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Deciding on a compensation package - Q & A

John calls in from Iowa to ask the Sloans how to develop some sort of fair compensation package or payment for someone who handles marketing and marketing strategy for his business.

Rich Sloan: We're going to Iowa.  Is it Wauken, Iowa, John?  Is that right?

John:   Waukon.

Rich Sloan:  Waukon, W-A-U-K-O-N.

John:   Yeah.  Yeah.  Northeast corner.

Rich Sloan:  I love it.  How can we help?

John:    We got a startup company in an early growth stage, and we're trying to determine a fair yet financially safe compensation package based on overall sales for someone we may want or need to help promote and market the new product.

Rich Sloan:  Okay.  You want --

John:   Our new product.

Rich Sloan:  You want to hire someone to do the marketing?

John:   Well, we were launching a new invention.

Rich Sloan:  Right.

John:    And this gentleman, I found him out in Ohio, and he's helping us do some videos and marketing things on our website, see.  And he wrote an instructional manual, and he produced a CD for us.

Rich Sloan:  Okay.

John:    And he indicated he would like to come on board, not as a member of the LLC per se, but whatever he does, he wants to be compensated based on the overall sales of the entire company.

Rich Sloan:  Yeah.

John:    And we're trying to figure out some fair thing to develop for him that would cover us to be (unintelligible) --

Rich Sloan:  Well, what do you think, Jeff?

Jeff Sloan:  Well, let me ask you, John.  This would be related to a specific -- a single product that the company would be selling?

John:   Yes.

Jeff Sloan:  Not to sales overall of the company?  Is that --

John:   Well, we just have the one product.

Jeff Sloan:  The one product.

John:   The one that we're launching.

Jeff Sloan:  Okay.  Well, one way that you can -- you know, there's a lot of different ways to do this.  This is very entrepreneurial.  There's a lot of different ways to do it.  One way to do it is to provide him with a royalty off the net sales of the product.  Do you think that might work?

John:   Well, possibly.  That's one question we have or have been debating is how to determine net sales that he would feel comfortable as true net.  You know, there's a lot of financial finagling going on.

Jeff Sloan:  Yeah.  Here's the way you do that.  It's at the net sales level, not at the net revenue level.  So it doesn't have anything to do with operating expenses of the company.  So you have no issue with respect to other salaries or anything else impacting the number which you use to figure his royalty amount on.  So there is a relatively standard definition for net sales out there.  And it's basically the gross sales, the total revenue that comes in from sales of the product, minus things like the cost to manufacture the product.

John:    Right.

Jeff Sloan:  The cost to ship the product.  Typically there's about a 5 percent amount put in there for marketing, and typically there's about a 2 percent amount put in there for returns.  So you take those numbers, you subtract them off from the gross sales and you get a net sales figure.  Now there's lots of ways to massage the net sales figure, too, but the main concern for someone receiving a royalty based on net sales, you want to make sure that operating expenses of the business are not included in the calculation.

John:   Huh.  Okay.

Jeff Sloan:  So do you understand the distinction?  So again, you take that gross sales number.  That's the total amount you've received --

John:   Right.

Jeff Sloan: -- from the sales of that product.

John:   Right.

Jeff Sloan:  Subtract off your cost to manufacture it, your cost to distribute it -- ship it, basically, get it to the customer, get it to wherever -- whoever your customer is, whether it's at the retail level or the customer level.  Take off the cost of distribution.

John:   Right.

Jeff Sloan: Take off the small agreed-upon number of percentage of returns.

John:   Uh-huh.

Jeff Sloan: And some margin for marketing and whatever else may be appropriate as long as it can be specific.

John:   Uh-huh.

Jeff Sloan:  But that generally will give you a net sales figure on which you can figure a standard royalty amount.  Now in the world of inventing, an inventor would be paid anywhere from a 5 to 10 percent royalty typically on the net sales amount.

John:   Right.  Right.  Right.

Jeff Sloan:  So that gives you some benchmarks on how to do it.

John:   Well, that's -- yeah, that's excellent.  That's very interesting.

Rich Sloan:  John, we're going to move on to another caller.  We hope that that strategy --

John:   Thank you. 

Rich Sloan:  -- meets your needs.  Thanks a lot.

John:    Thank you very much.