not a necessary requirement because IN-guy talent can be bought.

Small businesses being run by owner-managers of the IN-guy type are far and away the most common. Intentionally or otherwise these people have created a job for themselves and a handful of others rather than a business that has the potential to scale—this is, grow in size and value.

The reason for this is a bad habit that IN-guys get into (and even people with ON-guy talent can fall prey to) in the startup phase of their business journey. Two factors come into play here. First, there is a belief that success comes for hard work and hard work is considered to be putting in long hours “on the tools” so to speak. I agree that working hard is important but what’s more important is to work hard on the things that are aligned with your goal and if that’s to build a business that works you won’t achieve that by working on the tools.

The second factor at play concerns the capitalization of the business. Many small businesses are started on a shoe-string budget and because they’re under-capitalized the founder(s) need to (a) save costs by not hiring help or hiring idiots who are cheap, and (b) this leads to themselves working long hours doing the technical work and fixing the problems left by their idiot employees to pay the bills. The more they work IN the business the less time and attention they can give to the ON things that grow it and so they find themselves caught in a vicious circle of activity that’s producing limited results that are short term in nature.

This is not a mute point. The IN-guys enjoy the benefits of self-employment but at the end of they day they earn what they would otherwise have to pay someone to do the technical work they do in the business. This is a critically important point. The greater the proportion of your time you spend working IN your business the closer your earning capacity will be to whatever you would need to pay someone to do what you do.

More importantly, the ONLY way you can increase your income is to work harder, as in more hours, and even then there will be an absolute upper limit to your earning capacity. Jobs didn’t create the most valuable company in the world by simply working harder. He did it by working harder at working smarter and by surrounding himself with very smart people who’s skill he was able to leverage. This is what working ON a business is all about. Essentially it’s about achieving synergy from from a group of people with diverse skills.

You may have noticed when I referred to IN-guys above I only referenced small businesses not small and mid-sized businesses. That was intentional. Mid-sized and large business all start out as small but they grow because they were designed to grow by someone who worked ON them rather than IN them as a journeyman. One way to think of the distinction is the IN-guy is a blue collar worker for a good part of the day whereas the ON-guy wears a white collar for most (or all) of the day. If your name is printed on your shirt you’re most likely an IN-guy.

The ON-guy earns a salary in contrast to a wage which, if it reflects the net contribution to the business, should also be higher than a “worker’s” wage. Furthermore, the ON-guy, as an owner, would also benefit from higher rewards that typically accrue to an investor owner, namely significant value growth and passive income from dividends that are distributed after salaries and wages are taken care of. People who create businesses that work have the option not to but and that’s what makes them valuable (and saleable) because they now appeal to investor-owners as well as owner-managers and offer significant potential to scale.

You may argue the IN-guy is also an owner and therefore would be entitled to dividends and value growth and you’d be right but the reality is significant profitability over and above the IN-guy’s wage is rare and as a consequence significant growth in the value of the business is unlikely.

There is another very important point that needs to be made here and that is for a business to grow it needs to have access to financial resources to fund the growth. Small business rely very heavily on capital contributed by the owner and perhaps family and friends supplemented by borrowings.

However, there is a limit to how much debt and equity a business can raise so a critical source of funds for growth must come from retained earnings. Retained earnings, is profit that is not distributed to owners but is used to finance the growth of the business. Businesses that are run by IN-guys tend not to generate much profit over and above the value of the owner’s work contribution so they have limited access to growth funds.

This is where the vicious circle of mediocrity or failure comes into play. In an attempt to make more money the IN-guy borrows as much money as possible to fund growth or worse, his or her lifestyle, this gets the business into debt that has to be serviced and exposes it to higher financial risk which can become a life-and-death situation if the economy slows down or competition from rivals increases.

Before you know it you’re working for your creditors and providing an income stream for your employees. You get what’s left over. This turns out to be not much fun and soon enough people get sick of it. But it doesn’t have to be like that.

Small businesses do not have anywhere near the same access to debt and equity capital that their large counterparts do and their ability to raise funds will be due in part to their past and projected growth profile, their profitability, and their capital structure. Each of these things are financial management issues.

There are many things that need to be in place for a business to be great but a necessary condition is for someone in a position of significant authority in the business to have a solid understanding of the basics of sound financial management. Please note that I used the phrase: “someone in a position of significant authority” to make the point that the owner-manager does not have to be a financial wizard but s/he does need to have a solid understanding of the basics so s/he can rely on a trusted specialist to attend to the detail.

A QUICK PS to the Post

This is a draft of part of a chapter from a book I’m writing on Financial Management for SMEs that accountants who want to develop their advisory practice may care to white label and give to their SME clients and prospects. It’s being written in a way that positions an accountant as a logical and valuable partner in the process of business profit improvement and value growth. I’d love to hear your thoughts – email me at ric.payne@principa.net.

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